[Federal Register Volume 60, Number 244 (Wednesday, December 20, 1995)]
[Rules and Regulations]
[Pages 65553-65566]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30617]



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DEPARTMENT OF THE TREASURY
26 CFR Parts 1, 301 and 602

[TD 8632]
RIN 1544-AM00


Section 482 Cost Sharing Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to qualified 
cost sharing arrangements under section 482 of the Internal Revenue 
Code. These regulations reflect changes to section 482 made by the Tax 
Reform Act of 1986, and provide guidance to revenue agents and 
taxpayers implementing the changes.

DATES: These regulations are effective January 1, 1996.
    These regulations are applicable for taxable years beginning on or 
after January 1, 1996.

FOR FURTHER INFORMATION CONTACT: Lisa Sams of the Office of Associate 
Chief Counsel (International), IRS (202) 622-3840 (not a toll-free 
number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1364. Responses to these collections of information 
are required to determine whether an intangible development arrangement 
is a qualified cost sharing arrangement and who are the participants in 
such arrangement.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    The estimated average annual burden per recordkeeper is 8 hours. 
The estimated average annual burden per respondent is 0.5 hour.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, 
DC 20224, and to the Office of Management and Budget, Attn: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books and records relating to these collections of information must 
be retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 482 was amended by the Tax Reform Act of 1986, Public Law 
99-514, 100 Stat. 2085, 2561, et. seq. (1986-3 C.B. (Vol. 1) 1, 478). 
On January 30, 1992, a notice of proposed rulemaking concerning the 
section 482 amendment in the context of cost sharing was published in 
the Federal Register (INTL-0372-88, 57 FR 3571).
    Written comments were received with respect to the notice of 
proposed rulemaking, and a public hearing was held on August 31, 1992. 
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 (which contain the cost sharing 
regulations as in effect since 1968) are removed.

Explanation of Provisions

Introduction

    The Tax Reform Act of 1986 (the Act) amended section 482 to require 
that consideration for intangible property transferred in a controlled 
transaction be commensurate with the income attributable to the 
intangible. The Conference Committee report to the Act indicated that 
in revising section 482, Congress did not intend to preclude the use of 
bona fide research and development cost sharing arrangements as an 
appropriate method of allocating income attributable to intangibles 
among related parties. The Conference Committee report stated, however, 
that in order for cost sharing arrangements to produce results 
consistent with the commensurate-with-income standard, (a) a cost 
sharer should be expected to bear its portion of all research and 
development costs, on unsuccessful as well as successful products, 
within an appropriate product area, and the costs of research and 
development at all relevant development stages should be shared, (b) 
the allocation of costs generally should be proportionate to profit as 
determined before deduction for research and development, and (c) to 
the extent that one party contributes funds toward research and 
development at a significantly earlier point in time than another (or 
is otherwise putting its funds at risk to a greater extent than the 
other) that party should receive an appropriate return on its 
investment. See H.R. Rep. 99-281, 99th Cong., 2d Sess. (1986) at II-
638. 

[[Page 65554]]

    The Conference Committee report to the Act recommended that the IRS 
conduct a comprehensive study and consider whether the regulations 
under section 482 (issued in 1968) should be modified in any respect.

The White Paper

    In response to the Conference Committee's directive, the IRS and 
the Treasury Department issued a study of intercompany pricing [Notice 
88-123 (1988-2 C.B. 458)] on October 18, 1988 (the White Paper). The 
White Paper suggested that most bona fide cost sharing arrangements 
should have certain provisions. For example, the White Paper stated 
that most product areas covered by cost sharing arrangements should be 
within three-digit Standard Industrial Classification codes, that most 
participants should be assigned exclusive geographic rights in 
developed intangibles (and should predict benefits and divide costs 
accordingly) and that marketing intangibles should be excluded from 
bona fide cost sharing arrangements.
    Comments on the White Paper indicated that, in practice, there was 
a great deal of variety in the terms of bona fide cost sharing 
arrangements, and that if the White Paper's suggestions were 
incorporated in regulations, the regulations would unduly restrict the 
availability of cost sharing.

The 1992 Proposed Regulations

    The IRS issued proposed cost sharing regulations on January 30, 
1992 (INTL-0372-88, 57 FR 3571). In general, the proposed regulations 
allowed more flexibility than anticipated by the White Paper, relying 
on anti-abuse tests rather than requiring standard cost sharing 
provisions.
    The proposed regulations stated that in order to be qualified, a 
cost sharing arrangement had to meet the following five requirements: 
(1) the arrangement had to have two or more eligible participants, (2) 
the arrangement had to be recorded in writing contemporaneously with 
the formation of the cost sharing arrangement, (3) the eligible 
participants had to share the costs and risks of intangible development 
in return for a specified interest in any intangible produced, (4) the 
arrangement had to reflect a reasonable effort by each eligible 
participant to share costs and risks in proportion to anticipated 
benefits from using developed intangibles, and (5) the arrangement had 
to meet certain administrative requirements. The key requirements were 
that participants had to be eligible and that costs and risks had to be 
proportionate to benefits.
    Under the proposed regulations, only a controlled taxpayer that 
would use developed intangibles in the active conduct of its trade or 
business was eligible to participate in a cost sharing arrangement. 
This requirement was considered necessary to ensure that controlled 
foreign entities were not established simply to participate in cost 
sharing arrangements without performing any other meaningful function, 
and to ensure that each participant's share of anticipated benefits was 
measurable.
    The proposed regulations allowed costs to be divided based on any 
measurement that would reasonably predict cost sharing benefits (e.g., 
anticipated units of production or anticipated sales). However, the 
basis for measuring anticipated benefits and dividing costs was checked 
by a cost-to-operating-income ratio. The method for dividing costs was 
presumed to be unreasonable if a U.S. participant's ratio of shared 
costs to operating income attributable to developed intangibles was 
grossly disproportionate to the cost-to-operating-income ratio of the 
other participants.
    If a U.S. participant's cost-to-operating-income ratio was not 
grossly disproportionate, a section 482 allocation could still be made 
under three circumstances: (a) if the cost-to-operating-income ratio 
was disproportionate (allocation of costs), (b) if the pool of costs 
shared was too broad or too narrow, so that the U.S. participant was 
paying for research that it would not use (allocation of costs), or (c) 
if the cost-to-operating-income ratio was substantially 
disproportionate, such that a transfer of an intangible could be deemed 
to have occurred (allocation of income).
    Under the proposed regulations, the IRS could also make an 
allocation of income to reflect a buy-in or buy-out event, that is, a 
transfer of an intangible that could occur, for example, when a 
participant joined or left a cost sharing arrangement.

Comments on the 1992 Proposed Regulations

    The 1992 proposed cost sharing regulations were generally well 
received. However, there were five areas of particular concern to 
commenters. The first was the mechanical use of cost-to-operating-
income ratios as a standard for measuring the reasonableness of an 
effort to share costs in proportion to anticipated benefits. Commenters 
noted that operating income attributable to developed intangibles was 
difficult to measure, and that other bases for measuring benefits might 
produce more reliable results. Commenters also believed that the ratios 
might be overused, leading to adjustments to costs in every year, and 
to many deemed transfers of intangibles. In addition, commenters stated 
that the ratios did not provide any certainty that a cost sharing 
arrangement would not be disregarded, since a ``grossly 
disproportionate'' ratio was not numerically defined.
    The second area of concern was the eligible participant 
requirement. Commenters argued that separate research entities (with no 
separate active trade or business) should be allowed to participate in 
cost sharing arrangements, as should marketing affiliates. Commenters 
also argued that transfers of intangibles to unrelated entities should 
not disqualify a participant, and that foreign-to-foreign transfers 
should not necessarily be monitored. Some comments also stated that 
controlled entities should be able to participate even if their cost 
sharing payments would be characterized differently for purposes of 
foreign law.
    The third area of concern was the regulations' requirement that 
every participant be able to benefit from every intangible developed 
under a cost sharing arrangement. Commenters stated that the 
regulations should allow both single-product cost sharing arrangements 
and umbrella cost sharing arrangements (i.e., cost sharing arrangements 
under which a broad category of a controlled group's research and 
development would be covered).
    The fourth area of concern was the buy-in and buy-out rules. There 
were some suggestions for clarifying and simplifying the rules. For 
example, comments urged that the regulations provide that one 
participant's abandonment of its rights would not necessarily confer 
benefits on the other participants, and that a new participant need not 
always make a buy-in payment when joining a cost sharing arrangement. 
Suggestions for simplifying the rules generally consisted of proposed 
safe harbors for valuing intangibles.
    The final general area of concern was the administrative 
requirements. Several commenters suggested that annual adjustments to 
the method used to share costs should not be required. Commenters also 
suggested that taxpayers not be required to attach their cost sharing 
arrangements to their returns, and that the time period for producing 
records be increased.
    In addition to these general areas of concern, commenters noted 
that there should be more guidance about when the IRS would deem a cost 
sharing 

[[Page 65555]]
arrangement to exist. Commenters also argued that existing cost sharing 
arrangements should be grandfathered, or that there should be a longer 
transition period. Commenters suggested that financial accounting rules 
be used to calculate costs to be shared, and that the IRS address the 
impact of currency fluctuations on the cost-to-operating-income ratios. 
Finally, commenters asked that the regulations clarify that a cost 
sharing arrangement would not be deemed to create a partnership or a 
U.S. trade or business.

The Final Regulations

    Without fundamentally altering the policies of the 1992 proposed 
regulations, the final regulations reflect numerous modifications in 
response to the comments described above. They also reflect the 
approach of the final section 482 regulations relating to transfers of 
tangible and intangible property.
    Section 1.482-7(a)(1) defines a cost sharing arrangement as an 
agreement for sharing costs in proportion to reasonably anticipated 
benefits from the individual exploitation of interests in the 
intangibles that are developed. In order to claim the benefits of the 
safe harbor, a taxpayer must also satisfy certain formal requirements 
(enumerated in Sec. 1.482-7(b)). The district director may apply the 
cost sharing rules to any arrangement that in substance constitutes a 
cost sharing arrangement, notwithstanding any failure to satisfy 
particular requirements of the safe harbor. It is further provided that 
a qualified cost sharing arrangement, or an arrangement treated in 
substance as such, will not be treated as a partnership. (A 
corresponding provision is added to Sec. 301.7701-3 pertaining to the 
definition of a partnership.) Neither will a foreign participant be 
treated as engaged in a trade or business within the United States 
solely by virtue of its participation in such an arrangement.
    Section 1.482-7(a)(2) restates the general rule of cost sharing in 
a manner intended to emphasize its limitation on allocations: no 
section 482 allocation will be made with respect to a qualified cost 
sharing arrangement, except to make each controlled participant's share 
of the intangible development costs equal to its share of reasonably 
anticipated benefits.
    Section 1.482-7(b) contains the requirements for a qualified cost 
sharing arrangement. This provision substantially tracks the proposed 
regulations. A modification was made in the second requirement which 
now directs that the arrangement provide a method to calculate each 
controlled participant's share of intangible development costs, based 
on factors that can reasonably be expected to reflect anticipated 
benefits. The new standard is intended to ensure that cost sharing 
arrangements will not be disregarded by the IRS as long as the factors 
upon which an estimate of benefits was based were reasonable, even if 
the estimate proved to be inaccurate.
    Section 1.482-7(b)(4) requires that a cost sharing arrangement be 
set forth in writing and contain a number of specified provisions, 
including the interest that each controlled participant will receive in 
any intangibles developed pursuant to the arrangement. The intangibles 
developed under a cost sharing arrangement are referred to as the 
``covered intangibles.'' It is possible that the research activity 
undertaken may result in development of intangible property that was 
not foreseen at the inception of the cost sharing arrangement; any such 
property is also included within the definition of the term covered 
intangibles. The prescriptive rules in relation to the scope of the 
intangible development area under the proposed regulations are 
eliminated in favor of a flexible definition that encompasses any 
research and development actually undertaken under the cost sharing 
arrangement.
    Section 1.482-7(c) provides rules for being a participant in a 
qualified cost sharing arrangement. Unlike the proposed regulations, 
the final regulations permit participation by unrelated persons, which 
are referred to as ``uncontrolled participants.'' Controlled taxpayers 
may be participants, referred to as ``controlled participants,'' if 
they satisfy the conditions set forth in these rules. These 
qualification rules replace the proposed regulations' concept of 
``eligible participant.'' The tax treatment of controlled taxpayers 
that do not qualify as controlled participants provided in Sec. 1.482-
7(c)(4) essentially tracks the treatment provided for ineligible 
participants under the proposed regulations.
    The requirements for being a controlled participant are basically 
the same as in the proposed regulations. In particular, a controlled 
participant must use or reasonably expect to use covered intangibles in 
the active conduct of a trade or business. Thus, an entity that chiefly 
provides services (e.g., as a contract researcher) may not be a 
controlled participant. These provisions are necessary for the reason 
that they are necessary to the proposed regulations: to prevent foreign 
controlled entities from being established simply to participate in 
cost sharing arrangements. In accordance with Sec. 1.482-7(c)(4) 
mentioned above, service entities (such as contract researchers) may 
furnish research and development services to the members of a qualified 
cost sharing arrangement, with the appropriate consideration for such 
assistance in the research and development undertaken in the intangible 
development area being governed by the rules in Sec. 1.482- 
4(f)(3)(iii) (Allocations with respect to assistance provided to the 
owner). In the case of a controlled research entity, the appropriate 
arm's length compensation would generally be determined under the 
principles of Sec. 1.482-2(b) (Performance of services for another). 
Each controlled participant would be deemed to incur as part of its 
intangible development costs a share of such compensation equal to its 
share of reasonably anticipated benefits.
    As under the proposed regulations, the activity of another person 
may be attributed to a controlled taxpayer for purposes of meeting the 
active conduct requirement. However, modified language is adopted to be 
more precise concerning the intended requirements for attribution. 
These requirements were phrased in the proposed regulations as bearing 
the risk and receiving the benefits of the attributed activity. Under 
the final regulations, the attribution will be made only in cases in 
which the controlled taxpayer exercises substantial managerial and 
operational control over the attributed activities.
    As under the proposed regulations, a principal purpose to use cost 
sharing to accomplish a transfer or license of covered intangibles to 
uncontrolled or controlled taxpayers will defeat satisfaction of the 
active conduct requirement. However, a principal purpose will not be 
implied where there are legitimate business reasons for subsequently 
licensing covered intangibles.
    The subgroup rules of the proposed regulations are eliminated. 
Their major purpose is accomplished by a simpler provision (see the 
discussion of Sec. 1.482-7(h)). In addition, the final regulations 
treat all members of a consolidated group as a single participant.
    Section 1.482-7(d) defines intangible development costs as 
operating expenses other than depreciation and amortization expense, 
plus an arm's length charge for tangible property made available to the 
cost sharing arrangement. Costs to be shared include all costs relating 
to the intangible development area, which, as noted, comprises any 
research actually undertaken under the cost sharing 

[[Page 65556]]
arrangement. As under the proposed regulations, the district director 
may adjust the pool of costs shared in order to properly reflect costs 
that relate to the intangible development area.
    Section 1.482-7(e) defines anticipated benefits as additional 
income generated or costs saved by the use of covered intangibles. The 
pool of benefits may also be adjusted in order to properly reflect 
benefits that relate to the intangible development area.
    Section 1.482-7(f) governs cost allocations by the district 
director in order to make a controlled participant's share of costs 
equal to its share of reasonably anticipated benefits. Anticipated 
benefits of uncontrolled participants will be excluded from anticipated 
benefits in calculating the benefits shares of controlled participants. 
A share of reasonably anticipated benefits will be determined using the 
most reliable estimate of benefits. This rule echoes the best method 
rule for determining the most reliable measure of an arm's length 
result under Sec. 1.482-1(c).
    The reliability of an estimate of benefits principally depends on 
two factors: the reliability of the basis for measuring benefits used 
and the reliability of the projections used. The cost-to-operating-
income ratio used in the proposed regulations to check the 
reasonableness of an effort to share costs in proportion to anticipated 
benefits has not been included in the final regulations. Rather, the 
final regulations provide that an allocation of costs or income may be 
made if the taxpayer did not use the most reliable estimate of 
benefits, which depends on the facts and circumstances of each case.
    Section 1.482-7(f)(3)(ii) provides that in estimating a controlled 
participant's share of benefits, the most reliable basis for measuring 
anticipated benefits must be used, taking into account the factors set 
forth in Sec. 1.482-1(c)(2)(ii). The measurement basis used must be 
consistent for all controlled participants. The regulations provide 
that benefits may be measured directly or indirectly. In addition, 
regardless of whether a direct or indirect basis of measurement is 
employed, it may be necessary to make adjustments to account for 
material differences in the activities that controlled participants 
perform in connection with exploitation of covered intangibles, such as 
between wholesale and retail distribution.
    Section 1.482-7(f)(3)(iii) describes the scope of various indirect 
bases for measuring benefits, such as units, sales, and operating 
profit. Indirect bases other than those enumerated may be employed as 
long as they bear a relationship to benefits.
    Section 1.482-7(f)(3)(iv) discusses projections used to estimate 
benefits. Projections required for this purpose generally include a 
determination of the time period between the inception of the research 
and development and the receipt of benefits, a projection of the time 
over which benefits will be received, and a projection of the benefits 
anticipated for each year in which it is anticipated that the 
intangible will generate benefits. However, the regulations note that 
in certain circumstances, current annual benefit shares may be used in 
lieu of projections.
    Section 1.482-7(f)(3)(iv)(B) states that a significant divergence 
between projected and actual benefit shares may indicate that the 
projections were not reliable. A significant divergence is defined as 
divergence in excess of 20% between projected and actual benefit 
shares. If there is a significant divergence, which is not due to an 
unforeseeable event, then the district director may use actual benefits 
as the most reliable basis for measuring benefits. Conversely, no 
allocation will be made based on a divergence that is not considered 
significant as long as the estimate is made using the most reliable 
basis for measuring benefits.
    For purposes of the 20% test, all non-U.S. controlled participants 
are treated as a single controlled participant in order that a 
divergence by a foreign controlled participant with a very small share 
of the total costs will not necessarily trigger an allocation (section 
1.482-7(f)(3)(iv)(D), Example 8, illustrates this rule). Section 1.482-
7(f)(3)(iv)(B) and (C) notes that adjustments among foreign controlled 
participants will only be made if the adjustment will have a 
substantial U.S. tax impact, for example, under subpart F.
    Section 1.482-7(f)(4) states that cost allocations must be 
reflected for tax purposes in the year in which costs were incurred. 
This reflects a change from the rule in the 1992 proposed regulations, 
which stated that cost allocations would be included in income in the 
taxable year under review, even if the costs to be allocated were 
incurred in a prior taxable year. The purpose of the change was to 
match up cost adjustments with the year to which they relate in 
accordance with the clear reflection of income principle of section 
482.
    Section 1.482-7(g) provides buy-in and buy-out rules that are 
similar to the rules in the proposed regulations. However, some of the 
clarifications suggested by commenters have been incorporated in these 
rules. A ``substantially disproportionate'' cost-to-operating-income 
ratio will no longer trigger an adjustment to income under these rules. 
However, if, after any cost allocations authorized by Sec. 1.482-
7(a)(2), the economic substance of the arrangement is inconsistent with 
the terms of the arrangement over a period of years (for example, 
through a consistent pattern of one controlled participant bearing an 
inappropriately high or low share of the cost of intangible 
development), then the district director may impute an agreement 
consistent with the course of conduct. In that case, one or more of the 
participants would be deemed to own a greater interest in covered 
intangibles than provided under the arrangement, and must receive buy-
in payments from the other participants.
    The rules do not provide safe harbor methods for valuing 
intangibles, but rely on the intangible valuation rules of Secs. 1.482-
1 and 1.482-4 through 1.482-6. To the extent some participants furnish 
a disproportionately greater amount of existing intangibles to the 
arrangement, they must be compensated by royalties by the participants 
who furnish a disproportionately lesser amount of existing intangibles 
to the arrangement. Buy-in payments owed are netted against payments 
owing, and only the net payment is treated as a royalty. No implication 
is intended that netting of cross royalties is permissible outside of 
the qualified cost sharing safe harbor rules.
    Section 1.482-7(h) provides rules regarding the character of 
payments made pursuant to a qualified cost sharing arrangement. Cost 
sharing payments received are generally treated as reductions of 
research and development expense. A net approach is applied to foster 
simplicity and generally preserve the character of items actually 
incurred by a participant to the extent not reimbursed. In addition, 
for purposes of the research credit determined under section 41, cost 
sharing payments among controlled participants will be treated as 
provided for intra-group transactions in Sec. 1.41-8(e). Finally, any 
payment that in substance constitutes a cost sharing payment will be 
treated as such, regardless of its characterization under foreign law. 
This rule is intended to enable foreign entities to participate in cost 
sharing arrangements with U.S. controlled participants even if foreign 
law does not recognize cost sharing. This rule obviated the main reason 
for the subgroup rules which, as noted, have accordingly been 
eliminated. 

[[Page 65557]]

    Section 1.482-7(i) requires that controlled participants must use a 
consistent accounting method for measuring costs and benefits, and must 
translate foreign currencies on a consistent basis. To the extent that 
the accounting method materially differs from U.S. generally accepted 
accounting principles, any such material differences must be 
documented, as provided in Sec. 1.482-7(j)(2)(iv).
    Section 1.482-7(j) provides simplified recordkeeping and reporting 
requirements. It is anticipated that many of the background documents 
necessary for purposes of this section will be kept pursuant to section 
6662(e) and the regulations thereunder.
    Section 1.482-7(k) provides that this regulation is effective for 
taxable years beginning on or after January 1, 1996.
    Section 1.482-7(l) allows a one-year transition period for 
taxpayers to conform their cost sharing arrangements with the 
requirements of the final regulations. A longer period was not 
considered necessary, given the increased flexibility and the reduced 
number of administrative requirements of the final regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and, therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority for part 1 is amended by adding an entry 
for section 1.482-7 to read as follows:

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

    Section 1.482-7 is also issued under 26 U.S.C. 482. * * *
    Par. 2. Section 1.482-0 is amended by:
    1. Removing the entry for Sec. 1.482-7T.
    2. Adding the entry for Sec. 1.482-7 to read as follows:


Sec. 1.482-0  Outline of regulations under 482.

* * * * *

Sec. 1.482-7  Sharing of costs.

    (a) In general.
    (1) Scope and application of the rules in this section.
    (2) Limitation on allocations.
    (3) Cross references.
    (b) Qualified cost sharing arrangement.
    (c) Participant.
    (1) In general.
    (2) Active conduct of a trade or business.
    (i) Trade or business.
    (ii) Active conduct.
    (iii) Examples.
    (3) Use of covered intangibles in the active conduct of a trade 
or business.
    (i) In general.
    (ii) Example.
    (4) Treatment of a controlled taxpayer that is not a controlled 
participant.
    (i) In general.
    (ii) Example.
    (5) Treatment of consolidated group.
    (d(d) Costs.
    (1) Intangible development costs.
    (2) Examples.
    (e) Anticipated benefits.
    (1) Benefits.
    (2) Reasonably anticipated benefits.
    (f) Cost allocations.
    (1) In general.
    (2) Share of intangible development costs.
    (i) In general.
    (ii) Example.
    (3) Share of reasonably anticipated benefits.
    (i) In general.
    (ii) Measure of benefits.
    (iii) Indirect bases for measuring anticipated benefits.
    (A) Units used, produced or sold.
    (B) Sales.
    (C) Operating profit.
    (D) Other bases for measuring anticipated benefits.
    (E) Examples.
    (iv) Projections used to estimate anticipated benefits.
    (A) In general.
    (B) Unreliable projections.
    (C) Foreign-to-foreign adjustments.
    (D) Examples.
    (4) Timing of allocations.
    (g) Allocations of income, deductions or other tax items to 
reflect transfers of intangibles (buy-in).
    (1) In general.
    (2) Pre-existing intangibles.
    (3) New controlled participant.
    (4) Controlled participant relinquishes interests.
    (5) Conduct inconsistent with the terms of a cost sharing 
arrangement.
    (6)Failure to assign interests under a qualified cost sharing 
arrangement.
    (7) Form of consideration.
    (i) Lump sum payments.
    (ii) Installment payments.
    (iii) Royalties.
    (8) Examples.e
    (h) Character of payments made pursuant to a qualified cost 
sharing arrangement.
    (1) In general.
    (2) Examples.
    (i) Accounting requirements.
    (j) Administrative requirements.
    (1) In general.
    (2) Documentation.
    (3) Reporting requirements.
    (k) Effective date.
    (l) Transition rule.
* * * * *
    Par. 3. Section 1.482-7 is added to read as follows:


Sec. 1.482-7  Sharing of costs.

    (a) In general--(1) Scope and application of the rules in this 
section. A cost sharing arrangement is an agreement under which the 
parties agree to share the costs of development of one or more 
intangibles in proportion to their shares of reasonably anticipated 
benefits from their individual exploitation of the interests in the 
intangibles assigned to them under the arrangement. A taxpayer may 
claim that a cost sharing arrangement is a qualified cost sharing 
arrangement only if the agreement meets the requirements of paragraph 
(b) of this section. Consistent with the rules of Sec. 1.482-
1(d)(3)(ii)(B) (Identifying contractual terms), the district director 
may apply the rules of this section to any arrangement that in 
substance constitutes a cost sharing arrangement, notwithstanding a 
failure to comply with any requirement of this section. A qualified 
cost sharing arrangement, or an arrangement to which the district 
director applies the rules of this section, will not be treated as a 
partnership to which the rules of subchapter K apply. See 
Sec. 301.7701-3(e) of this chapter. Furthermore, a participant that is 
a foreign corporation or nonresident alien individual will not be 
treated as engaged in trade or business within the United States solely 


[[Page 65558]]
by reason of its participation in such an arrangement. See generally 
Sec. 1.864-2(a).
    (2) Limitation on allocations. The district director shall not make 
allocations with respect to a qualified cost sharing arrangement except 
to the extent necessary to make each controlled participant's share of 
the costs (as determined under paragraph (d) of this section) of 
intangible development under the qualified cost sharing arrangement 
equal to its share of reasonably anticipated benefits attributable to 
such development, under the rules of this section. If a controlled 
taxpayer acquires an interest in intangible property from another 
controlled taxpayer (other than in consideration for bearing a share of 
the costs of the intangible's development), then the district director 
may make appropriate allocations to reflect an arm's length 
consideration for the acquisition of the interest in such intangible 
under the rules of Secs. 1.482-1 and 1.482-4 through 1.482-6. See 
paragraph (g) of this section. An interest in an intangible includes 
any commercially transferable interest, the benefits of which are 
susceptible of valuation. See Sec. 1.482-4(b) for the definition of an 
intangible.
    (3) Cross references. Paragraph (c) of this section defines 
participant. Paragraph (d) of this section defines the costs of 
intangible development. Paragraph (e) of this section defines the 
anticipated benefits of intangible development. Paragraph (f) of this 
section provides rules governing cost allocations. Paragraph (g) of 
this section provides rules governing transfers of intangibles other 
than in consideration for bearing a share of the costs of the 
intangible's development. Rules governing the character of payments 
made pursuant to a qualified cost sharing arrangement are provided in 
paragraph (h) of this section. Paragraph (i) of this section provides 
accounting requirements. Paragraph (j) of this section provides 
administrative requirements. Paragraph (k) of this section provides an 
effective date. Paragraph (l) provides a transition rule.
    (b) Qualified cost sharing arrangement. A qualified cost sharing 
arrangement must--
    (1) Include two or more participants;
    (2) Provide a method to calculate each controlled participant's 
share of intangible development costs, based on factors that can 
reasonably be expected to reflect that participant's share of 
anticipated benefits;
    (3) Provide for adjustment to the controlled participants' shares 
of intangible development costs to account for changes in economic 
conditions, the business operations and practices of the participants, 
and the ongoing development of intangibles under the arrangement; and
    (4) Be recorded in a document that is contemporaneous with the 
formation (and any revision) of the cost sharing arrangement and that 
includes--
    (i) A list of the arrangement's participants, and any other member 
of the controlled group that will benefit from the use of intangibles 
developed under the cost sharing arrangement;
    (ii) The information described in paragraphs (b)(2) and (b)(3) of 
this section;
    (iii) A description of the scope of the research and development to 
be undertaken, including the intangible or class of intangibles 
intended to be developed;
    (iv) A description of each participant's interest in any covered 
intangibles. A covered intangible is any intangible property that is 
developed as a result of the research and development undertaken under 
the cost sharing arrangement (intangible development area);
    (v) The duration of the arrangement; and
    (vi) The conditions under which the arrangement may be modified or 
terminated and the consequences of such modification or termination, 
such as the interest that each participant will receive in any covered 
intangibles.
    (c) Participant--(1) In general. For purposes of this section, a 
participant is a controlled taxpayer that meets the requirements of 
this paragraph (c)(1) (controlled participant) or an uncontrolled 
taxpayer that is a party to the cost sharing arrangement (uncontrolled 
participant). See Sec. 1.482-1(i)(5) for the definitions of controlled 
and uncontrolled taxpayers. A controlled taxpayer may be a controlled 
participant only if it--
    (i) Uses or reasonably expects to use covered intangibles in the 
active conduct of a trade or business, under the rules of paragraphs 
(c)(2) and (c)(3) of this section;
    (ii) Substantially complies with the accounting requirements 
described in paragraph (i) of this section; and
    (iii) Substantially complies with the administrative requirements 
described in paragraph (j) of this section.
    (2) Active conduct of a trade or business--(i) Trade or business. 
The rules of Sec. 1.367(a)-2T(b)(2) apply in determining whether the 
activities of a controlled taxpayer constitute a trade or business. For 
this purpose, the term controlled taxpayer must be substituted for the 
term foreign corporation.
    (ii) Active conduct. In general, a controlled taxpayer actively 
conducts a trade or business only if it carries out substantial 
managerial and operational activities. For purposes only of this 
paragraph (c)(2), activities carried out on behalf of a controlled 
taxpayer by another person may be attributed to the controlled 
taxpayer, but only if the controlled taxpayer exercises substantial 
managerial and operational control over those activities.
    (iii) Examples. The following examples illustrate this paragraph 
(c)(2):

    Example 1. Foreign Parent (FP) enters into a cost sharing 
arrangement with its U.S. Subsidiary (USS) to develop a cheaper 
process for manufacturing widgets. USS is to receive the right to 
exploit the intangible to make widgets in North America, and FP is 
to receive the right to exploit the intangible to make widgets in 
the rest of the world. However, USS does not manufacture widgets; 
rather, USS acts as a distributor for FP's widgets in North America. 
Because USS is simply a distributor of FP's widgets, USS does not 
use or reasonably expect to use the manufacturing intangible in the 
active conduct of its trade or business, and thus USS is not a 
controlled participant.
    Example 2. The facts are the same as in Example 1, except that 
USS contracts to have widgets it sells in North America made by a 
related manufacturer (that is not a controlled participant) using 
USS' cheaper manufacturing process. USS purchases all the 
manufacturing inputs, retains ownership of the work in process as 
well as the finished product, and bears the risk of loss at all 
times in connection with the operation. USS compensates the 
manufacturer for the manufacturing functions it performs and 
receives substantially all of the intangible value attributable to 
the cheaper manufacturing process. USS exercises substantial 
managerial and operational control over the manufacturer to ensure 
USS's requirements are satisfied concerning the timing, quantity, 
and quality of the widgets produced. USS uses the manufacturing 
intangible in the active conduct of its trade or business, and thus 
USS is a controlled participant.

    (3) Use of covered intangibles in the active conduct of a trade or 
business--(i) In general. A covered intangible will not be considered 
to be used, nor will the controlled taxpayer be considered to 
reasonably expect to use it, in the active conduct of the controlled 
taxpayer's trade or business if a principal purpose for participating 
in the arrangement is to obtain the intangible for transfer or license 
to a controlled or uncontrolled taxpayer.
    (ii) Example. The following example illustrates the absence of such 
a principal purpose:

    Example. Controlled corporations A, B, and C enter into a 
qualified cost sharing arrangement for the purpose of developing a 
new technology. Costs are shared equally 

[[Page 65559]]
among the three controlled taxpayers. A, B, and C have the exclusive 
rights to manufacture and sell products based on the new technology 
in North America, South America, and Europe, respectively. When the 
new technology is developed, C expects to use it to manufacture and 
sell products in most of Europe. However, for sound business 
reasons, C expects to license to an unrelated manufacturer the right 
to use the new technology to manufacture and sell products within a 
particular European country owing to its relative remoteness and 
small size. In these circumstances, C has not entered into the 
arrangement with a principal purpose of obtaining covered 
intangibles for transfer or license to controlled or uncontrolled 
taxpayers, because the purpose of licensing the technology to the 
unrelated manufacturer is relatively insignificant in comparison to 
the overall purpose of exploiting the European market.

    (4) Treatment of a controlled taxpayer that is not a controlled 
participant--(i) In general. If a controlled taxpayer that is not a 
controlled participant (within the meaning of this paragraph (c)) 
provides assistance in relation to the research and development 
undertaken in the intangible development area, it must receive 
consideration from the controlled participants under the rules of 
Sec. 1.482-4(f)(3)(iii) (Allocations with respect to assistance 
provided to the owner). For purposes of paragraph (d) of this section, 
such consideration is treated as an operating expense and each 
controlled participant must be treated as incurring a share of such 
consideration equal to its share of reasonably anticipated benefits (as 
defined in paragraph (f)(3) of this section).
    (ii) Example. The following example illustrates this paragraph 
(c)(4):

    Example. (i) U.S. Parent (USP), one foreign subsidiary (FS), and 
a second foreign subsidiary constituting the group's research arm 
(R+D) enter into a cost sharing agreement to develop manufacturing 
intangibles for a new product line A. USP and FS are assigned the 
exclusive rights to exploit the intangibles respectively in the 
United States and Europe, where each presently manufactures and 
sells various existing product lines. R+D, whose activity consists 
solely in carrying out research for the group, is assigned the 
rights to exploit the new technology in Asia, where no group member 
presently operates, but which is reliably projected to be a major 
market for product A. R+D will license the Asian rights to an 
unrelated third party. It is reliably projected that the shares of 
reasonably anticipated benefits of USP and FS (i.e., not taking R+D 
into account) will be 66 \2/3\% and 33 \1/3\%, respectively. The 
parties' agreement provides that USP and FS will reimburse 40% and 
20%, respectively, of the intangible development costs incurred by 
R+D with respect to the new intangible.
    (ii) R+D does not qualify as a controlled participant within the 
meaning of paragraph (c) of this section. Therefore, R+D is treated 
as a service provider for purposes of this section and must receive 
arm's length consideration for the assistance it is deemed to 
provide to USP and FS, under the rules of Sec. 1.482-4(f)(3)(iii). 
Such consideration must be treated as intangible development costs 
incurred by USP and FS in proportion to their shares of reasonably 
anticipated benefits (i.e., 66 \2/3\% and 33 \1/3\%, respectively). 
R+D will not be considered to bear any share of the intangible 
development costs under the arrangement.
    (iii) The Asian rights nominally assigned to R+D under the 
agreement must be treated as being held by USP and FS in accordance 
with their shares of the intangible development costs (i.e., 66 \2/
3\% and 33 \1/3\%, respectively). See paragraph (g)(6) of this 
section. Thus, since under the cost sharing agreement the Asian 
rights are owned by R+D, the district director may make allocations 
to reflect an arm's length consideration owed by R+D to USP and FS 
for these rights under the rules of Secs. 1.482-1 and 1.482-4 
through 1.482-6.

    (5) Treatment of consolidated group. For purposes of this section, 
all members of the same affiliated group (within the meaning of section 
1504(a)) that join in the filing of a consolidated return for the 
taxable year under section 1501 shall be treated as one taxpayer.
    (d) Costs--(1) Intangible development costs. For purposes of this 
section, a controlled participant's costs of developing intangibles for 
a taxable year mean all of the costs incurred by that participant 
related to the intangible development area, plus all of the cost 
sharing payments it makes to other controlled and uncontrolled 
participants, minus all of the cost sharing payments it receives from 
other controlled and uncontrolled participants. Costs incurred related 
to the intangible development area consist of the following items: 
operating expenses as defined in Sec. 1.482-5(d)(3), other than 
depreciation or amortization expense, plus (to the extent not included 
in such operating expenses, as defined in Sec. 1.482-5(d)(3)) the 
charge for the use of any tangible property made available to the 
qualified cost sharing arrangement. If tangible property is made 
available to the qualified cost sharing arrangement by a controlled 
participant, the determination of the appropriate charge will be 
governed by the rules of Sec. 1.482-2(c) (Use of tangible property). 
Intangible development costs do not include the consideration for the 
use of any intangible property made available to the qualified cost 
sharing arrangement. See paragraph (g)(2) of this section. If a 
particular cost contributes to the intangible development area and 
other areas or other business activities, the cost must be allocated 
between the intangible development area and the other areas or business 
activities on a reasonable basis. In such a case, it is necessary to 
estimate the total benefits attributable to the cost incurred. The 
share of such cost allocated to the intangible development area must 
correspond to covered intangibles' share of the total benefits. Costs 
that do not contribute to the intangible development area are not taken 
into account.
    (2) Examples. The following examples illustrate this paragraph (d):

    Example 1. Foreign Parent (FP) and U.S. Subsidiary (USS) enter 
into a qualified cost sharing arrangement to develop a better 
mousetrap. USS and FP share the costs of FP's research and 
development facility that will be exclusively dedicated to this 
research, the salaries of the researchers, and reasonable overhead 
costs attributable to the project. They also share the cost of a 
conference facility that is at the disposal of the senior executive 
management of each company but does not contribute to the research 
and development activities in any measurable way. In this case, the 
cost of the conference facility must be excluded from the amount of 
intangible development costs.
    Example 2. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a qualified cost sharing arrangement to develop a new device. 
USP and FS share the costs of a research and development facility, 
the salaries of researchers, and reasonable overhead costs 
attributable to the project. USP also incurs costs related to field 
testing of the device, but does not include them in the amount of 
intangible development costs of the cost sharing arrangement. The 
district director may determine that the field testing costs are 
intangible development costs that must be shared.

    (e) Anticipated benefits--(1) Benefits. Benefits are additional 
income generated or costs saved by the use of covered intangibles.
    (2) Reasonably anticipated benefits. For purposes of this section, 
a controlled participant's reasonably anticipated benefits are the 
aggregate benefits that it reasonably anticipates that it will derive 
from covered intangibles.
    (f) Cost allocations--(1) In general. For purposes of determining 
whether a cost allocation authorized by paragraph (a)(2) of this 
section is appropriate for a taxable year, a controlled participant's 
share of intangible development costs for the taxable year under a 
qualified cost sharing arrangement must be compared to its share of 
reasonably anticipated benefits under the arrangement. A controlled 
participant's share of intangible development costs is determined under 
paragraph (f)(2) of this section. A controlled participant's share of 
reasonably anticipated benefits under the arrangement is determined 
under paragraph (f)(3) of this section. In 

[[Page 65560]]
determining whether benefits were reasonably anticipated, it may be 
appropriate to compare actual benefits to anticipated benefits, as 
described in paragraph (f)(3)(iv) of this section.
    (2) Share of intangible development costs--(i) In general. A 
controlled participant's share of intangible development costs for a 
taxable year is equal to its intangible development costs for the 
taxable year (as defined in paragraph (d) of this section), divided by 
the sum of the intangible development costs for the taxable year (as 
defined in paragraph (d) of this section) of all the controlled 
participants.
    (ii) Example. The following example illustrates this paragraph 
(f)(2):

    Example. (i) U.S. Parent (USP), Foreign Subsidiary (FS), and 
Unrelated Third Party (UTP) enter into a cost sharing arrangement to 
develop new audio technology. In the first year of the arrangement, 
the controlled participants incur $2,250,000 in the intangible 
development area, all of which is incurred directly by USP. In the 
first year, UTP makes a $250,000 cost sharing payment to USP, and FS 
makes a $800,000 cost sharing payment to USP, under the terms of the 
arrangement. For that year, the intangible development costs borne 
by USP are $1,200,000 (its $2,250,000 intangible development costs 
directly incurred, minus the cost sharing payments it receives of 
$250,000 from UTP and $800,000 from FS); the intangible development 
costs borne by FS are $800,000 (its cost sharing payment); and the 
intangible development costs borne by all of the controlled 
participants are $2,000,000 (the sum of the intangible development 
costs borne by USP and FS of $1,200,000 and $800,000, respectively). 
Thus, for the first year, USP's share of intangible development 
costs is 60% ($1,200,000 divided by $2,000,000), and FS's share of 
intangible development costs is 40% ($800,000 divided by 
$2,000,000).
    (ii) For purposes of determining whether a cost allocation 
authorized by paragraph Sec. 1.482-7(a)(2) is appropriate for the 
first year, the district director must compare USP's and FS's shares 
of intangible development costs for that year to their shares of 
reasonably anticipated benefits. See paragraph (f)(3) of this 
section.

    (3) Share of reasonably anticipated benefits--(i) In general. A 
controlled participant's share of reasonably anticipated benefits under 
a qualified cost sharing arrangement is equal to its reasonably 
anticipated benefits (as defined in paragraph (e)(2) of this section), 
divided by the sum of the reasonably anticipated benefits (as defined 
in paragraph (e)(2) of this section) of all the controlled 
participants. The anticipated benefits of an uncontrolled participant 
will not be included for purposes of determining each controlled 
participant's share of anticipated benefits. A controlled participant's 
share of reasonably anticipated benefits will be determined using the 
most reliable estimate of reasonably anticipated benefits. In 
determining which of two or more available estimates is most reliable, 
the quality of the data and assumptions used in the analysis must be 
taken into account, consistent with Sec. 1.482-1(c)(2)(ii) (Data and 
assumptions). Thus, the reliability of an estimate will depend largely 
on the completeness and accuracy of the data, the soundness of the 
assumptions, and the relative effects of particular deficiencies in 
data or assumptions on different estimates. If two estimates are 
equally reliable, no adjustment should be made based on differences in 
the results. The following factors will be particularly relevant in 
determining the reliability of an estimate of anticipated benefits--
    (A) The reliability of the basis used for measuring benefits, as 
described in paragraph (f)(3)(ii) of this section; and
    (B) The reliability of the projections used to estimate benefits, 
as described in paragraph (f)(3)(iv) of this section.
    (ii) Measure of benefits. In order to estimate a controlled 
participant's share of anticipated benefits from covered intangibles, 
the amount of benefits that each of the controlled participants is 
reasonably anticipated to derive from covered intangibles must be 
measured on a basis that is consistent for all such participants. See 
paragraph (f)(3)(iii)(E), Example 8, of this section. Anticipated 
benefits are measured either on a direct basis, by reference to 
estimated additional income to be generated or costs to be saved by the 
use of covered intangibles, or on an indirect basis, by reference to 
certain measurements that reasonably can be assumed to be related to 
income generated or costs saved. Such indirect bases of measurement of 
anticipated benefits are described in paragraph (f)(3)(iii) of this 
section. A controlled participant's anticipated benefits must be 
measured on the most reliable basis, whether direct or indirect. In 
determining which of two bases of measurement of reasonably anticipated 
benefits is most reliable, the factors set forth in Sec. 1.482-
1(c)(2)(ii) (Data and assumptions) must be taken into account. It 
normally will be expected that the basis that provided the most 
reliable estimate for a particular year will continue to provide the 
most reliable estimate in subsequent years, absent a material change in 
the factors that affect the reliability of the estimate. Regardless of 
whether a direct or indirect basis of measurement is used, adjustments 
may be required to account for material differences in the activities 
that controlled participants undertake to exploit their interests in 
covered intangibles. See Example 6 of paragraph (f)(3)(iii)(E) of this 
section.
    (iii) Indirect bases for measuring anticipated benefits. Indirect 
bases for measuring anticipated benefits from participation in a 
qualified cost sharing arrangement include the following:
    (A) Units used, produced or sold. Units of items used, produced or 
sold by each controlled participant in the business activities in which 
covered intangibles are exploited may be used as an indirect basis for 
measuring its anticipated benefits. This basis of measurement will be 
more reliable to the extent that each controlled participant is 
expected to have a similar increase in net profit or decrease in net 
loss attributable to the covered intangibles per unit of the item or 
items used, produced or sold. This circumstance is most likely to arise 
when the covered intangibles are exploited by the controlled 
participants in the use, production or sale of substantially uniform 
items under similar economic conditions.
    (B) Sales. Sales by each controlled participant in the business 
activities in which covered intangibles are exploited may be used as an 
indirect basis for measuring its anticipated benefits. This basis of 
measurement will be more reliable to the extent that each controlled 
participant is expected to have a similar increase in net profit or 
decrease in net loss attributable to covered intangibles per dollar of 
sales. This circumstance is most likely to arise if the costs of 
exploiting covered intangibles are not substantial relative to the 
revenues generated, or if the principal effect of using covered 
intangibles is to increase the controlled participants' revenues (e.g., 
through a price premium on the products they sell) without affecting 
their costs substantially. Sales by each controlled participant are 
unlikely to provide a reliable basis for measuring benefits unless each 
controlled participant operates at the same market level (e.g., 
manufacturing, distribution, etc.).
    (C) Operating profit. Operating profit of each controlled 
participant from the activities in which covered intangibles are 
exploited may be used as an indirect basis for measuring its 
anticipated benefits. This basis of measurement will be more reliable 
to the extent that such profit is largely attributable to the use of 
covered intangibles, or if the share of profits attributable to the use 
of covered intangibles is expected to be similar for each controlled 
participant. This circumstance is most likely to arise when covered 
intangibles are integral to the activity that generates the profit and 

[[Page 65561]]
the activity could not be carried on or would generate little profit 
without use of those intangibles.
    (D) Other bases for measuring anticipated benefits. Other bases for 
measuring anticipated benefits may, in some circumstances, be 
appropriate, but only to the extent that there is expected to be a 
reasonably identifiable relationship between the basis of measurement 
used and additional income generated or costs saved by the use of 
covered intangibles. For example, a division of costs based on employee 
compensation would be considered unreliable unless there were a 
relationship between the amount of compensation and the expected income 
of the controlled participants from the use of covered intangibles.
    (E) Examples. The following examples illustrate this paragraph 
(f)(3)(iii):

    Example 1. Foreign Parent (FP) and U.S. Subsidiary (USS) both 
produce a feedstock for the manufacture of various high-performance 
plastic products. Producing the feedstock requires large amounts of 
electricity, which accounts for a significant portion of its 
production cost. FP and USS enter into a cost sharing arrangement to 
develop a new process that will reduce the amount of electricity 
required to produce a unit of the feedstock. FP and USS currently 
both incur an electricity cost of X% of its other production costs 
and rates for each are expected to remain similar in the future. How 
much the new process, if it is successful, will reduce the amount of 
electricity required to produce a unit of the feedstock is 
uncertain, but it will be about the same amount for both companies. 
Therefore, the cost savings each company is expected to achieve 
after implementing the new process are similar relative to the total 
amount of the feedstock produced. Under the cost sharing arrangement 
FP and USS divide the costs of developing the new process based on 
the units of the feedstock each is anticipated to produce in the 
future. In this case, units produced is the most reliable basis for 
measuring benefits and dividing the intangible development costs 
because each participant is expected to have a similar decrease in 
costs per unit of the feedstock produced.
    Example 2. The facts are the same as in Example 1, except that 
USS pays X% of its other production costs for electricity while FP 
pays 2X% of its other production costs. In this case, units produced 
is not the most reliable basis for measuring benefits and dividing 
the intangible development costs because the participants do not 
expect to have a similar decrease in costs per unit of the feedstock 
produced. The district director determines that the most reliable 
measure of benefit shares may be based on units of the feedstock 
produced if FP's units are weighted relative to USS' units by a 
factor of 2. This reflects the fact that FP pays twice as much as 
USS as a percentage of its other production costs for electricity 
and, therefore, FP's savings per unit of the feedstock would be 
twice USS's savings from any new process eventually developed.
    Example 3. The facts are the same as in Example 2, except that 
to supply the particular needs of the U.S. market USS manufactures 
the feedstock with somewhat different properties than FP's 
feedstock. This requires USS to employ a somewhat different 
production process than does FP. Because of this difference, it will 
be more costly for USS to adopt any new process that may be 
developed under the cost sharing agreement. In this case, units 
produced is not the most reliable basis for measuring benefit 
shares. In order to reliably determine benefit shares, the district 
director offsets the reasonably anticipated costs of adopting the 
new process against the reasonably anticipated total savings in 
electricity costs.
    Example 4. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a cost sharing arrangement to develop new anesthetic drugs. USP 
obtains the right to use any resulting patent in the U.S. market, 
and FS obtains the right to use the patent in the European market. 
USP and FS divide costs on the basis of anticipated operating profit 
from each patent under development. USP anticipates that it will 
receive a much higher profit than FS per unit sold because drug 
prices are uncontrolled in the U.S., whereas drug prices are 
regulated in many European countries. In this case, the controlled 
taxpayers' basis for measuring benefits is the most reliable.
    Example 5. (i) Foreign Parent (FP) and U.S. Subsidiary (USS) 
both manufacture and sell fertilizers. They enter into a cost 
sharing arrangement to develop a new pellet form of a common 
agricultural fertilizer that is currently available only in powder 
form. Under the cost sharing arrangement, USS obtains the rights to 
produce and sell the new form of fertilizer for the U.S. market 
while FP obtains the rights to produce and sell the fertilizer for 
the rest of the world. The costs of developing the new form of 
fertilizer are divided on the basis of the anticipated sales of 
fertilizer in the participants' respective markets.
    (ii) If the research and development is successful the pellet 
form will deliver the fertilizer more efficiently to crops and less 
fertilizer will be required to achieve the same effect on crop 
growth. The pellet form of fertilizer can be expected to sell at a 
price premium over the powder form of fertilizer based on the 
savings in the amount of fertilizer that needs to be used. If the 
research and development is successful, the costs of producing 
pellet fertilizer are expected to be approximately the same as the 
costs of producing powder fertilizer and the same for both FP and 
USS. Both FP and USS operate at approximately the same market 
levels, selling their fertilizers largely to independent 
distributors.
    (iii) In this case, the controlled taxpayers' basis for 
measuring benefits is the most reliable.
    Example 6. The facts are the same as in Example 5, except that 
FP distributes its fertilizers directly while USS sells to 
independent distributors. In this case, sales of USS and FP are not 
the most reliable basis for measuring benefits unless adjustments 
are made to account for the difference in market levels at which the 
sales occur.
    Example 7. Foreign Parent (FP) and U.S. Subsidiary (USS) enter 
into a cost sharing arrangement to develop materials that will be 
used to train all new entry-level employees. FP and USS determine 
that the new materials will save approximately ten hours of training 
time per employee. Because their entry-level employees are paid on 
differing wage scales, FP and USS decide that they should not divide 
costs based on the number of entry-level employees hired by each. 
Rather, they divide costs based on compensation paid to the entry-
level employees hired by each. In this case, the basis used for 
measuring benefits is the most reliable because there is a direct 
relationship between compensation paid to new entry-level employees 
and costs saved by FP and USS from the use of the new training 
materials.
    Example 8. U.S. Parent (USP), Foreign Subsidiary 1 (FS1) and 
Foreign Subsidiary 2 (FS2) enter into a cost sharing arrangement to 
develop computer software that each will market and install on 
customers' computer systems. The participants divide costs on the 
basis of projected sales by USP, FS1, and FS2 of the software in 
their respective geographic areas. However, FS1 plans for sound 
business reasons not only to sell but also to license the software, 
and FS1's licensing income (which is a percentage of the licensees' 
sales) is not counted in the projected benefits. In this case, the 
basis used for measuring the benefits of each participant is not the 
most reliable because all of the benefits received by participants 
are not taken into account. In order to reliably determine benefit 
shares, FS1's projected benefits from licensing must be included in 
the measurement on a basis that is the same as that used to measure 
its own and the other participants' projected benefits from sales 
(e.g., all participants might measure their benefits on the basis of 
operating profit).

    (iv) Projections used to estimate anticipated benefits--(A) In 
general. The reliability of an estimate of anticipated benefits also 
depends upon the reliability of projections used in making the 
estimate. Projections required for this purpose generally include a 
determination of the time period between the inception of the research 
and development and the receipt of benefits, a projection of the time 
over which benefits will be received, and a projection of the benefits 
anticipated for each year in which it is anticipated that the 
intangible will generate benefits. A projection of the relevant basis 
for measuring anticipated benefits may require a projection of the 
factors that underlie it. For example, a projection of operating 
profits may require a projection of sales, cost of sales, operating 
expenses, and other factors that affect operating profits. If it is 
anticipated that there will be significant variation among controlled 
participants in the timing of their receipt of benefits, and 
consequently 

[[Page 65562]]
benefit shares are expected to vary significantly over the years in 
which benefits will be received, it may be necessary to use the present 
discounted value of the projected benefits to reliably determine each 
controlled participant's share of those benefits. If it is not 
anticipated that benefit shares will significantly change over time, 
current annual benefit shares may provide a reliable projection of 
anticipated benefit shares. This circumstance is most likely to occur 
when the cost sharing arrangement is a long-term arrangement, the 
arrangement covers a wide variety of intangibles, the composition of 
the covered intangibles is unlikely to change, the covered intangibles 
are unlikely to generate unusual profits, and each controlled 
participant's share of the market is stable.
    (B) Unreliable projections. A significant divergence between 
projected benefit shares and actual benefit shares may indicate that 
the projections were not reliable. In such a case, the district 
director may use actual benefits as the most reliable measure of 
anticipated benefits. If benefits are projected over a period of years, 
and the projections for initial years of the period prove to be 
unreliable, this may indicate that the projections for the remaining 
years of the period are also unreliable and thus should be adjusted. 
Projections will not be considered unreliable based on a divergence 
between a controlled participant's projected benefit share and actual 
benefit share if the amount of such divergence for every controlled 
participant is less than or equal to 20% of the participant's projected 
benefit share. Further, the district director will not make an 
allocation based on such divergence if the difference is due to an 
extraordinary event, beyond the control of the participants, that could 
not reasonably have been anticipated at the time that costs were 
shared. For purposes of this paragraph, all controlled participants 
that are not U.S. persons will be treated as a single controlled 
participant. Therefore, an adjustment based on an unreliable projection 
will be made to the cost shares of foreign controlled participants only 
if there is a matching adjustment to the cost shares of controlled 
participants that are U.S. persons. Nothing in this paragraph 
(f)(3)(iv)(B) will prevent the district director from making an 
allocation if the taxpayer did not use the most reliable basis for 
measuring anticipated benefits. For example, if the taxpayer measures 
anticipated benefits based on units sold, and the district director 
determines that another basis is more reliable for measuring 
anticipated benefits, then the fact that actual units sold were within 
20% of the projected unit sales will not preclude an allocation under 
this section.
    (C) Foreign-to-foreign adjustments. Notwithstanding the limitations 
on adjustments provided in paragraph (f)(3)(iv)(B) of this section, 
adjustments to cost shares based on an unreliable projection also may 
be made solely among foreign controlled participants if the variation 
between actual and projected benefits has the effect of substantially 
reducing U.S. tax.
    (D) Examples. The following examples illustrate this paragraph 
(f)(3)(iv):

    Example 1. (i) Foreign Parent (FP) and U.S. Subsidiary (USS) 
enter into a cost sharing arrangement to develop a new car model. 
The participants plan to spend four years developing the new model 
and four years producing and selling the new model. USS and FP 
project total sales of $4 billion and $2 billion, respectively, over 
the planned four years of exploitation of the new model. Cost shares 
are divided for each year based on projected total sales. Therefore, 
USS bears 66\2/3\% of each year's intangible development costs and 
FP bears 33\1/3\% of such costs.
    (ii) USS typically begins producing and selling new car models a 
year after FP begins producing and selling new car models. The 
district director determines that in order to reflect USS' one-year 
lag in introducing new car models, a more reliable projection of 
each participant's share of benefits would be based on a projection 
of all four years of sales for each participant, discounted to 
present value.
    Example 2. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a cost sharing arrangement to develop new and improved 
household cleaning products. Both participants have sold household 
cleaning products for many years and have stable market shares. The 
products under development are unlikely to produce unusual profits 
for either participant. The participants divide costs on the basis 
of each participant's current sales of household cleaning products. 
In this case, the participants' future benefit shares are reliably 
projected by current sales of cleaning products.
    Example 3. The facts are the same as in Example 2, except that 
FS's market share is rapidly expanding because of the business 
failure of a competitor in its geographic area. The district 
director determines that the participants' future benefit shares are 
not reliably projected by current sales of cleaning products and 
that FS's benefit projections should take into account its growth in 
sales.
    Example 4. Foreign Parent (FP) and U.S. Subsidiary (USS) enter 
into a cost sharing arrangement to develop synthetic fertilizers and 
insecticides. FP and USS share costs on the basis of each 
participant's current sales of fertilizers and insecticides. The 
market shares of the participants have been stable for fertilizers, 
but FP's market share for insecticides has been expanding. The 
district director determines that the participants' projections of 
benefit shares are reliable with regard to fertilizers, but not 
reliable with regard to insecticides; a more reliable projection of 
benefit shares would take into account the expanding market share 
for insecticides.
    Example 5. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a cost sharing arrangement to develop new food products, 
dividing costs on the basis of projected sales two years in the 
future. In year 1, USP and FS project that their sales in year 3 
will be equal, and they divide costs accordingly. In year 3, the 
district director examines the participants' method for dividing 
costs. USP and FS actually accounted for 42% and 58% of total sales, 
respectively. The district director agrees that sales two years in 
the future provide a reliable basis for estimating benefit shares. 
Because the differences between USP's and FS's actual and projected 
benefit shares are less than 20% of their projected benefit shares, 
the projection of future benefits for year 3 is reliable.
    Example 6. The facts are the same as in Example 5, except that 
the in year 3 USP and FS actually accounted for 35% and 65% of total 
sales, respectively. The divergence between USP's projected and 
actual benefit shares is greater than 20% of USP's projected benefit 
share and is not due to an extraordinary event beyond the control of 
the participants. The district director concludes that the 
projection of anticipated benefit shares was unreliable, and uses 
actual benefits as the basis for an adjustment to the cost shares 
borne by USP and FS.
    Example 7. U.S. Parent (USP), a U.S. corporation, and its 
foreign subsidiary (FS) enter a cost sharing arrangement in year 1. 
They project that they will begin to receive benefits from covered 
intangibles in years 4 through 6, and that USP will receive 60% of 
total benefits and FS 40% of total benefits. In years 4 through 6, 
USP and FS actually receive 50% each of the total benefits. In 
evaluating the reliability of the participants' projections, the 
district director compares these actual benefit shares to the 
projected benefit shares. Although USP's actual benefit share (50%) 
is within 20% of its projected benefit share (60%), FS's actual 
benefit share (50%) is not within 20% of its projected benefit share 
(40%). Based on this discrepancy, the district director may conclude 
that the participants' projections were not reliable and may use 
actual benefit shares as the basis for an adjustment to the cost 
shares borne by USP and FS.
    Example 8. Three controlled taxpayers, USP, FS1 and FS2 enter 
into a cost sharing arrangement. FS1 and FS2 are foreign. USP is a 
United States corporation that controls all the stock of FS1 and 
FS2. The participants project that they will share the total 
benefits of the covered intangibles in the following percentages: 
USP 50%; FS1 30%; and FS2 20%. Actual benefit shares are as follows: 
USP 45%; FS1 25%; and FS2 30%. In evaluating the reliability of the 
participants' projections, the district director compares these 
actual benefit shares to the projected benefit shares. For this 
purpose, FS1 and FS2 are treated as a single participant. The actual 
benefit share received by USP (45%) is within 20% of its projected 
benefit share 

[[Page 65563]]
(50%). In addition, the non-US participants' actual benefit share (55%) 
is also within 20% of their projected benefit share (50%). 
Therefore, the district director concludes that the participants' 
projections of future benefits were reliable, despite the fact that 
FS2's actual benefit share (30%) is not within 20% of its projected 
benefit share (20%).
    Example 9. The facts are the same as in Example 8. In addition, 
the district director determines that FS2 has significant operating 
losses and has no earnings and profits, and that FS1 is profitable 
and has earnings and profits. Based on all the evidence, the 
district director concludes that the participants arranged that FS1 
would bear a larger cost share than appropriate in order to reduce 
FS1's earnings and profits and thereby reduce inclusions USP 
otherwise would be deemed to have on account of FS1 under subpart F. 
Pursuant to Sec. 1.482-7 (f)(3)(iv)(C), the district director may 
make an adjustment solely to the cost shares borne by FS1 and FS2 
because FS2's projection of future benefits was unreliable and the 
variation between actual and projected benefits had the effect of 
substantially reducing USP's U.S. income tax liability (on account 
of FS1 subpart F income).
    Example 10. (i)(A) Foreign Parent (FP) and U.S. Subsidiary (USS) 
enter into a cost sharing arrangement in 1996 to develop a new 
treatment for baldness. USS's interest in any treatment developed is 
the right to produce and sell the treatment in the U.S. market while 
FP retains rights to produce and sell the treatment in the rest of 
the world. USS and FP measure their anticipated benefits from the 
cost sharing arrangement based on their respective projected future 
sales of the baldness treatment. The following sales projections are 
used:

                                  Sales                                 
                        [In millions of dollars]                        
------------------------------------------------------------------------
                          Year                              USS     FP  
------------------------------------------------------------------------
1997....................................................       5      10
1998....................................................      20      20
1999....................................................      30      30
2000....................................................      40      40
2001....................................................      40      40
2002....................................................      40      40
2003....................................................      40      40
2004....................................................      20      20
2005....................................................      10      10
2006....................................................       5       5
------------------------------------------------------------------------

    (B) In 1997, the first year of sales, USS is projected to have 
lower sales than FP due to lags in U.S. regulatory approval for the 
baldness treatment. In each subsequent year USS and FP are projected 
to have equal sales. Sales are projected to build over the first 
three years of the period, level off for several years, and then 
decline over the final years of the period as new and improved 
baldness treatments reach the market.
    (ii) To account for USS's lag in sales in the first year, the 
present discounted value of sales over the period is used as the 
basis for measuring benefits. Based on the risk associated with this 
venture, a discount rate of 10 percent is selected. The present 
discounted value of projected sales is determined to be 
approximately $154.4 million for USS and $158.9 million for FP. On 
this basis USS and FP are projected to obtain approximately 49.3% 
and 50.7% of the benefit, respectively, and the costs of developing 
the baldness treatment are shared accordingly.
    (iii) (A) In the year 2002 the district director examines the 
cost sharing arrangement. USS and FP have obtained the following 
sales results through the year 2001:

                                  Sales                                 
                        [In millions of dollars]                        
------------------------------------------------------------------------
                          Year                              USS     FP  
------------------------------------------------------------------------
1997....................................................       0      17
1998....................................................      17      35
1999....................................................      25      41
2000....................................................      38      41
2001....................................................      39      41
------------------------------------------------------------------------

    (B) USS's sales initially grew more slowly than projected while 
FP's sales grew more quickly. In each of the first three years of 
the period the share of total sales of at least one of the parties 
diverged by over 20% from its projected share of sales. However, by 
the year 2001 both parties' sales had leveled off at approximately 
their projected values. Taking into account this leveling off of 
sales and all the facts and circumstances, the district director 
determines that it is appropriate to use the original projections 
for the remaining years of sales. Combining the actual results 
through the year 2001 with the projections for subsequent years, and 
using a discount rate of 10%, the present discounted value of sales 
is approximately $141.6 million for USS and $187.3 million for FP. 
This result implies that USS and FP obtain approximately 43.1% and 
56.9%, respectively, of the anticipated benefits from the baldness 
treatment. Because these benefit shares are within 20% of the 
benefit shares calculated based on the original sales projections, 
the district director determines that, based on the difference 
between actual and projected benefit shares, the original 
projections were not unreliable. No adjustment is made based on the 
difference between actual and projected benefit shares.
    Example 11. (i) The facts are the same as in Example 10, except 
that the actual sales results through the year 2001 are as follows:

                                  Sales                                 
                        [In millions of dollars]                        
------------------------------------------------------------------------
                          Year                              USS     FP  
------------------------------------------------------------------------
1997....................................................       0      17
1998....................................................      17      35
1999....................................................      25      44
2000....................................................      34      54
2001....................................................      36      55
------------------------------------------------------------------------

    (ii) Based on the discrepancy between the projections and the 
actual results and on consideration of all the facts, the district 
director determines that for the remaining years the following sales 
projections are more reliable than the original projections:

                                  Sales                                 
                        [In millions of dollars]                        
------------------------------------------------------------------------
                          Year                             USS      FP  
------------------------------------------------------------------------
2002...................................................     36        55
2003...................................................     36        55
2004...................................................     18        28
2005...................................................      9        14
2006...................................................      4.5       7
------------------------------------------------------------------------

    (iii) Combining the actual results through the year 2001 with 
the projections for subsequent years, and using a discount rate of 
10%, the present discounted value of sales is approximately $131.2 
million for USS and $229.4 million for FP. This result implies that 
USS and FP obtain approximately 35.4% and 63.6%, respectively, of 
the anticipated benefits from the baldness treatment. These benefit 
shares diverge by greater than 20% from the benefit shares 
calculated based on the original sales projections, and the district 
director determines that, based on the difference between actual and 
projected benefit shares, the original projections were unreliable. 
The district director adjusts costs shares for each of the taxable 
years under examination to conform them to the recalculated shares 
of anticipated benefits.

    (4) Timing of allocations. If the district director reallocates 
costs under the provisions of this paragraph (f), the allocation must 
be reflected for tax purposes in the year in which the costs were 
incurred. When a cost sharing payment is owed by one member of a 
qualified cost sharing arrangement to another member, the district 
director may make appropriate allocations to reflect an arm's length 
rate of interest for the time value of money, consistent with the 
provisions of Sec. 1.482-2(a) (Loans or advances).
    (g) Allocations of income, deductions or other tax items to reflect 
transfers of intangibles (buy-in)--(1) In general. A controlled 
participant that makes intangible property available to a qualified 
cost sharing arrangement will be treated as having transferred 
interests in such property to the other controlled participants, and 
such other controlled participants must make buy-in payments to it, as 
provided in paragraph (g)(2) of this section. If the other controlled 
participants fail to make such payments, the district director may make 
appropriate allocations, under the provisions of Secs. 1.482-1 and 
1.482-4 through 1.482-6, to reflect an arm's length consideration for 
the transferred intangible property. Further, if a group of controlled 
taxpayers participates in a qualified cost sharing arrangement, any 
change in the controlled participants' interests in covered 
intangibles, whether by reason of entry of a new participant or 
otherwise by reason of transfers (including deemed transfers) of 
interests among existing participants, is a transfer 

[[Page 65564]]
of intangible property, and the district director may make appropriate 
allocations, under the provisions of Secs. 1.482-1 and 1.482-4 through 
1.482-6, to reflect an arm's length consideration for the transfer. See 
paragraphs (g) (3), (4), and (5) of this section. Paragraph (g)(6) of 
this section provides rules for assigning unassigned interests under a 
qualified cost sharing arrangement.
    (2) Pre-existing intangibles. If a controlled participant makes 
pre-existing intangible property in which it owns an interest available 
to other controlled participants for purposes of research in the 
intangible development area under a qualified cost sharing arrangement, 
then each such other controlled participant must make a buy-in payment 
to the owner. The buy-in payment by each such other controlled 
participant is the arm's length charge for the use of the intangible 
under the rules of Secs. 1.482-1 and 1.482-4 through 1.482-6, 
multiplied by the controlled participant's share of reasonably 
anticipated benefits (as defined in paragraph (f)(3) of this section). 
A controlled participant's payment required under this paragraph (g)(2) 
is deemed to be reduced to the extent of any payments owed to it under 
this paragraph (g)(2) from other controlled participants. Each payment 
received by a payee will be treated as coming pro rata out of payments 
made by all payors. See paragraph (g)(8), Example 4, of this section. 
Such payments will be treated as consideration for a transfer of an 
interest in the intangible property made available to the qualified 
cost sharing arrangement by the payee. Any payment to or from an 
uncontrolled participant in consideration for intangible property made 
available to the qualified cost sharing arrangement will be shared by 
the controlled participants in accordance with their shares of 
reasonably anticipated benefits (as defined in paragraph (f)(3) of this 
section). A controlled participant's payment required under this 
paragraph (g)(2) is deemed to be reduced by such a share of payments 
owed from an uncontrolled participant to the same extent as by any 
payments owed from other controlled participants under this paragraph 
(g)(2). See paragraph (g)(8), Example 5, of this section.
    (3) New controlled participant. If a new controlled participant 
enters a qualified cost sharing arrangement and acquires any interest 
in the covered intangibles, then the new participant must pay an arm's 
length consideration, under the provisions of Secs. 1.482-1 and 1.482-4 
through 1.482-6, for such interest to each controlled participant from 
whom such interest was acquired.
    (4) Controlled participant relinquishes interests. A controlled 
participant in a qualified cost sharing arrangement may be deemed to 
have acquired an interest in one or more covered intangibles if another 
controlled participant transfers, abandons, or otherwise relinquishes 
an interest under the arrangement, to the benefit of the first 
participant. If such a relinquishment occurs, the participant 
relinquishing the interest must receive an arm's length consideration, 
under the provisions of Secs. 1.482-1 and 1.482-4 through 1.482-6, for 
its interest. If the controlled participant that has relinquished its 
interest subsequently uses that interest, then that participant must 
pay an arm's length consideration, under the provisions of Secs. 1.482-
1 and 1.482-4 through 1.482-6, to the controlled participant that 
acquired the interest.
    (5) Conduct inconsistent with the terms of a cost sharing 
arrangement. If, after any cost allocations authorized by paragraph 
(a)(2) of this section, a controlled participant bears costs of 
intangible development that over a period of years are consistently and 
materially greater or lesser than its share of reasonably anticipated 
benefits, then the district director may conclude that the economic 
substance of the arrangement between the controlled participants is 
inconsistent with the terms of the cost sharing arrangement. In such a 
case, the district director may disregard such terms and impute an 
agreement consistent with the controlled participants' course of 
conduct, under which a controlled participant that bore a 
disproportionately greater share of costs received additional interests 
in covered intangibles. See Sec. 1.482-1(d)(3)(ii)(B) (Identifying 
contractual terms) and Sec. 1.482- 4(f)(3)(ii) (Identification of 
owner). Accordingly, that participant must receive an arm's length 
payment from any controlled participant whose share of the intangible 
development costs is less than its share of reasonably anticipated 
benefits over time, under the provisions of Secs. 1.482-1 and 1.482-4 
through 1.482-6.
    (6) Failure to assign interests under a qualified cost sharing 
arrangement. If a qualified cost sharing arrangement fails to assign an 
interest in a covered intangible, then each controlled participant will 
be deemed to hold a share in such interest equal to its share of the 
costs of developing such intangible. For this purpose, if cost shares 
have varied materially over the period during which such intangible was 
developed, then the costs of developing the intangible must be measured 
by their present discounted value as of the date when the first such 
costs were incurred.
    (7) Form of consideration. The consideration for an acquisition 
described in this paragraph (g) may take any of the following forms:
    (i) Lump sum payments. For the treatment of lump sum payments, see 
Sec. 1.482-4(f)(5) (Lump sum payments);
    (ii) Installment payments. Installment payments spread over the 
period of use of the intangible by the transferee, with interest 
calculated in accordance with Sec. 1.482-2(a) (Loans or advances); and
    (iii) Royalties. Royalties or other payments contingent on the use 
of the intangible by the transferee.
    (8) Examples. The following examples illustrate allocations 
described in this paragraph (g):

    Example 1. In year one, four members of a controlled group enter 
into a cost sharing arrangement to develop a commercially feasible 
process for capturing energy from nuclear fusion. Based on a 
reliable projection of their future benefits, each cost sharing 
participant bears an equal share of the costs. The cost of 
developing intangibles for each participant with respect to the 
project is approximately $1 million per year. In year ten, a fifth 
member of the controlled group joins the cost sharing group and 
agrees to bear one-fifth of the future costs in exchange for part of 
the fourth member's territory reasonably anticipated to yield 
benefits amounting to one-fifth of the total benefits. The fair 
market value of intangible property within the arrangement at the 
time the fifth company joins the arrangement is $45 million. The new 
member must pay one-fifth of that amount (that is, $9 million total) 
to the fourth member from whom it acquired its interest in covered 
intangibles.
    Example 2. U.S. Subsidiary (USS), Foreign Subsidiary (FS) and 
Foreign Parent (FP) enter into a cost sharing arrangement to develop 
new products within the Group X product line. USS manufactures and 
sells Group X products in North America, FS manufactures and sells 
Group X products in South America, and FP manufactures and sells 
Group X products in the rest of the world. USS, FS and FP project 
that each will manufacture and sell a third of the Group X products 
under development, and they share costs on the basis of projected 
sales of manufactured products. When the new Group X products are 
developed, however, USS ceases to manufacture Group X products, and 
FP sells its Group X products to USS for resale in the North 
American market. USS earns a return on its resale activity that is 
appropriate given its function as a distributor, but does not earn a 
return attributable to exploiting covered intangibles. The district 
director determines that USS' share of the costs (one-third) was 
greater than its share of reasonably anticipated benefits (zero) and 
that it has transferred an interest in the intangibles for which it 
should receive a payment from FP, whose share of the 

[[Page 65565]]
intangible development costs (one-third) was less than its share of 
reasonably anticipated benefits over time (two-thirds). An 
allocation is made under Secs. 1.482-1 and 1.482-4 through 1.482-6 
from FP to USS to recognize USS' one-third interest in the 
intangibles. No allocation is made from FS to USS because FS did not 
exploit USS' interest in covered intangibles.
    Example 3. U.S. Parent (USP), Foreign Subsidiary 1 (FS1), and 
Foreign Subsidiary 2 (FS2) enter into a cost sharing arrangement to 
develop a cure for the common cold. Costs are shared USP-50%, FS1-
40% and FS2-10% on the basis of projected units of cold medicine to 
be produced by each. After ten years of research and development, 
FS1 withdraws from the arrangement, transferring its interests in 
the intangibles under development to USP in exchange for a lump sum 
payment of $10 million. The district director may review this lump 
sum payment, under the provisions of Sec. 1.482-4(f)(5), to ensure 
that the amount is commensurate with the income attributable to the 
intangibles.
    Example 4. (i) Four members A, B, C, and D of a controlled group 
form a cost sharing arrangement to develop the next generation 
technology for their business. Based on a reliable projection of 
their future benefits, the participants agree to bear shares of the 
costs incurred during the term of the agreement in the following 
percentages: A 40%; B 15%; C 25%; and D 20%. The arm's length 
charges, under the rules of Secs. 1.482-1 and 1.482-4 through 1.482-
6, for the use of the existing intangible property they respectively 
make available to the cost sharing arrangement are in the following 
amounts for the taxable year: A 80X; B 40X; C 30X; and D 30X. The 
provisional (before offsets) and final buy-in payments/receipts 
among A, B, C, and D are shown in the table as follows:

------------------------------------------------------------------------
                                      A         B         C         D   
------------------------------------------------------------------------
Payments........................      <40>      <21>    <37.5>      <30>
Receipts........................        48        34      22.5        24
                                 ---------------------------------------
Final...........................         8        13      <15>       <6>
------------------------------------------------------------------------

    (ii) The first row/first column shows A's provisional buy-in 
payment equal to the product of 100X (sum of 40X, 30X, and 30X) and 
A's share of anticipated benefits of 40%. The second row/first 
column shows A's provisional buy-in receipts equal to the sum of the 
products of 80X and B's, C's, and D's anticipated benefits shares 
(15%, 25%, and 20%, respectively). The other entries in the first 
two rows of the table are similarly computed. The last row shows the 
final buy-in receipts/payments after offsets. Thus, for the taxable 
year, A and B are treated as receiving the 8X and 13X, respectively, 
pro rata out of payments by C and D of 15X and 6X, respectively.
    Example 5. A and B, two members of a controlled group form a 
cost sharing arrangement with an unrelated third party C to develop 
a new technology useable in their respective businesses. Based on a 
reliable projection of their future benefits, A and B agree to bear 
shares of 60% and 40%, respectively, of the costs incurred during 
the term of the agreement. A also makes available its existing 
technology for purposes of the research to be undertaken. The arm's 
length charge, under the rules of Secs. 1.482-1 and 1.482-4 through 
1.482-6, for the use of the existing technology is 100X for the 
taxable year. Under its agreement with A and B, C must make a 
specified cost sharing payment as well as a payment of 50X for the 
taxable year on account of the pre- existing intangible property 
made available to the cost sharing arrangement. B's provisional buy-
in payment (before offsets) to A for the taxable year is 40X (the 
product of 100X and B's anticipated benefits share of 40%). C's 
payment of 50X is shared provisionally between A and B in accordance 
with their shares of reasonably anticipated benefits, 30X (50X times 
60%) to A and 20X (50X times 40%) to B. B's final buy-in payment 
(after offsets) is 20X (40X less 20X). A is treated as receiving the 
70X total provisional payments (40X plus 30X) pro rata out of the 
final payments by B and C of 20X and 50X, respectively.

    (h) Character of payments made pursuant to a qualified cost sharing 
arrangement--(1) In general. Payments made pursuant to a qualified cost 
sharing arrangement (other than payments described in paragraph (g) of 
this section) generally will be considered costs of developing 
intangibles of the payor and reimbursements of the same kind of costs 
of developing intangibles of the payee. For purposes of this paragraph 
(h), a controlled participant's payment required under a qualified cost 
sharing arrangement is deemed to be reduced to the extent of any 
payments owed to it under the arrangement from other controlled or 
uncontrolled participants. Each payment received by a payee will be 
treated as coming pro rata out of payments made by all payors. Such 
payments will be applied pro rata against deductions for the taxable 
year that the payee is allowed in connection with the qualified cost 
sharing arrangement. Payments received in excess of such deductions 
will be treated as in consideration for use of the tangible property 
made available to the qualified cost sharing arrangement by the payee. 
For purposes of the research credit determined under section 41, cost 
sharing payments among controlled participants will be treated as 
provided for intra-group transactions in Sec. 1.41-8(e). Any payment 
made or received by a taxpayer pursuant to an arrangement that the 
district director determines not to be a qualified cost sharing 
arrangement, or a payment made or received pursuant to paragraph (g) of 
this section, will be subject to the provisions of Secs. 1.482-1 and 
1.482-4 through 1.482-6. Any payment that in substance constitutes a 
cost sharing payment will be treated as such for purposes of this 
section, regardless of its characterization under foreign law.
    (2) Examples. The following examples illustrate this paragraph (h):

    Example 1. U.S. Parent (USP) and its wholly owned Foreign 
Subsidiary (FS) form a cost sharing arrangement to develop a 
miniature widget, the Small R. Based on a reliable projection of 
their future benefits, USP agrees to bear 40% and FS to bear 60% of 
the costs incurred during the term of the agreement. The principal 
costs in the intangible development area are operating expenses 
incurred by FS in Country Z of 100X annually, and operating expenses 
incurred by USP in the United States also of 100X annually. Of the 
total costs of 200X, USP's share is 80X and FS's share is 120X, so 
that FS must make a payment to USP of 20X. This payment will be 
treated as a reimbursement of 20X of USP's operating expenses in the 
United States. Accordingly, USP's Form 1120 will reflect an 80X 
deduction on account of activities performed in the United States 
for purposes of allocation and apportionment of the deduction to 
source. The Form 5471 for FS will reflect a 100X deduction on 
account of activities performed in Country Z, and a 20X deduction on 
account of activities performed in the United States.
    Example 2. The facts are the same as in Example 1, except that 
the 100X of costs borne by USP consist of 5X of operating expenses 
incurred by USP in the United States and 95X of fair market value 
rental cost for a facility in the United States. The depreciation 
deduction attributable to the U.S. facility is 7X. The 20X net 
payment by FS to USP will first be applied in reduction pro rata of 
the 5X deduction for operating expenses and the 7X depreciation 
deduction attributable to the U.S. facility. The 8X remainder will 
be treated as rent for the U.S. facility.

    (i) Accounting requirements. The accounting requirements of this 
paragraph are that the controlled 

[[Page 65566]]
participants in a qualified cost sharing arrangement must use a 
consistent method of accounting to measure costs and benefits, and must 
translate foreign currencies on a consistent basis.
    (j) Administrative requirements--(1) In general. The administrative 
requirements of this paragraph consist of the documentation 
requirements of paragraph (j)(2) of this section and the reporting 
requirements of paragraph (j)(3) of this section.
    (2) Documentation. A controlled participant must maintain 
sufficient documentation to establish that the requirements of 
paragraphs (b)(4) and (c)(1) of this section have been met, as well as 
the additional documentation specified in this paragraph (j)(2), and 
must provide any such documentation to the Internal Revenue Service 
within 30 days of a request (unless an extension is granted by the 
district director). Documents necessary to establish the following must 
also be maintained--
    (i) The total amount of costs incurred pursuant to the arrangement;
    (ii) The costs borne by each controlled participant;
    (iii) A description of the method used to determine each controlled 
participant's share of the intangible development costs, including the 
projections used to estimate benefits, and an explanation of why that 
method was selected;
    (iv) The accounting method used to determine the costs and benefits 
of the intangible development (including the method used to translate 
foreign currencies), and, to the extent that the method materially 
differs from U.S. generally accepted accounting principles, an 
explanation of such material differences; and
    (v) Prior research, if any, undertaken in the intangible 
development area, any tangible or intangible property made available 
for use in the arrangement, by each controlled participant, and any 
information used to establish the value of pre-existing and covered 
intangibles.
    (3) Reporting requirements. A controlled participant must attach to 
its U.S. income tax return a statement indicating that it is a 
participant in a qualified cost sharing arrangement, and listing the 
other controlled participants in the arrangement. A controlled 
participant that is not required to file a U.S. income tax return must 
ensure that such a statement is attached to Schedule M of any Form 5471 
or to any Form 5472 filed with respect to that participant.
    (k) Effective date. This section is effective for taxable years 
beginning on or after January 1, 1996.
    (l) Transition rule. A cost sharing arrangement will be considered 
a qualified cost sharing arrangement, within the meaning of this 
section, if, prior to January 1, 1996, the arrangement was a bona fide 
cost sharing arrangement under the provisions of Sec. 1.482-7T (as 
contained in the 26 CFR part 1 edition revised as of April 1, 1995), 
but only if the arrangement is amended, if necessary, to conform with 
the provisions of this section by December 31, 1996.


Sec. 1.482-7T  [Removed]

    Par. 4. Section 1.482-7T is removed.

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 5. The authority for part 301 continues to read in part as 
follows:

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

    Par. 6. Section 301.7701-3 is amended by adding paragraph (e) to 
read as follows:


Sec. 301.7701-3  Partnerships.

* * * * *
    (e) Qualified cost sharing arrangements. A qualified cost sharing 
arrangement that is described in Sec. 1.482-7 of this chapter and any 
arrangement that is treated by the Service as a qualified cost sharing 
arrangement under Sec. 1.482-7 of this chapter is not classified as a 
partnership for purposes of the Internal Revenue Code. See Sec. 1.482-7 
of this chapter for the proper treatment of qualified cost sharing 
arrangements.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 7. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 8. In Sec. 602.101, paragraph (c) is amended by adding an 
entry to the table in numerical order to read as follows:

``1.482-7..................................................1545-1364''.

Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: November 30, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-30617 Filed 12-19-95; 8:45 am]
BILLING CODE 4830-01-U