[Federal Register Volume 71, Number 150 (Friday, August 4, 2006)]
[Rules and Regulations]
[Pages 44466-44519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-6497]



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Part V





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 31



Treatment of Services Under Section 482; Allocation of Income and 
Deductions From Intangibles; Stewardship Expense; Final Rule

  Federal Register / Vol. 71, No. 150 / Friday, August 4, 2006 / Rules 
and Regulations  

[[Page 44466]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 31

[TD 9278]
RIN 1545-BB31, 1545-AY38, 1545-BC52


Treatment of Services Under Section 482; Allocation of Income and 
Deductions From Intangibles; Stewardship Expense

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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

DATES: Effective Date: These regulations are effective on January 1, 
2007.
    Applicability Dates: These regulations apply to taxable years 
beginning after December 31, 2006.

FOR FURTHER INFORMATION CONTACT: Thomas A. Vidano, (202) 435-5265, or 
Carol B. Tan, (202) 435-5265 for matters relating to section 482, or 
David Bergkuist (202) 622-3850 for matters relating to stewardship 
expenses (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 482 of the Internal Revenue Code generally provides that 
the Secretary may allocate gross income, deductions and credits between 
or among two or more taxpayers owned or controlled by the same 
interests in order to prevent evasion of taxes or to clearly reflect 
income of a controlled taxpayer. Regulations under section 482 
published in the Federal Register (33 FR 5849) on April 16, 1968, 
provided guidance with respect to a wide range of controlled 
transactions, including transfers of tangible and intangible property 
and the provision of services. Revised and updated transfer pricing 
regulations were published in the Federal Register (59 FR 34971, 60 FR 
65553 and 61 FR 21955) on July 8, 1994, December 20, 1995, and May 13, 
1996. A notice of proposed rulemaking and notice of public hearing were 
published in the Federal Register (68 FR 53448) on September 10, 2003. 
A correction to the notice of proposed rulemaking and notice of public 
hearing was published in the Federal Register (68 FR 70214) on December 
17, 2003. A public hearing was held on January 14, 2004.
    The Treasury Department and the IRS received a substantial volume 
of comments on a wide range of issues addressed in the 2003 proposed 
regulations. These comments were very helpful and substantial changes 
have been incorporated in response. In order to achieve the goal of 
updating the 1968 regulations, while facilitating consideration of 
further public input in refining final rules, these regulations are 
issued in temporary form with a delayed effective date for taxable 
years beginning after December 31, 2006.
    These regulations are issued a significant amount of time after 
proposed revisions to the regulations pertaining to cost sharing 
arrangements were issued. Commentators suggested that this type of 
timing sequence was important so that each regulation could be assessed 
properly. Commentators also suggested, among other things, that the 
services regulations be reissued in temporary and proposed form. By 
issuing these regulations in temporary and proposed form, the Treasury 
Department and the IRS provide taxpayers an opportunity to submit 
additional comments prior to the time these regulations become 
effective, allowing commentators to consider the potential interaction 
between these regulations and the cost sharing regulations.

Explanation of Provisions

A. Controlled Services

1. Services Cost Method--Temp. Treas. Reg. Sec.  1.482-9T(b)
a. The Simplified Cost Based Method and Public Comments
    The 2003 proposed regulations set forth a simplified cost based 
method (SCBM). The SCBM was intended to preserve the salutary aspects 
of the current Sec.  1.482-2(b) cost safe harbor that provide 
appropriately reduced administrative and compliance burdens for low 
margin services. At the same time, the existing rules would be brought 
more in line with the arm's length standard, and various problematic 
features of those rules would be eliminated. The goal was to provide 
certainty concerning the pricing of low margin services, thus allowing 
the compliance efforts of both taxpayers and the IRS to concentrate on 
those services for which a robust transfer pricing analysis is 
particularly appropriate. The preamble to the 2003 proposed regulations 
also indicated that in certain cases, the allocation or sharing among 
group members of expenses or charges relating to corporate headquarters 
or other centralized service activities may be consistent with the 
proposed regulations, but no further guidance was provided on such 
service sharing arrangements.
    A number of commentators argued that the SCBM was actually 
counterproductive to its stated goals. These commentators contended 
that to apply the SCBM, taxpayers would potentially need to expend 
substantial sums to prepare comparability studies, perhaps separately 
for each of the numerous categories of back office services. They 
contended that, although taxpayers have in-depth knowledge concerning 
their businesses and the relative value added by their back offices, 
the SCBM called for quantitative judgments that business people are not 
qualified to make by themselves, especially in the prevailing 
compliance environment. As a matter of proper accountability, taxpayers 
would be required as a practical matter to devote significant 
compliance resources to enlist outside consultants or otherwise to 
develop support for those judgments.
    Commentators suggested a range of proposed alternatives to the SCBM 
regime. One such proposal was simply to return to the approach in the 
existing regulations under Sec.  1.482-2(b). The 1968 regulations are 
fairly rudimentary in nature, particularly, in today's tax compliance 
environment. In addition, those regulations were open to substantial 
manipulation by taxpayers (both inbound and outbound). Moreover, there 
have been extensive and far-reaching developments in the services 
economy since the existing regulations were published in 1968, with 
real prospects that many intragroup services have values significantly 
in excess of their cost. As a result, in the course of considering 
comments on the 2003 proposed regulations, the Treasury Department and 
the IRS have concluded that it would not be appropriate simply to 
readopt the standard in the 1968 regulations. Additional proposals by 
commentators included development of

[[Page 44467]]

a list of activities that would qualify to be priced at cost or 
detailed provisions regarding cost sharing arrangements for low value 
services performed on a centralized basis, and other options.
    The Treasury Department and the IRS may have decided not to return 
to the 1968 regulations, but have nonetheless taken the full range of 
comments on the 2003 proposed regulations seriously. Therefore, in 
light of the extensive comments on these issues, the Treasury 
Department and the IRS have substantially redesigned the relevant 
provisions. The Treasury Department and the IRS recognize that the 
section 482 services regulations potentially affect a large volume of 
intragroup back office services that are common across many industries. 
It is in the interest of good tax administration to minimize the 
compliance burdens applicable to such services, especially to the 
extent that the arm's length markups are low and the activities do not 
significantly contribute to business success or failure.
    Accordingly, based on the comments, these temporary regulations 
eliminate the SCBM and replace it with the services cost method (SCM), 
as set forth in Sec.  1.482-9T(b). The SCM evaluates whether the price 
for covered services, as defined, is arm's length by reference to the 
total services costs with no markup. Where the conditions on 
application of the method are met, the SCM will be considered the best 
method for purposes of Sec.  1.482-1(c).
b. Services Cost Method: Identification of Covered Services and Other 
Eligibility Criteria
    Section 1.482-9T(b)(4) provides for two categories of covered 
services that are eligible for the SCM if the other conditions on 
application of the method are met. If the conditions are satisfied, 
covered services in each category may be charged at cost with no 
markup. The first category consists of specified covered services 
identified in a revenue procedure published by the IRS. This revenue 
procedure approach is consistent with taxpayer comments. Services will 
be identified in such revenue procedure based upon the determination of 
the Treasury Department and the IRS that they constitute support 
services of a type common across industry sectors and generally do not 
involve a significant arm's length markup on total services costs. 
Because the government performs the analysis necessary to determine the 
eligibility of specified covered services, the compliance burden that 
was previously imposed by the SCBM is eliminated for a broad class of 
commonly provided services.
    An initial proposed list of specified covered services is contained 
in an Announcement being published contemporaneously with these 
temporary regulations. This Announcement will be published in the 
Internal Revenue Bulletin. For copies of the Internal Revenue Bulletin, 
see Sec.  601.601(d)(2)(ii)(b). The Treasury Department and the IRS 
solicit public input on whether the list of services sufficiently 
covers the full range of back office services typical within 
multinational groups, on the descriptions provided for these covered 
services, and on other matters related to the Announcement. It is 
contemplated that a final revenue procedure, reflecting appropriate 
comments, will be issued to coincide with the effective date of the 
temporary regulations for taxable years beginning after December 31, 
2006. In the future, particular services may be added to, clarified in, 
or deleted from the list, depending on ongoing developments.
    The second category of covered services is certain low margin 
covered services. Taxpayers objected to the requirement under the SCBM 
that all services qualify for that method based on a quantitative 
analysis, but based on comments the Treasury Department and the IRS 
believe that controlled taxpayers might nonetheless want the discretion 
to show that particular services--not otherwise covered by the revenue 
procedure--qualify for the SCM, using a modified quantitative approach. 
Low margin covered services consist of services for which the median 
comparable arm's length markup on total services costs is less than or 
equal to seven percent. As under the SCBM, the median comparable arm's 
length markup on total services costs means the excess of the arm's 
length price of the controlled services transaction over total services 
costs, expressed as a percentage of total services costs. For this 
purpose, the arm's length price is determined under the general 
transfer pricing rules without regard to the SCM, using the 
interquartile range (including any adjustment to the median in the case 
of results outside such range). Again, if the markup on costs for 
eligible services is seven percent or less, this category of services 
can be charged out at cost with no markup.
    Under Sec.  1.482-9T(b)(2), specified covered services or low 
margin covered services otherwise eligible for the SCM will qualify for 
the method if the taxpayer reasonably concludes in its business 
judgment that the services do not contribute significantly to key 
competitive advantages, core capabilities, or fundamental chances of 
success or failure in one or more trades or businesses of the renderer, 
the recipient, or both. Unlike the quantitative judgment called for 
under the SCBM, this is a business judgment preeminently within the 
business person's own expertise. Exact precision is not needed and it 
is expected that the taxpayer's judgment will be accepted in most 
cases. This condition is intended to focus transfer pricing compliance 
resources of both taxpayers and the IRS principally on significant 
valuation issues. Thus, it is anticipated that in most cases the 
examination of relevant services will focus only on verification of 
total services costs and their appropriate allocation. These are issues 
even under the 1968 regulations. There will be little need in all but 
the most unusual cases to challenge the taxpayer's reasonable business 
judgment in concluding that such typical back office services do not 
contribute significantly to fundamental risks of success or failure. 
The condition effectively is reserved to allow the IRS to reject any 
attempt to claim that a core competency of the taxpayer's business 
qualifies as a mere back office service. For illustrations of the role 
performed by this condition, see the contrasting pairs of Example 1 and 
Example 2, Example 3 and Example 4, Example 5 and Example 6, Example 8 
and Example 9, Example 10 and Example 11, and Example 12 and Example 13 
in Sec.  1.482-9T(b)(6).
    As indicated in this preamble, it is expected that in all but 
unusual cases, the taxpayer's business judgment will be respected. In 
evaluating the reasonableness of the taxpayer's conclusion, the 
Commissioner will consider all the relevant facts and circumstances. 
This provision avoids the need to exclude from the SCM certain back 
office services that as a general matter and across a range of industry 
sectors are low margin, but that in the context of a particular 
business nonetheless constitute high margin services. That is, it 
permits the Treasury Department and the IRS to include a greater range 
of service categories under the SCM, even though in specific 
circumstances an otherwise covered service of a particular taxpayer 
will be ineligible.
    In addition, under Sec.  1.482-9T(b)(3)(i), a single procedural 
requirement applies under the SCM. The taxpayer must maintain 
documentation of covered services costs and their allocation. The 
documentation must include a statement evidencing the taxpayer's 
intention to apply the SCM.
    In Sec.  1.482-9T(b)(3)(ii), the SCM preserves the same list of 
categories of

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controlled transactions that are not eligible to be priced under the 
method as under the SCBM. The Treasury Department and the IRS continue 
to believe that these transactions tend to be high margin transactions, 
transactions for which total services costs constitute an inappropriate 
reference point, or other types of transactions that should be subject 
to a more robust arm's length analysis under the general section 482 
rules. Comments are requested in this regard in light of the other 
substantial changes made in the regulations.
    Consistent with the purpose of providing for appropriately reduced 
compliance burdens for services subject to the SCM, the temporary 
regulations retain provisions in Sec.  1.6662-6T(d)(2) similar to those 
associated with the SCBM.
c. Shared Services Arrangements
    Section 1.482-9T(b)(5) of the temporary regulations provides 
explicit guidance on shared services arrangements (SSAs). In general, 
an SSA must include two or more participants; must include as 
participants all controlled taxpayers that benefit from one or more 
covered services subject to the SSA; and must be structured such that 
each covered service (or group of covered services) confers a benefit 
on at least one participant. A participant is a controlled taxpayer 
that reasonably anticipates benefits from covered services subject to 
the SSA and that substantially complies with the SSA requirements.
    Under an SSA, the arm's length charge to each participant is the 
portion of the total costs of the services otherwise determined under 
the SCM that is properly allocated to such participant under the 
arrangement. For purposes of an SSA, two or more covered services may 
be aggregated, provided that the aggregation is reasonable based on the 
facts and circumstances, including whether it reasonably reflects the 
relative magnitude of the benefits that the participants reasonably 
anticipate from the services in question. Such aggregation may, but 
need not, correspond to the aggregation used in applying other 
provisions of the SCM. If the taxpayer reasonably concludes that the 
SSA (including any aggregation for purposes of the SSA) results in an 
allocation of the costs of covered services that provides the most 
reliable measure of the participants' respective shares of the 
reasonably anticipated benefits from those services, then the 
Commissioner may not adjust such allocation basis.
    In addition, as a procedural matter, the taxpayer must maintain 
documentation concerning the SSA, including a statement that it intends 
to apply the SCM under the SSA and information on the participants, the 
allocation basis, and grouping of services for purposes of the SSA. 
Guidance is also provided on the coordination of cost allocations under 
an SSA and cost allocations under a qualified cost sharing arrangement.
d. Deleted Provisions
    The SCM is considerably streamlined as compared to the SCBM. Upon 
further consideration, and in light of public comments, many of the 
conditions, contractual requirements, quantitative screens, and other 
technicalities associated with the SCBM have been eliminated. The 
Treasury Department and the IRS believe this streamlined approach 
serves the interests of both the government and taxpayers by reducing 
complexity and administrative burden.
2. Comparable Uncontrolled Services Price Method--Temp. Treas. Reg. 
Sec.  1.482-9T(c)
    The 2003 proposed regulations set forth the comparable uncontrolled 
services price (CUSP) method. This method evaluated whether the 
consideration in a controlled services transaction is arm's length by 
comparison to the price charged in a comparable uncontrolled services 
transaction. This method was closely analogous to the comparable 
uncontrolled price (CUP) method in existing Sec.  1.482-3(b).
    One commentator objected to the statement in Sec.  1.482-9(b)(1) of 
the 2003 proposed regulations that, to be evaluated under the CUSP 
method, a controlled service ordinarily needed to be ``identical to or 
have a high degree of similarity'' to the uncontrolled comparable 
transactions. The commentator viewed the comparability analysis in the 
examples in proposed Sec.  1.482-9(b)(4) as more consistent with the 
standard in existing Sec.  1.482-3(b)(2)(ii)(A). The Treasury 
Department and the IRS agree that the comparability standards under the 
CUSP method for services should run parallel to those under the CUP 
method for sales of tangible property. Indeed, the provisions are 
parallel. The commentator misconstrues the purpose of the quoted 
provision.
    Although the provision contains general guidance on situations in 
which the method ordinarily applies, it is not intended to and does not 
alter the substantive comparability standards. Just like the CUP 
method, the standards under the CUSP method emphasize the relative 
similarity of the controlled services to the uncontrolled transaction 
and the presence or absence of nonroutine intangibles. Section 1.482-
9T(c)(2)(ii) of the temporary regulations also provides, consistent 
with the best method rule, that the CUSP method generally provides the 
most direct and reliable measure of an arm's length result if the 
uncontrolled transaction either has no differences from the controlled 
services transaction or has only minor differences that have a definite 
and reasonably ascertainable effect on price, and appropriate 
adjustments may be made for such differences. If such adjustments 
cannot be made, or if there are more than minor differences between the 
controlled and uncontrolled transactions, the comparable uncontrolled 
services price method may be used, but the reliability of the results 
as a measure of the arm's length price will be reduced. Further, if 
there are material differences for which reliable adjustments cannot be 
made, this method ordinarily will not provide a reliable measure of an 
arm's length result.
    The CUSP provisions in these temporary regulations are 
substantially similar to the corresponding provisions in the 2003 
proposed regulations.
3. Gross Services Margin Method--Temp. Treas. Reg. Sec.  1.482-9T(d)
    The 2003 proposed regulations provided for a gross services margin 
method, which evaluated the amount charged in a controlled services 
transaction by reference to the gross services profit margin in 
uncontrolled transactions that involve similar services. The method was 
analogous to the resale price method for transfers of tangible property 
in existing Sec.  1.482-3(c).
    Under the 2003 proposed regulations, this method would ordinarily 
be used where a controlled taxpayer performs activities in connection 
with a ``related uncontrolled transaction'' between a member of the 
controlled group and an uncontrolled taxpayer. For example, the method 
may be used where a controlled taxpayer renders services to another 
member of the controlled group in connection with a transaction between 
that other member and an uncontrolled party (agent services), or where 
a controlled taxpayer contracts to provide services to an uncontrolled 
taxpayer and another member of the controlled group actually performs 
the services (intermediary function).
    The 2003 proposed regulations defined the terms ``related 
uncontrolled transaction,'' ``applicable uncontrolled

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price,'' and ``appropriate gross services profit''. A ``related 
uncontrolled transaction'' is a transaction between a member of the 
controlled group and an uncontrolled taxpayer for which a controlled 
taxpayer performs either agent services or an intermediary function. 
The ``applicable uncontrolled price'' is the sales price paid by the 
uncontrolled party in the related uncontrolled transaction. The 
``appropriate gross services profit'' is the product of the applicable 
uncontrolled price and the gross services profit margin in comparable 
uncontrolled services transactions. The gross services profit margin 
takes into account all functions performed by other members of the 
controlled group and any other relevant factors.
    One commentator mistakenly interpreted the term ``related 
uncontrolled transaction'' to suggest that the comparable transaction 
under this method is one that takes place between controlled parties. 
While this was not intended, the Treasury Department and the IRS agree 
that the nomenclature is potentially confusing, and as a result, these 
regulations substitute the term ``relevant uncontrolled transaction'' 
in lieu of ``related uncontrolled transaction'' wherever that appeared. 
In other respects, the gross services margin provisions in these 
temporary regulations are substantially similar to the provisions in 
the 2003 proposed regulations.
4. Cost of Services Plus Method--Temp. Treas. Reg. Sec.  1.482-9T(e)
    The 2003 proposed regulations set forth the cost of services plus 
method. This method evaluated the amount charged in a controlled 
services transaction by reference to the gross services profit markup 
in comparable uncontrolled services transactions. The gross services 
profit is determined by reference to the markup as a percentage of 
comparable transactional costs in comparable uncontrolled transactions. 
This method would ordinarily apply where the renderer of controlled 
services provides the same or similar services to both controlled and 
uncontrolled parties. In general, those are the only circumstances in 
which a controlled taxpayer would likely have the detailed information 
concerning comparable transactional costs necessary to apply this 
method reliably.
    The cost of services plus method in the 2003 proposed regulations 
was generally analogous to the cost plus method for transfers of 
tangible property in existing Sec.  1.482-3(d). The method implicitly 
recognized that financial accounting standards applicable to services 
have not developed to the same degree as the standards applicable to 
other categories of transactions, such as manufacturing or distribution 
of tangible property. For that reason, the method adopted the concept 
of ``comparable transactional costs,'' which the 2003 proposed 
regulations defined as all costs of providing the services taken into 
account in determining the gross services profit markup in comparable 
uncontrolled services transactions. In this context, comparable 
uncontrolled transactions could be either services transactions between 
the controlled taxpayer and uncontrolled parties (internal 
comparables), or services transactions between two uncontrolled parties 
(external comparables).
    The 2003 proposed regulations also recognized that comparable 
transactional costs could be a subset of total services costs. 
Generally accepted accounting principles (GAAP) or Federal income tax 
accounting rules (if income tax data for comparable uncontrolled 
transactions are available) could provide an appropriate platform for 
analysis under this provision, but neither is necessarily conclusive.
    Commentators objected that the concept of comparable transactional 
costs was imprecise, and they suggested that such costs should in any 
event include only the direct costs associated with providing a 
particular service, as determined under GAAP or Federal income tax 
accounting rules. As noted above, the financial accounting standards 
for services transactions are not as precise as the standards 
applicable to other types of transactions. The relative lack of 
uniformity in turn makes it impractical to derive a single definition 
of cost that would apply generally to controlled services transactions.
    Comparable transactional costs may potentially include direct and 
indirect costs, if such costs are included in the internal or external 
uncontrolled transactions that form the basis for comparison. Section 
1.482-9T(e)(4) Example 1 has been modified to clarify this concept.
    Several commentators objected to Sec.  1.482-9(d)(3)(ii)(A) of the 
2003 proposed regulations. In their view, this provision required the 
results obtained under the cost of services plus method to be confirmed 
by means of a separate analysis under the comparable profits method 
(CPM) for services. If a confirming analysis under the CPM for services 
were required in all cases, commentators reasoned, the cost of services 
plus method could not be viewed as a specified method in its own right.
    The Treasury Department and the IRS agree and clarify that the 
intent of the rules is not to require confirmation of the results under 
the cost of services plus method. In response to public comments, Sec.  
1.482-9T(e)(3)(ii)(A) of these temporary regulations incorporates 
several changes. First, restatement of the price under this method in 
the form of a markup on total costs of the controlled taxpayer is 
necessary only if the cost of services plus method utilizes external 
comparables. If internal comparables are used, this calculation need 
not be performed. Second, in situations where the price is restated, 
the sole purpose is to determine whether it is necessary to perform 
additional evaluation of functional comparability.
    For example, if the price under the cost of services plus method, 
when restated, indicates a markup on the renderer's total services 
costs that is either low or negative, this may indicate differences in 
functions that have not been accounted for under the traditional 
comparability factors. A low or negative markup suggests the need for 
additional inquiry, the outcome of which may suggest that the cost of 
services plus method is not the most reliable measure of an arm's 
length result under the best method rule. Conforming changes have been 
made in Sec.  1.482-9T(e)(4) Example 3 of these temporary regulations.
5. Comparable Profits Method for Services--Temp. Treas. Reg. Sec.  
1.482-9T(f)
    The 2003 proposed regulations provided for a Comparable Profits 
Method (CPM) for services, which was similar to the CPM in existing 
Sec.  1.482-5. In general, the CPM for services evaluated whether the 
amount charged in a controlled services transaction is arm's length by 
reference to objective measures of profitability (profit level 
indicators or PLIs) derived from financial information regarding 
uncontrolled taxpayers that engage in similar services transactions 
under similar circumstances. The CPM for services applied only where 
the renderer of controlled services is the tested party.
    Section 1.482-9(e) of the 2003 proposed regulations provided that 
the profit level indicators (PLIs) provided for in existing Sec.  
1.482-5(b)(4)(ii) may also be used under the CPM for services. The 
relative lack of uniformity in financial accounting standards for 
services, combined with potentially incomplete information regarding 
the cost accounting practices of the

[[Page 44470]]

uncontrolled comparables, strongly suggest that PLIs that require 
accurate segmentation of costs may have limited reliability.
    The 2003 proposed regulations stated that the degree of consistency 
in accounting practices between the controlled services transaction and 
the uncontrolled services transaction might affect the reliability of 
the results under the CPM for services. If appropriate adjustments to 
account for such differences are not possible, the reliability of the 
results under this method will be reduced.
    Section 1.482-9(e)(2)(ii) of the 2003 proposed regulations provided 
for a new profit level indicator that may be particularly useful for 
controlled services transactions: the ratio of operating profits to 
total services costs, or the markup on total costs (also referred to as 
the ``net cost plus''). Because this profit level indicator evaluates 
operating profits by reference to the markup on all costs related to 
the provision of services, it is more likely to use a cost base of the 
tested party that is comparable to the cost base used by uncontrolled 
parties in performing similar business activities.
    The Treasury Department and the IRS received a number of comments 
concerning the CPM for services. Commentators questioned whether the 
definition of ``total services costs,'' which provides the net cost 
plus cost base under the CPM for services, included stock-based 
compensation. In response to these comments, the Treasury Department 
and the IRS clarify their intent that Sec.  1.482-5(c)(2)(iv) of the 
existing regulations apply to the CPM for services. Accordingly, new 
Example 3, Example 4, Example 5, and Example 6 are included in Sec.  
1.482-9T(f)(3) of these temporary regulations. These examples show the 
application of existing Sec.  1.482-5(c)(2)(iv) to fact patterns that 
involve differences in the utilization of or accounting for stock-based 
compensation in the context of controlled services transactions.
    One commentator expressed reservations concerning a statement in 
the preamble to the 2003 proposed regulations, which indicated that 
PLIs based on return on capital or assets might be unreliable for 
controlled services because the reliability of these PLIs decreases as 
operating assets play a less prominent role in generating operating 
profits. This commentator contended that such PLIs are reliable for all 
firms, including service providers. The Treasury Department and the IRS 
clarify that, although return on capital PLIs may produce reliable 
results in the case of certain service providers, in general, such PLIs 
are subject to the general reservation in existing Sec.  1.482-
5(b)(4)(i) to the effect that the reliability of such PLIs increases as 
operating assets play a greater role in general operating profits.
    Aside from the addition of the examples described above, the CPM 
for services provisions in these temporary regulations are 
substantially similar to the provisions in the 2003 proposed 
regulations.
6. Profit Split Method--Temp. Treas. Reg. Sec. Sec.  1.482-9T(g) and 
1.482-6T(c)(3)(i)(B)
    The 2003 proposed regulations provided additional guidance 
concerning application of the comparable profit split and the residual 
profit split methods to controlled services transactions. Generally, 
these methods evaluated whether the allocation of the combined 
operating profit or loss attributable to one or more controlled 
transactions is arm's length by reference to the relative value of each 
controlled taxpayer's contributions to the combined operating profit or 
loss.
    The 2003 proposed regulations provided that the guidance regarding 
the profit split methods in existing Sec.  1.482-6, as amended by 
proposed Sec.  1.482-6(c)(3)(i)(B) and by other changes, applied to 
controlled services transactions. Section 1.482-9(g) of the 2003 
proposed regulations also provided specific additional guidance 
concerning application of existing Sec.  1.482-6, as amended, to 
controlled services transactions.
    The Treasury Department and the IRS received numerous comments on 
the profit split method. Commentators objected in particular to 
references in the 2003 proposed regulations to ``interrelated'' 
transactions in Sec.  1.482-6(c)(3)(i)(B)(1), and to ``high-value 
services'' and ``highly integrated transactions'' in Sec.  1.482-
9(g)(1). Commentators viewed these terms as vague and subjective. 
Commentators also sought more specific guidance concerning the 
circumstances in which the residual profit split method would 
constitute the best method under the principles of existing Sec.  
1.482-1(c). In addition, some commentators suggested that one hallmark 
of a nonroutine contribution in the context of controlled services is 
that the renderer bears substantial risks. Another commentator 
suggested that the arm's length compensation for a function performed 
by an employee or group of employees should not in any event be 
evaluated under a profit split method. In this commentator's view, such 
an activity should be classified as routine because the market return 
for the function is equivalent to the total compensation paid to the 
employees. Commentators also raised several objections to the factual 
assumptions in the proposed analysis concerning Sec.  1.482-9(g)(2) 
Example 2 of the 2003 proposed regulations.
    The Treasury Department and the IRS agreed with a number of 
comments and, as a result, have made substantial changes to these 
provisions. Under these temporary regulations, all references to 
``interrelated'' transactions in Sec.  1.482-6(c)(3)(i)(B)(1), as well 
as references to ``high-value services'' and ``highly integrated 
transactions'' in Sec.  1.482-9(g)(1) have been eliminated. Section 
1.482-9T(g)(1) now states that the profit split method is ``ordinarily 
used in controlled services transactions involving a combination of 
nonroutine contributions by multiple controlled taxpayers.'' This 
change from the 2003 proposed regulations (which referred to ``high-
value'' or ``highly-integrated'' transactions), conforms to the changes 
to Sec.  1.482-6T(c)(3)(i)(B)(1), as described below.
    Section 1.482-6T(c)(3)(i)(B)(1) of these temporary regulations 
defines a nonroutine contribution as ``a contribution that is not 
accounted for as a routine contribution.'' In other words, a nonroutine 
contribution is one for which the return cannot be determined by 
reference to market benchmarks. Importantly, in this context, the term 
``routine'' does not necessarily signify that a contribution is low 
value. In fact, comparable uncontrolled transactions may indicate that 
the returns to a routine contribution are very significant.
    In response to the comments and in accordance with the revised 
definition of nonroutine contribution in these temporary regulations, 
the following references were eliminated as unnecessary: (1) 
Contributions not fully accounted for by market returns; and (2) 
contributions so interrelated with other transactions that they cannot 
be reliably evaluated on a separate basis. These changes will bring 
added clarity to the temporary regulations.
    The Treasury Department and the IRS believe that these revised 
provisions respond to the public comments and offer more specific 
guidance concerning the circumstances in which the profit split method 
would likely constitute the best method under existing Sec.  1.482-
1(c). In particular, the term ``high-value'' is not included in 
temporary Sec.  1.482-9T(g)(1), thus eliminating any implication that 
the profit split method is a ``default'' method for controlled services 
that have value significantly in excess of cost. This shift in emphasis 
is

[[Page 44471]]

also reflected in section B.2 of this preamble, which describes the 
deletion of language from several examples that some believed suggested 
that the residual profit split is a default method. The clear intent is 
that no method, including the profit split, is a default method for 
purposes of the best method rule. Rather, the profit split method 
applies if a controlled services transaction has one or more material 
elements for which it is not possible to determine a market-based 
return. The Treasury Department and the IRS believe that the above 
changes address the comments made and so do not believe that it is 
necessary for the regulations to adopt alternative definitions of 
nonroutine contribution put forward by commentators, such as 
definitions based on the degree of risk borne by the renderer of 
services or the extent to which an activity is performed solely by 
employees of the taxpayer.
    Finally, based on the public comments, and in light of the changes 
described in this preamble, Sec.  1.482-9(g)(2) Example 2 of the 2003 
proposed regulations has been withdrawn and replaced by a new example 
that more effectively illustrates application of the profit split 
method to nonroutine contributions by multiple controlled parties.
7. Unspecified Methods--Sec.  1.482-9T(h)
    The 2003 proposed regulations provided that an unspecified method 
may provide the most reliable measure of an arm's length result under 
the best method rule. Such an unspecified method must take into account 
that uncontrolled taxpayers compare the terms of a particular 
transaction to the realistic alternatives to that transaction.
    No significant comments were received concerning the unspecified 
method provisions. Consistent with the general aim to coordinate the 
analyses under the various sections of the regulations under section 
482 so that economically similar transactions will be evaluated 
similarly, however, Sec.  1.482-9T(h) has been modified to provide that 
in applying an unspecified method to services, the realistic 
alternatives to be considered include ``economically similar 
transactions structured as other than services transactions.'' This 
provision allows flexibility to consider non-services alternatives to a 
services transaction, for example, a transfer or license of intangible 
property, if such an approach provides the most reliable measure of an 
arm's length result. The Treasury Department and the IRS are 
considering similar changes to Sec. Sec.  1.482-3(e)(1) and 1.482-
4(d)(1) of the existing regulations. Public comments are requested 
regarding the advisability of such changes and the form they should 
take. Aside from this change, the unspecified method provisions in 
these temporary regulations are substantially similar to the provisions 
in the 2003 proposed regulations.
8. Contingent-Payment Contractual Terms--Temp. Treas. Reg. Sec.  1.482-
9T(i)
    The contingent-payment contractual term provisions in the 2003 
proposed regulations built on the fundamental principle that, in 
structuring controlled transactions, taxpayers are free to choose from 
among a wide range of risk allocations. This provision in the 2003 
proposed regulations also acknowledged that contingent-payment terms--
terms requiring compensation to be paid only if specified results are 
obtained--may be particularly relevant in the context of controlled 
services transactions. The 2003 proposed regulations provided detailed 
guidance concerning contingent-payment contractual terms, including 
economic substance considerations as well as documentation 
requirements.
    Under Sec.  1.482-9(i)(2) of the 2003 proposed regulations, a 
contingent-payment arrangement was given effect if it met three basic 
requirements: (1) The arrangement is contained in a written contract 
executed prior to the start of the activity; (2) the contract makes 
payment contingent on a future benefit directly related to the outcome 
of the controlled services transaction; and (3) the contract provides 
for payment on a basis that reflects the recipient's benefit from the 
services rendered and the risks borne by the renderer.
    Commentators generally supported the contingent-payment terms 
provision as providing guidance concerning a contractual structure with 
particular relevance to controlled services transactions. However, they 
also raised three fundamental concerns regarding the scope and 
operation of this provision. First, the commentators questioned whether 
controlled taxpayers would need to identify uncontrolled comparables 
for any contingent-payment terms that they seek to adopt. Second, they 
pointed out that certain references to economic substance provisions 
and documentation requirements were either unclear or duplicative of 
provisions in existing Sec.  1.482-1(d)(3). Third, commentators 
expressed concern that the IRS might improperly impute contingent-
payment terms as a means of addressing erroneous transfer pricing in 
situations that do not involve lack of economic substance, for example, 
non-arm's length pricing of activities such as marketing or research 
and development.
    The temporary regulations respond to each of these concerns. First, 
under Sec.  1.482-9(i)(1) of the 2003 proposed regulations, one factor 
that needed to be considered was whether an uncontrolled taxpayer would 
have paid a contingent fee if it engaged in a similar transaction under 
comparable circumstances. In response to comments, the temporary 
regulations eliminate this requirement and instead emphasize the 
importance of the economic substance principles under Sec.  1.482-
1(d)(3) of the existing regulations. That is, whether a particular 
arrangement entered into by controlled parties has economic substance 
is not determined by reference to whether it corresponds to 
arrangements adopted by uncontrolled parties.
    Second, in response to comments, the temporary regulations 
eliminate duplicative or unnecessary references to the economic 
substance rules. For example, Sec.  1.482-9T(i)(2)(ii) has been 
modified to provide that the contingent-payment arrangement as a whole, 
including both the contingency and the basis of payment, must be 
consistent with economic substance, as evaluated under existing Sec.  
1.482-1(d)(3)(ii)(B). This section eliminates the additional 
requirement under the 2003 proposed regulations, that the arm's length 
charge under a contingent-payment arrangement must be evaluated by 
reference to economic substance principles.
    Third, the temporary regulations respond to the concern identified 
by commentators that the IRS might apply the contingent-payment 
provisions in an inappropriate manner, for example, to correct 
erroneous transfer pricing in prior taxable years that are not under 
examination. As discussed in more detail in section C of this preamble, 
the temporary regulations include an example to illustrate factual 
circumstances in which contractual terms pertaining to risk allocations 
(provided they are otherwise consistent with taxpayers' conduct and 
arrangements) are fully respected, notwithstanding that on examination 
the activities were determined to have been priced on a non-arm's 
length basis. Other concerns, relating to interaction of the 
contingent-payment terms provision with the commensurate with income 
standard, are also addressed in section C of this preamble.
    New Sec.  1.482-9T(i)(5) Example 3 illustrates the application of 
these rules to a situation in which the contingency identified in a 
contingent-payment

[[Page 44472]]

provision is not satisfied. The example responds to a request by 
commentators for additional guidance to address such a factual 
scenario.
9. Total Services Costs--Temp. Treas. Reg. Sec.  1.482-9T(j)
    Section 1.482-9(j) of the 2003 proposed regulations defined ``total 
services costs'' for purposes of the SCBM, the CPM for services, and 
the cost of services plus method where the gross services profit was 
restated in the form of a markup on total services costs.
    Under the 2003 proposed regulations, total services costs included 
all costs directly identified with provision of the controlled 
services, as well as all other costs reasonably allocable to such 
services under Sec.  1.482-9(k). The Treasury Department and the IRS 
intended that, in this context, ``costs'' must comprise provision for 
all resources expended, used, or made available to render the service. 
Generally accepted accounting principles (GAAP) or Federal income tax 
accounting rules may provide an appropriate analytic platform, but 
neither would necessarily be conclusive in evaluating whether an item 
must be included in total services costs. The issue of determining 
total services costs is not a new one; it is relevant under the current 
1968 regulations as well.
    Commentators objected that Sec.  1.482-9(j) of the 2003 proposed 
regulations failed to list the specific items that were included in 
total services costs. Some commentators suggested that, absent more 
precise guidance in this regard, controlled taxpayers should be 
permitted to rely on the definition of costs applicable under GAAP or 
Federal income tax principles. Commentators also requested 
clarification whether total services costs included stock-based 
compensation.
    The Treasury Department and the IRS view the definition of total 
services costs in the 2003 proposed regulations as having struck the 
correct balance between specificity and flexibility. In general, the 
accounting standards applicable to services do not provide a uniform 
means of determining all costs that relate to the provision of 
services. Consequently, the Treasury Department and the IRS conclude 
that total services costs for purposes of section 482 cannot be 
determined solely by reference to GAAP or other accounting standards or 
practices.
    In response to comments, however, Sec.  1.482-9T(j) of the 
temporary regulations clarifies that all contributions in cash or in 
kind (including stock-based compensation) are included in total 
services costs. In addition, the third sentence of Sec.  1.482-9T(j) 
states that ``costs for this purpose should comprise provision for all 
resources expended, used, or made available to achieve the specific 
objective for which the service is rendered.'' To better reflect, for 
example, the inclusion of stock-based compensation in total services 
costs, the term ``provision'' is adopted in place of the term 
``consideration'' as used in the 2003 proposed regulations.
    Commentators also observed that the definition of total services 
costs in the 2003 proposed regulations did not address situations in 
which the costs of a controlled service provider include significant 
charges from uncontrolled parties. Commentators posited that such 
third-party costs should be permitted to ``pass through,'' rather than 
being subject to a markup under the transfer pricing method used to 
analyze the controlled services transaction. The Treasury Department 
and the IRS agree that these comments raised an issue that needs to be 
addressed, but decided to do so in a manner different from that 
suggested by the commentators. In response to this comment, the 
temporary regulations add Sec.  1.482-9T(l)(4), which under certain 
circumstances allows a controlled services transaction that involves 
third-party costs to be evaluated on a disaggregated basis. See section 
A.11.e of this preamble.
10. Allocation of Costs--Temp. Treas. Reg. Sec.  1.482-9T(k)
    Section 1.482-9(k) of the 2003 proposed regulations retained the 
flexible approach of existing Sec.  1.482-2(b)(3) through (6), which 
permitted taxpayers to use any reasonable allocation and apportionment 
of costs in determining an arm's length charge for services. In 
evaluating whether the allocation used by the taxpayer is appropriate, 
the 2003 proposed regulations required that consideration be given to 
all bases and factors, including practices used by the taxpayer to 
apportion costs for other (non-tax) purposes. Such practices, although 
relevant, need not be given conclusive weight by the Commissioner in 
evaluating the arms length charge for controlled services.
    Commentators urged that any technique that a taxpayer uses to 
allocate costs should be entitled to deference, provided it is 
consistent with GAAP. For the reasons expressed above concerning Sec.  
1.482-9T(j), GAAP may provide an appropriate analytic platform but is 
not necessarily controlling in evaluating the arm's length charge for 
controlled services.
    In the case of administrative or support services, commentators 
suggested that the Commissioner should accept any reasonable allocation 
used by the taxpayer, for example, revenue, sales, or employee 
headcount. In general, the cost of a service that provides benefits to 
multiple parties must be allocated in a manner that reliably reflects 
the proportional benefit received by each of those parties. This 
standard is intended to be substantially equivalent to the standard in 
Sec.  1.482-2(b)(2)(i) and 1.482-2(b)(6) of the existing regulations. 
In response to comments, Sec.  1.482-9T(b)(5)(i)(B) of these temporary 
regulations also provides rules whereby the costs of covered services 
subject to a shared services arrangement are allocated to participants 
in a manner that the taxpayer reasonably concludes will most reliably 
reflect each participant's reasonably anticipated benefits from the 
services. See section A.1.c of this preamble.
11. Controlled Services Transactions--Temp. Treas. Reg. Sec.  1.482-
9T(l)
a. Definition of Activity--Temp. Treas. Reg. Sec.  1.482-9T(l)(2)
    Section 1.482-9(l) of the 2003 proposed regulations set forth a 
threshold test for determining whether an activity constituted a 
controlled services transaction subject to the general framework of 
Sec.  1.482-9. The 2003 proposed regulations broadly defined a 
controlled services transaction as any activity by a controlled 
taxpayer that resulted in a benefit to one or more other controlled 
taxpayers. An ``activity'' was in turn defined as the use by the 
renderer, or the making available to the recipient, of any property or 
other resources of the renderer.
    One commentator interpreted this provision as indicating that any 
activity properly analyzed under one or more other provisions of the 
transfer pricing regulations should not be subject to Sec. 1.482-9 of 
the 2003 proposed regulations. Other commentators suggested that the 
``predominant character'' of a transaction should control whether it is 
analyzed as a controlled service under Sec. 1.482-9 of the 2003 
proposed regulations or under other provisions of the section 482 
regulations.
    Controlled taxpayers have a great deal of flexibility to structure 
transactions in various ways that are economically equivalent. In some 
cases, an overall transaction may include separate elements of 
differing characters, for example, a transfer of tangible property 
bundled together with the provision of

[[Page 44473]]

a service. The structure adopted may sometimes be more reliably 
analyzed on either a disaggregated or an aggregated basis under the 
relevant section of the section 482 regulations, for example, either as 
a separate transfer of tangible property under the existing section 482 
regulations in Sec.  1.482-3 and a separate controlled services 
transaction under these temporary regulations in Sec.  1.482-9T, or as 
an overall controlled services transaction under these temporary 
regulations. To the extent that a controlled transaction is structured 
so that it is most reliably evaluated as a controlled services 
transaction, it will be analyzed as such. To the extent that multiple 
elements of a single overall transaction potentially create an overlap 
between the section 482 regulations applicable to other types of 
transactions and these temporary regulations concerning controlled 
services transactions, the Treasury Department and the IRS believe that 
the appropriate coordination is achieved by applying the rules in Sec.  
1.482-9T(m). See section A.12.a of this preamble.
b. Benefit Test--Temp. Treas. Reg. Sec.  1.482-9T(l)(3)
    Section 1.482-9(l)(3) of the 2003 proposed regulations provided 
rules for determining whether an activity provides a benefit. Under 
Sec.  1.482-9(l)(3)(i), a benefit is present if the activity directly 
results in a reasonably identifiable increment of economic or 
commercial value that enhances the recipient's commercial position, or 
is reasonably anticipated to do so. Another requirement is that an 
uncontrolled taxpayer in circumstances comparable to those of the 
recipient would be willing to pay an uncontrolled party to perform the 
same or a similar activity, or be willing to perform for itself the 
same or similar activity. The 2003 proposed regulations thus made 
significant changes to the benefit test under the existing regulations, 
which is based on whether an uncontrolled party in the position of the 
renderer would expect payment for a particular activity. The 2003 
proposed regulations adopted the so-called ``specific benefit'' 
approach, which mandates an arm's length charge only if a particular 
activity provides an identifiable benefit to a particular taxpayer. In 
addition, Sec.  1.482-9(l)(3)(ii) of the 2003 proposed regulations 
provided that no benefit is present if an activity has only indirect or 
remote effects.
    Commentators viewed the 2003 proposed regulations as providing 
insufficient guidance concerning methods that controlled taxpayers 
might use to allocate or share expenses or charges, in particular with 
respect to centralized services performed on a centralized basis for 
multiple affiliates.
    In response to these comments, the temporary regulations authorize 
the use of shared services arrangements for centralized services that 
qualify for the SCM in Sec.  1.482-9T(b). By entering into such 
arrangements, taxpayers can, among other things, reduce the burden 
associated with analysis of centralized services, which would 
presumably include activities that provide benefits on only an 
occasional or intermittent basis. See section A.1.c of this preamble, 
concerning shared services arrangements.
    One commentator suggested that, because the benefit test in the 
2003 proposed regulations focused on the recipient, the arm's length 
charge should also be analyzed from the perspective of the recipient 
and economic conditions in the recipient's geographic market. The 
commentator misunderstands the application of the benefit test. 
Although the benefit test focuses on the recipient, evaluation of the 
arm's length charge under the best method rule in a particular case 
(for example, under a profit split method) may require analysis of the 
recipient, the renderer, or both (depending, for example, on which 
party performs the simplest, most easily measurable functions).
c. Specific Applications of the Benefit Test--Temp Treas. Reg. Sec.  
1.482-9T(l)(3)(ii) through (v)
    The 2003 proposed regulations provided additional rules concerning 
application of the benefit test to particular circumstances, such as 
application to activities with indirect or remote effects, duplicative 
activities, shareholder activities, and passive association. These 
rules in the 2003 proposed regulations were substantially similar to 
the rules in existing Sec.  1.482-2(b)(2). For example, Sec.  1.482-
9(l)(3)(ii) and (l)(3)(iii) provided that no benefit is present if an 
activity has only indirect or remote effects or merely duplicates an 
activity that the recipient has already performed on its own behalf. 
Section 1.482-9(l)(3)(iv) provided that shareholder activities do not 
confer a benefit on controlled parties and therefore do not give rise 
to an arm's length charge. Shareholder activities were defined as 
activities that primarily benefit the owner-member of a controlled 
group in its capacity as owner, rather than other controlled parties.
    In addition, Sec.  1.482-9(l)(3)(v) of the 2003 proposed 
regulations provided that certain ``passive association'' effects do 
not give rise to a benefit within the meaning of the regulations 
concerning controlled services. Passive association was defined as an 
increment of value that a controlled party obtains on account of its 
membership in the controlled group. Section 1.482-9(l)(3)(v) of the 
2003 proposed regulations provided, however, that membership in a 
controlled group may be considered in evaluating comparability between 
controlled and uncontrolled transactions.
    Concerning indirect or remote effects, one commentator suggested 
that if a centralized activity by a parent confers only occasional or 
intermittent benefits on a subsidiary, such benefits should be 
classified as indirect or remote. As to the shareholder provisions, 
commentators noted that the 2003 proposed regulations failed to address 
the potential that an activity that confers a reasonably identifiable 
increment of value on a controlled party might also be appropriately 
classified as a shareholder activity. As to the passive association 
provisions, commentators questioned whether membership in a controlled 
group is relevant to evaluation of comparability. Commentators raised 
the concern that virtually any uncontrolled transaction could 
potentially be considered unreliable, because it generally would not 
reflect the same efficiencies and synergies as the controlled services 
transaction.
    Regarding the comments concerning indirect or remote effects, the 
Treasury Department and the IRS believe that to equate occasional or 
intermittent benefits in all cases with indirect or remote effects 
would conflict with the specific-benefit rule. That rule requires that 
any service that produces an identifiable and direct benefit warrants 
an arm's length charge, even if the service is provided only 
occasionally or intermittently. Accordingly, the temporary regulations 
retain this provision without change.
    In response to comments relating to shareholder activities, Sec.  
1.482-9T(l)(3)(iv) of the temporary regulations refers to the ``sole 
effect'' rather than the ``primary effect'' of an activity. This change 
clarifies that a shareholder activity is one of which the sole effect 
is either to protect the renderer's capital investment in one or more 
members of the controlled group, or to facilitate compliance by the 
renderer with reporting, legal, or regulatory requirements specifically 
applicable to the renderer, or both. As modified, the definition in 
temporary Sec.  1.482-9T(l)(3)(iv) now conforms to the general

[[Page 44474]]

definition of benefit in Sec.  1.482-9T(l)(3)(i).
    In response to commentators' request for clarification regarding 
the passive association rules, new Sec.  1.482-9T(l)(5) Example 19 
illustrates a situation in which group membership would be taken into 
account in evaluating comparability.
    The Treasury Department and the IRS have inserted the word 
``generally'' in the description of duplicative activities in Sec.  
1.482-9T(l)(3)(iii). This change clarifies that although a duplicative 
activity does not generally give rise to a benefit, under certain 
circumstances, such an activity may provide an increment of value to 
the recipient by reference to the general rule in Sec.  1.482-
9T(l)(3)(i). In such cases, the activity would be appropriately 
classified as a controlled services transaction.
d. Guarantees, Including Financial Guarantees
    The proposed regulations appear to have created confusion on the 
part of some taxpayers regarding the appropriate characterization of 
financial guarantees for tax purposes. The provision of a financial 
guarantee does not constitute a service for purposes of determining the 
source of the guarantee fees. See Centel Communications, Inc. v. 
Commissioner, 920 F.2d 1335 (7th Cir. 1990); Bank of America v. United 
States, 680 F.2d 142 (Ct. Cl. 1980). Nevertheless, some taxpayers have 
suggested that guarantees are services that could qualify for the cost 
safe harbor and that the provision of a guarantee has no cost. This 
position would mean that in effect guarantees are uniformly non-
compensatory. The Treasury Department and the IRS do not agree with 
this uniform no charge rule for guarantees. As a result, financial 
transactions, including guarantees, are explicitly excluded from 
eligibility for the SCM by Sec.  1.482-9T(b)(3)(ii)(H). However, no 
inference is intended by this exclusion that financial transactions 
(including guarantees) would otherwise be considered the provision of 
services for transfer pricing purposes. The Treasury Department and the 
IRS subsequently intend to issue transfer pricing guidance regarding 
financial guarantees, in particular, along with other guidance 
concerning the treatment of global dealing operations. See Section 
A.12.e of this preamble for a discussion of coordination with global 
dealing operations. Such guidance will also include rules to determine 
the source of income from financial guarantees.
e. Third-Party Costs--Temp. Treas. Reg. Sec.  1.482-9T(l)(4)
    Commentators observed that the definition of ``total services 
costs'' in Sec.  1.482-9(j) of the 2003 proposed regulations did not 
address situations in which the costs of a controlled service provider 
included significant charges from uncontrolled parties. Commentators 
claimed that such third-party costs should be treated as ``pass 
through'' items that, in most cases, should not be subject to the 
markup (if any) applicable to costs incurred by the renderer in its 
capacity as service provider. This comment was potentially relevant to 
all cost-based methods in Sec.  1.482-9 of the 2003 proposed 
regulations. The Treasury Department and the IRS agreed that these 
comments raised an issue that needed to be addressed, but decided to do 
so in a manner different from that suggested by the commentators.
    In response to this comment, these temporary regulations include a 
new Sec.  1.482-9T(l)(4). Under this provision, if total services costs 
include material third-party costs, the controlled services transaction 
may be analyzed either as a single transaction or as two separate 
transactions, depending on which approach provides the most reliable 
measure of the arm's length result under the best method rule in 
existing Sec.  1.482-1(c). Consistent with the best method rule, in 
determining which approach provides the most reliable indication of the 
arm's length result, the primary factors are the degree of 
comparability between the controlled services transaction and the 
uncontrolled comparables and the quality of the data and assumptions 
used. New Sec.  1.482-9T(l)(5) Example 20 and Example 21 provide 
illustrations of this rule.
    The rule in Sec.  1.482-9T(l)(4) of the temporary regulations 
applies to all specified methods that use cost to evaluate the arm's 
length charge for controlled services, including the SCM in Sec.  
1.482-9T(b). A determination that a controlled services transaction is 
more reliably evaluated on a disaggregated basis may have an effect on 
the analysis of that transaction under other provisions of these 
regulations.
f. Examples, Temp. Treas. Reg. Sec.  1.482-9T(l)(5)
    Section 1.482-9T(l)(5) of the temporary regulations provides 
numerous examples that illustrate applications of the rules in Sec.  
1.482-9T(l). Changes have been made to certain of these examples to 
conform to the modifications described under the previous headings in 
this section.
12. Coordination With Other Transfer Pricing Rules--Temp. Treas. Reg. 
Sec.  1.482-9T(m)
    Section 1.482-9(m) of the 2003 proposed regulations provided 
coordination rules applicable to a controlled services transaction that 
is combined with, or includes elements of, a non-services transaction. 
These coordination rules relied on the best method rule in existing 
Sec.  1.482-1(c)(1) to determine which method or methods would provide 
the most reliable measure of an arm's length result for a particular 
controlled transaction.
a. Services Transactions That Include Other Types of Transactions--
Temp. Treas. Reg. Sec.  1.482-9T(m)(1)
    A transaction structured as a controlled services transaction may 
include material elements that do not constitute controlled services. 
Section 1.482-9(m)(1) of the 2003 proposed regulations provided that, 
the decision whether to evaluate such a transaction in an integrated 
manner under the transfer pricing methods in Sec.  1.482-9 or to 
evaluate one or more elements separately under services and non-
services methods depends on which of these approaches would provide the 
most reliable measure of an arm's length result. If the non-services 
component(s) of an integrated transaction could be adequately accounted 
for in evaluating the comparability of the controlled transaction to 
the uncontrolled comparables, then the transaction could generally be 
evaluated solely as a controlled service under Sec.  1.482-9.
    One commentator criticized this coordination rule as inherently 
subjective and proposed that a ``predominant character'' test be 
adopted instead. Another commentator interpreted certain statements in 
the preamble as indicating that any controlled transaction that was 
reliably analyzed under one of the transfer pricing methods applicable 
to tangible or intangible property would necessarily be outside the 
scope of the regulations regarding controlled services.
    Upon further consideration, the Treasury Department and the IRS 
believe that no changes are necessary to the coordination rule in Sec.  
1.482-9T(m)(1) because these commentators have misconstrued the 
application of this rule to integrated transactions. The coordination 
rule in Sec.  1.482-9T(m)(1) focuses on the underlying economics of 
such transactions and the most reliable means of evaluating those 
economics under the best method rule. The Treasury Department and the 
IRS recognize that controlled taxpayers have

[[Page 44475]]

substantial flexibility to structure transactions in a variety of 
economically equivalent ways. Provided that the structure adopted has 
economic substance, the coordination rule is designed to respect that 
structure and to seek the most reliable means of evaluating the arm's 
length price. Consequently, if a taxpayer structures a transaction so 
that it constitutes a controlled service, the transaction will 
generally be analyzed under the principles of Sec.  1.482-9T, without 
regard to other provisions of the section 482 regulations.
b. Services Transactions That Effect a Transfer of Intangible 
Property--Temp. Treas. Reg. Sec.  1.482-9T(m)(2)
    Section 1.482-9(m)(2) of the 2003 proposed regulations provided 
that a transaction structured as a controlled service may result in the 
transfer of intangible property, may include an element that 
constitutes the transfer of intangible property, or may have an effect 
similar to the transfer of intangible property. In such cases, if the 
element of the transaction that related to intangible property was 
material, the arm's length result for that element would be determined 
or corroborated under a method provided for in the regulations 
applicable to transfers of intangible property. See existing Sec.  
1.482-4.
    Commentators viewed this rule as potentially authorizing the 
Commissioner to recharacterize a controlled services transaction as a 
transaction that involved a transfer of intangible property. Such 
authority, commentators claimed, was inconsistent with existing Sec.  
1.482-4(b), which defines an intangible as an item that has 
``substantial value independent of the services of any individual.'' 
Commentators also contended that the coordination rules impermissibly 
extended the commensurate with income standard to controlled services 
transactions. Commentators suggested that, assuming each component of a 
controlled services transaction may be reliably accounted for under a 
specified transfer pricing method, no additional analysis is necessary 
concerning elements that arguably pertain to intangible property.
    The Treasury Department and the IRS agree with the commentators 
that the phrase ``may have an effect similar to the transfer of 
intangible property'' could be interpreted as improperly expanding 
Sec.  1.482-4 of the existing regulations to non-intangible 
transactions. This is not the intent of this provision. Consequently, 
to make this clear, the temporary regulations omit this phrase.
    Other concerns raised by commentators misinterpret the interaction 
between this coordination rule and the definition of intangibles in 
Sec.  1.482-4(b). Section 1.482-4(b) of the existing regulations 
contains a list of specified intangibles and a residual category of 
other similar items, all of which must have ``substantial value 
independent of the services of any individual.'' In contrast, the 
coordination rule in Sec.  1.482-9T(m)(2) applies after it is 
determined that an integrated transaction includes an intangible 
component that is material. Because the coordination rule in Sec.  
1.482-9T(m)(2) applies only to transactions that incorporate a material 
intangible component, it is not inconsistent with existing Sec.  1.482-
4(b), nor does it apply the commensurate with income standard of 
existing Sec.  1.482-4(f)(2) to transactions that do not have a 
material element that constitutes an intangible transfer.
    Section 1.482-9(m)(6) Example 4 of the 2003 proposed regulations 
illustrated the application of this rule to a controlled services 
transaction that included an element constituting the transfer of an 
intangible. Several commentators questioned the factual assumptions in 
Example 4. Commentators contended that a controlled party performing 
R&D for another controlled party generally would not have rights in any 
know-how or technical data arising out of the R&D activity; instead the 
contract would specify that the party that paid for the research would 
obtain such rights.
    The Treasury Department and the IRS agree with these comments and 
have concluded that the factual assumptions in this example are 
unclear. Consequently, Example 4 has been redrafted to illustrate a 
situation in which the controlled party performing the R&D is the owner 
of know-how or technical data that resulted from that R&D activity. The 
controlled party then transfers its rights to another controlled party. 
As revised, this example more clearly illustrates application of the 
rule in Sec.  1.482-9T(m)(2).
c. Services Subject to a Qualified Cost Sharing Arrangement--Temp. 
Treas. Reg. Sec.  1.482-9T(m)(3)
    Section 1.482-9(m)(3) of the 2003 proposed regulations provided 
that services provided by a controlled participant under a qualified 
cost sharing arrangement are subject to existing Sec.  1.482-7. The 
Treasury Department and the IRS are in the process of comprehensively 
revising the regulations applicable to cost sharing. In the interim, 
and pending issuance of final regulations that coordinate these two 
provisions, the rule Sec.  1.482-9T(m)(3) retains this coordination 
rule.
d. Other Types of Transaction That Include a Services Transaction--
Temp. Treas. Reg. Sec.  1.482-9T(m)(4)
    Section 1.482-9T(m)(4) is adopted in substantially the same form as 
in the 2003 proposed regulations. A transaction structured other than 
as a controlled services transaction may include material elements that 
constitute controlled services. Section 1.482-9T(m)(4) of these 
temporary regulations provides rules for evaluating such integrated 
transactions. As with the corresponding rules in the 2003 proposed 
regulations, these rules complement the more general rule in Sec.  
1.482-9(m)(1), which relates to integrated transactions structured as 
controlled services transactions.
e. Global Dealing Operations
    In Sec.  1.482-9(m)(5) of the 2003 proposed regulations, the 
section for coordination with the global dealing regulations was 
``reserved.'' In response to comments, this provision is omitted in 
these temporary regulations, based on the view that reserved treatment 
is not appropriate. The Treasury Department and the IRS are presently 
working on new global dealing regulations. The intent of the Treasury 
Department and the IRS is that when final regulations are issued, those 
regulations, not Sec.  1.482-9T, will govern the evaluation of the 
activities performed by a global dealing operation within the scope of 
those regulations. Pending finalization of the global dealing 
regulations, taxpayers may rely on the proposed global dealing 
regulations, not the temporary services regulations, to govern 
financial transactions entered into in connection with a global dealing 
operation as defined in proposed Sec.  1.482-8. Therefore, proposed 
regulations under Sec.  1.482-9(m)(5) issued elsewhere in the Federal 
Register clarify that a controlled services transaction does not 
include a financial transaction entered into in connection with a 
global dealing operation.

B. Income Attributable to Intangibles--Temp. Treas. Reg. Sec.  1.482-
4T(f)(3) and (4)

    The 2003 proposed regulations substantially replaced Sec.  1.482-
4(f)(3) of the existing regulations, which dealt with issues relating 
to the allocation of income from intangibles. The 2003 proposed 
regulations adopted new Sec.  1.482-4(f)(3) and (f)(4), which

[[Page 44476]]

provided modified rules for determining the owner of an intangible for 
purposes of section 482 and also provided rules for determining the 
arm's length compensation in situations where a controlled party other 
than the owner makes contributions to the value of an intangible.
1. Ownership of Intangible Property--Temp. Treas. Reg. Sec.  1.482-
4T(f)(3)
    Section 1.482-4(f)(3)(i)(A) of the 2003 proposed regulations 
contained modified rules for determining the owner of intangible 
property for purposes of section 482. In general, under these rules, 
the controlled party that was identified as the owner of a legally 
protected intangible under the intellectual property laws of the 
relevant jurisdiction or other legal provision was treated as the owner 
of that intangible for purposes of section 482.
    The 2003 proposed regulations also clarified that a license or 
other right to use an intangible may constitute an item of intangible 
property for purposes of section 482. This provision, which 
contemplated the identification of a single owner for each discrete set 
of rights that constitutes an intangible, replaced provisions in the 
existing regulations that could be interpreted as providing for 
multiple owners of an intangible. See Proposed Sec.  1.482-4(f)(3)(i) 
and (f)(3)(iv), Example 4.
    The 2003 proposed regulations also adopted a provision that 
parallels the requirement in the existing regulations, to the effect 
that ownership for purposes of section 482 must be consistent with the 
economic substance of the controlled transaction. Intellectual property 
law generally places relatively few limitations on the ability of 
members of a controlled group to assign or transfer legal ownership 
among themselves. As a result, this rule is a safeguard against purely 
formal assignments of ownership that, if given effect for purposes of 
section 482, could produce results that are inconsistent with the arm's 
length standard.
    Under Sec.  1.482-4(f)(3)(i)(A) of the 2003 proposed regulations, 
in situations where it was not possible to identify the owner of an 
intangible under the intellectual property law of the relevant 
jurisdiction, contractual term, or other legal provision, the 
controlled taxpayer with practical control over the intangible would be 
treated as the owner for purposes of section 482. This provision 
replaced the so-called ``developer-assister'' rule in existing Sec.  
1.482-4(f)(3)(ii)(B). In the case of non-legally protected intangibles, 
the developer-assister rule assigned ownership of an intangible to the 
controlled taxpayer that bore the largest portion of the costs of 
development.
    The 2003 proposed regulations did not adopt the developer-assister 
rule, so they also eliminated related provisions pertaining to 
assistance to the owner of intangible property. In place of those 
rules, the 2003 proposed regulations contained new provisions relating 
to contributions to the value of intangible property owned by another 
controlled party. See Proposed Sec.  1.482-4(f)(4)(i). These rules are 
discussed in greater detail in section B.2 of this preamble.
    Section 1.482-4(f)(3)(i)(B) of the 2003 proposed regulations 
excluded certain intangibles that are subject to the cost sharing 
provisions of Sec.  1.482-7. The Treasury Department and the IRS are 
currently revising the existing regulations related to cost sharing. 
When final cost sharing regulations are issued, Sec.  1.482-4(f)(3) and 
(4) will take into account the changes made to the cost sharing 
provisions.
    Extensive comments were received concerning the revised approach to 
determining ownership of intangibles under section 482. To varying 
degrees, many commentators supported the new ownership standard, noting 
that it should be easier to apply and should produce more certainty of 
results in this area. Other commentators, however, took issue with the 
proposed rules. Some of these commentators took the position that legal 
ownership does not provide an appropriate basis for determining 
ownership under section 482, while others believed that the 
determination of ownership under section 482 should include a full-
scale application of substantive intellectual property law, including 
relevant statutory provisions as well as judicial doctrines and common 
law principles that may bear on the issue of ownership.
    After considering the public comments, the Treasury Department and 
the IRS conclude that legal ownership provides the appropriate 
framework for determining ownership of intangibles under section 482. 
In this specific context, the Treasury Department and the IRS intend 
that the ``legal owner'' under these rules will be the controlled party 
that possesses title to the intangible, based on consideration of the 
facts and circumstances. This analysis would take into account 
applications filed with a central government registry (such as the U.S. 
Patent and Trademark Office or the Copyright Office in the United 
States), any contractual provisions in effect between the controlled 
parties, and other legal provisions. Legal ownership, understood in 
this manner, provides a practical and administrable framework for 
determining ownership of intangibles for purposes of section 482.
    The suggestions that the ownership rules under section 482 should 
in effect incorporate by reference the substantive intellectual 
property rules have not been adopted. In the view of the Treasury 
Department and the IRS, it would be counterproductive to require an in-
depth application of intellectual property law in determining which 
controlled party is treated as the owner under section 482. The primary 
function of intellectual property law is to define the rights of a 
legal entity, which in some cases might be a controlled group, as 
compared with one or more uncontrolled parties that have competing 
claims to the same item of intangible property. For this reason, 
application of the substantive provisions of intellectual property law 
would not be useful, and might in fact produce inappropriate results, 
given that under section 482 the relevant determination is which of 
several controlled parties should be classified as the owner of an 
intangible.
    The Treasury Department and the IRS anticipate that ownership of an 
intangible as determined under the legal owner standard will not 
conflict with the simultaneous requirement that ownership under section 
482 be determined in accordance with the economic substance. For 
example, if the economic substance of the controlled parties' dealings 
conflicts with treatment of the legal owner as the owner under section 
482, the Commissioner may determine ownership by reference to the 
economic substance of the transaction. In other cases, ownership for 
purposes of section 482 should be consistent with the ownership 
determined by reference to either legal ownership or practical control.
    The Treasury Department and the IRS also believe that the 2003 
proposed regulations properly adopted a practical control standard for 
``non-legally protected'' intangibles. The control standard should not 
displace valid contractual terms intended to specify that a particular 
controlled party is the owner of an existing intangible or an 
intangible under development. Because a contractual term constitutes a 
``legal provision,'' the intangible would be analyzed as a legally 
protected intangible, as opposed to a non-legally protected intangible 
subject to the practical control rule.
    Commentators suggested that certain statements in the 2003 proposed 
regulations incorrectly equated a licensee of intangible property with 
a

[[Page 44477]]

distributor of tangible property. In response to these comments, the 
Treasury Department and the IRS have revised the examples in Sec.  
1.482-4T(f)(4)(ii) to avoid any implication that these regulations 
equate or distinguish these business relationships.
2. Contributions to the Value of an Intangible--Temp. Treas. Reg. Sec.  
1.482-4T(f)(4)
    Under Sec.  1.482-4(f)(4)(i) of the 2003 proposed regulations, the 
rules of section 482 were applied to determine the arm's length 
compensation for any activity that was reasonably anticipated to 
increase the value of an intangible owned by another controlled party. 
Such an activity was defined as a ``contribution'' under this 
provision. This provision replaced certain rules in the existing 
regulations that required arm's length compensation to be provided for 
any assistance by a controlled party to the owner of the intangible.
    This new guidance concerning contributions to the value of an 
intangible was intended to provide a more refined framework than the 
rules in existing Sec.  1.482-4(f)(3), in particular by reducing the 
potential for inappropriate, all-or-nothing results. Moreover, because 
the revised rules afforded heightened deference to contractual 
arrangements, they were intended to give controlled taxpayers 
incentives to document transactions on a contemporaneous basis and to 
adhere to the contractual terms agreed upon at the outset of the 
arrangement.
    Section 1.482-4(f)(4)(i) of the 2003 proposed regulations provided 
that compensation for a contribution may be embedded within the terms 
of another transaction, may be stated separately as a fee for services, 
or may be provided for as a reduction in the royalty or the transfer 
price of tangible property. The regulations also recognized that if a 
controlled party's activities are reasonably anticipated to enhance 
only the value of its own rights under a license or exclusive 
distribution arrangement, no compensation is due under the arm's length 
standard. The rules addressed the most commonly encountered factual 
scenarios that potentially give rise to contributions on the part of a 
controlled party.
    Section 1.482-4(f)(4)(i) of the 2003 proposed regulations provided 
that in general a separate allocation is not appropriate if the 
compensation for a contribution was embedded within the terms of a 
related controlled transaction. In such cases, the contribution is 
taken into account in evaluating the comparability of the controlled 
transaction to the uncontrolled comparables and in determining the 
arm's length consideration for the controlled transaction that includes 
the embedded contribution.
    This rule potentially interacted with Sec.  1.482-3(f) of the 
existing regulations, concerning transfers of tangible property 
together with an embedded intangible. For example, assume that a 
reseller of trademarked goods performs activities that are classified 
as contributions within the meaning of Sec.  1.482-4(f)(4). If no 
separate compensation for these activities is provided for by a 
contractual term, then ordinarily no allocation would be appropriate 
either for the embedded trademark or for the underlying activities. 
Both elements would, however, be taken into account in evaluating the 
comparability of the controlled transfer to the uncontrolled 
comparables and in determining the arm's length consideration for the 
controlled transfer of the trademarked goods. See Sec.  1.482-
4T(f)(4)(ii) Example 2.
    Commentators objected to certain aspects of Example 2, Example 3, 
Example 5, and Example 6 in Sec.  1.482-4(f)(4)(ii) of the 2003 
proposed regulations. Those examples stated that, if it is not possible 
to identify uncontrolled transactions that incorporated a similar range 
of interrelated elements as the nonroutine contributions by the 
controlled parties, it may be appropriate to apply a residual profit 
split analysis. In the opinion of commentators, these statements 
implied that profit split methods were preferred methods in any case 
that involved a contribution to the value of an intangible.
    The Treasury Department and the IRS agree with these comments. 
There was no intention to imply any such treatment of the residual 
profit split method. As a result, these statements in the examples have 
been eliminated. In addition, the examples in the temporary regulations 
specifically refer to the best method rule and cross-reference new 
Example 10, Example 11, and Example 12 in Sec.  1.482-8, which show 
application of the best method rule to intangible development 
activities. See also section A.6 of this preamble, concerning 
definition of nonroutine contribution for purposes of the profit split 
methods.
    In addition, and in response to comments, a new Example 5 in Sec.  
1.482-1T(d)(3)(ii)(C) illustrates factual circumstances in which 
contractual terms pertaining to intangible development activities are 
respected, although on examination the activities are found to be 
priced on a non-arm's length basis. Together, these changes clarify 
that, subject to the best method rule and satisfaction of economic 
substance requirements, controlled parties may adopt contractual terms 
that provide for marketing, research and development, or other 
intangible development activities to be compensated based on 
reimbursement of specified costs plus a profit element. The underlying 
contractual compensation terms will be given effect for purposes of 
section 482 as long as they have economic substance.
    Commentators sought clarification regarding the term ``incremental 
marketing activities,'' which was used in several examples in Sec.  
1.482-4(f)(4)(ii) of the 2003 proposed regulations.
    In the examples, the term ``incremental marketing activities'' 
referred to activities by a controlled party that are quantitatively 
greater (in terms of volume, expense, etc.) than the activities 
undertaken by comparable uncontrolled parties in the transactions used 
to analyze the controlled transaction. Such activities must be taken 
into account by either evaluating a separate transaction that accounts 
for such incremental activities or analyzing the underlying transaction 
and making necessary adjustments to the uncontrolled transactions to 
incorporate such activities into the comparability analysis. Discrete 
changes were made to the examples to clarify these principles. As a 
result, apart from this additional clarification, these comments are 
not adopted.
    Commentators proposed that the Treasury Department and the IRS 
adopt discounted cash-flow analysis (DCF) as a specified method for 
analysis of contributions. The Treasury Department and the IRS find it 
unnecessary to do so because they already recognize DCF as one of 
several approaches that may be reliably applied to evaluate intangible 
property. This method may be particularly useful, either as an 
unspecified method or in conjunction with one of the specified methods, 
in evaluating contributions within the meaning of Sec.  1.482-
4T(f)(4)(i). Further consideration is being given to the suggestion to 
adopt DCF as a specified method in its own right.

C. Contractual Terms Imputed From Economic Substance--Sec.  1.482-
1(d)(3)(ii)(C), Examples 3, 4, 5, and 6

    Central to the approach taken in the 2003 proposed regulations were 
the concepts that controlled taxpayers have substantial freedom to 
adopt contractual terms, and that such contractual terms are given 
effect under section 482, provided they are in accord with the economic 
substance of the controlled

[[Page 44478]]

parties' dealings. An important corollary of these principles, however, 
applies where controlled parties fail to specify contractual terms, or 
specify terms that are not consistent with economic substance. In such 
cases, the Commissioner may impute contractual terms to accord with the 
economic substance of the controlled parties' activities. See Sec.  
1.482-1(d)(3) of the existing regulations.
    Commentators raised several concerns regarding the potential 
interaction between the economic substance rules in existing Sec.  
1.482-1(d)(3) and certain provisions in the 2003 proposed regulations, 
including those relating to contributions to the value of intangibles 
and contingent-payment contractual terms. Some commentators suggested 
that application of these provisions together with the existing 
economic substance rules could create incentives for the Commissioner 
to make inappropriate adjustments, e.g., to impute contingent-payment 
terms or transfers of intangibles in any situation in which non-arm's 
length pricing was identified.
    It bears emphasis that the Commissioner may invoke his authority 
under Sec.  1.482-1(d)(3)(ii) in only two situations: (1) Controlled 
taxpayers fail to specify contractual terms for the transaction; or (2) 
controlled taxpayers specify contractual terms that are not in 
accordance with economic substance. Clearly, if contributions within 
the meaning of Sec.  1.482-4T(f)(4)(i) are present, the contractual 
terms of the controlled transaction should address those contributions 
in a manner that accords with economic substance. If this is not the 
case, the Commissioner must impute an arrangement that best conforms to 
the economic substance of the transaction. In given facts and 
circumstances, it may be possible to rely on evidence that the taxpayer 
brings forward. In other circumstances, the Commissioner will impute an 
arrangement based on economic substance, taking into account the facts 
and circumstances, the parties' conduct, and other relevant evidence, 
including any that the taxpayer brings forward on examination. See 
Example 3, Example 4, and Example 6 in Sec.  1.482-1T(d)(3)(ii)(C).
    In response to comments, Sec.  1.482-1T(d)(3)(ii)(C) includes a new 
Example 5, which illustrates the interaction of the economic substance 
rule with general transfer pricing rules in the context of intangible 
development activities. In the example, the contractual terms specify 
that intangible development activities are priced by reference to 
reimbursement of specified costs plus a markup or profit component. On 
examination, the Commissioner determines that the specified 
compensation falls outside the arm's length range, as determined by 
comparison to uncontrolled transactions. The example illustrates that 
this determination, without more, does not support a conclusion that 
the contractual terms lacked economic substance. If, however, the 
compensation paid is outside the arm's length range by a substantial 
amount, the Commissioner may take that fact into account in determining 
whether the contractual arrangement as a whole possessed economic 
substance.
    The examples in Sec.  1.482-1(d)(3)(ii)(C) of the 2003 proposed 
regulations described alternative constructions that the Commissioner 
might adopt if the contractual terms for the controlled transaction 
were not in accordance with economic substance: These alternatives 
included: (1) Imputation of a separate services arrangement, with 
contingent-payment terms; (2) imputation of a long-term, exclusive 
distribution arrangement; or (3) requiring compensation for termination 
of an imputed long-term license arrangement. The Treasury Department 
and the IRS believe that one or more of these arrangements may be 
appropriate, depending on the facts of the specific case.
    Commentators expressed concerns regarding the scope of the 
Commissioner's authority to impute arrangements based on economic 
substance. Some commentators suggested that a single set of contractual 
terms should apply in any situation where the Commissioner determines 
that the controlled parties' contractual terms lack economic substance. 
Another commentator recommended that the Commissioner should impute 
only contractual terms similar to those observed in comparable 
uncontrolled transactions. After much consideration, the Treasury 
Department and the IRS have not adopted these comments. The 
determination of the economic substance of a transaction between 
related parties necessarily turns on an examination of all the facts 
and circumstances. Under the regulations, the taxpayer is in control of 
this issue in the first instance to the extent it expressly sets forth 
the economic substance in contractual terms and its conduct and 
arrangements are consistent with these terms. Otherwise, the IRS is 
forced to try and impute the economic substance based on whatever facts 
and circumstances are available, including any information the taxpayer 
brings forward on examination.
    Commentators also suggested that under the 2003 proposed 
regulations, the Commissioner's authority to impute contingent-payment 
contractual terms was unnecessarily broad. In the commentators' view, 
this authority would lead the Commissioner to apply commensurate with 
income principles to controlled transactions that have no significant 
intangible property component. The Commissioner's authority to impute 
contingent-payment contractual terms was appropriately tailored to 
result in application of economic substance principles in those 
situations where it was warranted. The Treasury Department and the IRS 
believe that the commensurate with income principle of the statute is 
consistent with the arm's length principle and fundamentally relates to 
the underlying economic substance and true risk allocations inherent in 
the relevant controlled transactions. Related parties may, with 
economic substance, agree to compensate one another for services with 
compensation payable only in future periods contingent on the success 
or failure of the services to produce the contemplated results. Related 
parties may expressly enter into those contractual terms and, in the 
absence of express terms or where the related parties' conduct and 
arrangements are inconsistent with their contractual terms, the IRS may 
in appropriate facts and circumstances impute contingent-payment 
contractual terms.

D. Stewardship Expenses--Sec.  1.861-8T

    The temporary regulations would modify the present regulations 
under Sec.  1.861-8(e)(4) to conform to, and to be consistent with, the 
revised language relating to controlled services transactions as set 
forth in Sec.  1.482-9T(l).

E. Effective Date--Sec.  1.482-9T(n)

    In order to achieve the goal of updating the 1968 regulations, 
while facilitating consideration of further public input in refining 
final rules, these regulations are issued in temporary form with a 
delayed effective date for taxable years beginning after December 31, 
2006. Controlled taxpayers may also elect to apply these temporary 
regulations to any taxable year beginning after September 10, 2003, the 
date of publication of the 2003 proposed regulations. Where such an 
election is made, the temporary regulations will apply in full to such 
taxable year and all subsequent taxable years of the taxpayer making 
the election. Such an election must be made by attaching a statement to 
the taxpayer's timely filed U.S. tax return

[[Page 44479]]

(including extensions) for its first taxable year after December 31, 
2006.
    These regulations are issued after proposed revisions to the 
regulations pertaining to cost sharing arrangements. By issuing 
regulations in temporary and proposed form concerning controlled 
services and the allocation of income from intangibles, the Treasury 
Department and the IRS also provide taxpayers an opportunity to submit 
comments that take into account the potential interaction between these 
two sets of regulations.
    The initial list of specified covered services for purposes of the 
SCM is being issued for public input in the form of an Announcement in 
tandem with these temporary regulations. This Announcement will be 
published in the Internal Revenue Bulletin. For copies of the Internal 
Revenue Bulletin, see Sec.  601.601(d)(2)(ii)(b). The Treasury 
Department and the IRS intend to take all public comments into account 
and issue a final revenue procedure that will be effective coincident 
with the delayed effective date of these temporary regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
refer to the Special Analyses section of the preamble to the cross-
reference notice of proposed rulemaking published in the Proposed Rules 
section in this issue of the Federal Register. Pursuant to section 
7805(f) of the Internal Revenue Code, these temporary regulations will 
be submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are Thomas A. Vidano and 
Carol B. Tan, Office of Associate Chief Counsel (International) for 
matters relating to section 482, and David Bergkuist, Office of 
Associate Chief Counsel (International) for matters relating to 
stewardship.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

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

Amendment to the Regulations

0
Accordingly, 26 CFR parts 1 and 31 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.482-9 also issued under 26 U.S.C. 482. * * *

0
Par. 2. Section 1.482-0 is amended as follows:
0
1. The section heading is revised.
0
2. The entries for 1.482-1(a)(1), (b)(2)(i), (d)(3)(ii)(C), (d)(3)(v), 
(f)(2)(ii)(A), (f)(2)(ii)(B), (g)(4)(iii), (i) and (j) are revised.
0
3. The entries for Sec.  1.482-2(b) are revised.
0
4. The entries for Sec.  1.482-4(f)(3), (f)(4) and (f)(5) are revised 
and new entries for Sec.  1.482-4(f)(6) and (f)(7) are added.
0
5. The entries for 1.482-6(c)(2)(ii)(B)(1), (c)(2)(ii)(D), 
(c)(3)(i)(A), (c)(3)(i)(B) and (c)(3)(ii)(D) are revised and the entry 
for 1.482-6(d) is added.
0
6. The entry for 1.482-8(a) is revised.
0
7. The entries for 1.482-9 are added.
    The additions and revisions read as follows:


Sec.  1.482-0  Outline of regulations under section 482.

* * * * *


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

    (a)(1) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(a)(1).
* * * * *
    (b) * * *
    (2) * * *
    (i) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(b)(2)(i).
* * * * *
    (d) * * *
    (3) * * *
    (ii) * * *
    (C) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(d)(3)(ii)(C).
    (v) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(d)(3)(v).
* * * * *
    (f) * * *
    (2) * * *
    (ii) * * *
    (A) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(f)(2)(ii)(A).
    (iii) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(f)(2)(iii)(B).
* * * * *
    (g) * * *
    (4) * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(g)(4)(iii).
* * * * *
    (i) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(i).
* * * * *
    (j) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-1T(j).


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

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


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

* * * * *
    (f) * * *
    (3) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-4T(f)(3).
    (4) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-4T(f)(4).
    (5) Consideration not artificially limited.
    (6) Lump sum payments
    (i) In general.
    (ii) Exceptions.
    (iii) Example.
    (7) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-4T(f)(7).


Sec.  1.482-6  Profit split method.

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (B) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-6T(c)(2)(ii)(B)(1).
* * * * *
    (D) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-6T(c)(2)(ii)(D).
    (3) * * *
    (i) * * *
    (A) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-6T(c)(3)(i)(A).
    (B) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-6T(c)(3)(i)(B).
    (ii) * * *
    (D) [Reserved]. For further guidance, see Sec.  1.482-0T, the 
entry for Sec.  1.482-6T(c)(3)(ii)(D).
* * * * *
    (d) Effective date. [Reserved]. For further guidance, see Sec.  
1.482-0T, the entry for Sec.  1.482-6T(d).


Sec.  1.482-8  Examples of the best method rule.

    (a) Introduction.
* * * * *

[[Page 44480]]

Sec.  1.482-9  Methods to determine taxable income in connection with a 
controlled services transaction. [Reserved].

    For further guidance, see Sec.  1.482-0T, the entries for Sec.  
1.482-9T.

0
Par. 3. Section 1.482-0T is added to read as follows:


Sec.  1.482-0T  Outline of regulations under section 482.

    This section contains major captions for Sec. Sec.  1.482-1T, 
1.482-2T, 1.482-4T, 1.482-6T, 1.482-8T, and Sec.  1.482-9T.


Sec.  1.482-1T  Allocation of income and deductions among taxpayers.

    (a) In general.
    (1) Purpose and scope.
    (2) through (b)(1) [Reserved]. For further guidance, see Sec.  
1.482-0, the entry for Sec.  1.482-1(a)(2) through (b)(1).
    (b)(2) Arm's length methods.
    (i) Methods.
    (b)(2)(ii) through (d)(3)(ii)(B) [Reserved]. For further 
guidance, see Sec.  1.482-0, the entry for Sec.  1.482-1(b)(2)(ii) 
through (c)(3)(ii)(B).
    (C) Examples.
    (d)(3)(iii) and (iv) [Reserved]. For further guidance, see Sec.  
1.482-0, the entry for Sec.  1.482-1(d)(3)(iii) and (iv).
    (v) Property or services.
    (d)(4) through (f)(2)(i) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entry for Sec.  1.482-1(d)(4) through (f)(2)(i).
    (ii) Allocation based on taxpayer's actual transactions.
    (A) In general.
    (f)(2)(ii)(B) through (f)(2)(iii)(A) [Reserved]. For further 
guidance, see Sec.  1.482-0, the entry for Sec.  1.482-
1(f)(2)(ii)(B) through (f)(2)(iii)(A).
    (B) Circumstances warranting consideration of multiple year 
data.
    (f)(2)(iii)(C) through (g)(3) [Reserved]. For further guidance, 
see Sec.  1.482-0, the entry for Sec.  1.482-1(f)(2)(iii)(C) through 
(g)(3).
    (4) Setoffs.
    (i) In general.
    (g)(4)(ii) [Reserved]. For further guidance, see Sec.  1.482-0, 
the entry for Sec.  1.482-1(g)(4)(ii).
    (iii) Examples.
    (g)(4)(iii) Example 2 through (h) [Reserved]. For further 
guidance, see Sec.  1.482-0, the entry for Sec.  1.482-1(g)(4)(iii) 
Example 2 through (h).
    (i) Definitions.
    (i)(1) through (10) [Reserved]. For further guidance, see Sec.  
1.482-0, the entry for Sec.  1.482-1(i)(1) through (10).
    (j) Effective date.
    (1) In general.
    (2) Election to apply regulation to earlier years.
    (3) Expiration date.


Sec.  1.482-2T  Determination of taxable income in specific situations.

    (a) [Reserved]. For further guidance, see Sec.  1.482-0, the 
entry for Sec.  1.482-2(a).
    (b) Rendering of services.
    (c) [Reserved]. For further guidance, see Sec.  1.482-0, the 
entry for Sec.  1.482-2(c).
    (d) [Reserved]. For further guidance, see Sec.  1.482-0, the 
entry for Sec.  1.482-2(d).
    (e) Effective date.
    (1) In general.
    (2) Election to apply regulation to earlier years.
    (3) Expiration date.


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

    (a) through (f)(2) [Reserved]. For further guidance, see Sec.  
1.482-0, the entry for Sec.  1.482-4(a) through (f)(2).
    (3) Ownership of intangible property.
    (i) Identification of owner.
    (A) In general.
    (B) Cost sharing arrangements.
    (ii) Examples.
    (4) Contribution to the value of an intangible owned by another.
    (i) In general.
    (ii) Examples.
    (f)(5) and (f)(6) [Reserved]. For further guidance, see Sec.  
1.482-0, the entry for Sec.  1.482-4(f)(5) and (f)(6).
    (7) Effective date.
    (i) In general.
    (ii) Election to apply regulation to earlier years.
    (iii) Expiration date.


Sec.  1.482-6T  Profit split method.

    (a) through (c)(2)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entry for Sec.  1.482-6(a) through (c)(2)(ii)(A).
    (B) Comparability.
    (1) In general.
    (c)(2)(ii)(B)(2) through (C) [Reserved]. For further guidance, 
see Sec.  1.482-0, the entry for Sec.  1.482-6(c)(2)(ii)(B)(2) 
through (C).
    (D) Other factors affecting reliability.
    (c)(3)(i) [Reserved]. For further guidance, see Sec.  1.482-0, 
the entry for Sec.  1.482-6(c)(3)(i).
    (A) Allocate income to routine contributions.
    (B) Allocate residual profit.
    (1) Nonroutine contributions generally.
    (2) Nonroutine contributions of intangible property.
    (c)(3)(ii)(A) through (C) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entry for Sec.  1.482-6(c)(3)(ii)(A) through (C).
    (D) Other factors affecting reliability.
    (c)(3)(iii) [Reserved]. For further guidance, see Sec.  1.482-0, 
the entry for Sec.  1.482-6(c)(3)(iii).
    (d) Effective date.
    (1) In general.
    (2) Election to apply regulation to earlier taxable years.
    (3) Expiration date.


Sec.  1.482-8T  Examples of the best method rule.

    (a) [Reserved]. For further guidance, see Sec.  1.482-0, the 
entry for Sec.  1.482-8(a).
    (b) [Reserved]. For further guidance, see Sec.  1.482-0, the 
entry for Sec.  1.482-8(b)
    (c) Effective date.
    (1) In general.
    (2) Election to apply regulation to earlier taxable years.
    (3) Expiration date.


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

    (a) In general.
    (b) Services cost method
    (1) In general.
    (2) Not services that contribute significantly to fundamental 
risks of business success or failure.
    (3) Other conditions on application of services cost method.
    (i) Adequate books and records.
    (ii) Excluded transactions.
    (4) Covered services.
    (i) Specified covered services.
    (ii) Low margin covered services.
    (5) Shared services arrangement.
    (i) In general.
    (ii) Requirements for shared services arrangement.
    (A) Eligibility.
    (B) Allocation.
    (C) Documentation.
    (iii) Definition and special rules.
    (A) Participant.
    (B) Aggregation.
    (C) Coordination with cost sharing arrangements.
    (6) Examples.
    (c) Comparable uncontrolled services price method.
    (1) In general.
    (2) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) In general.
    (B) Adjustments for differences between controlled and 
uncontrolled transactions.
    (iii) Data and assumptions.
    (3) Arm's length range.
    (4) Examples.
    (5) Indirect evidence of the price of a comparable uncontrolled 
services transaction.
    (i) In general.
    (ii) Example.
    (d) Gross services margin method.
    (1) In general.
    (2) Determination of arm's length price.
    (i) In general.
    (ii) Relevant uncontrolled transaction.
    (iii) Applicable uncontrolled price.
    (iv) Appropriate gross services profit.
    (v) Arm's length range.
    (3) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) Functional comparability.
    (B) Other comparability factors.
    (C) Adjustments for differences between controlled and 
uncontrolled transactions.
    (D) Buy-sell distributor.
    (iii) Data and assumptions.
    (A) In general.
    (B) Consistency in accounting.
    (4) Examples.
    (e) Cost of services plus method.
    (1) In general.
    (2) Determination of arm's length price.
    (i) In general.
    (ii) Appropriate gross services profit.
    (iii) Comparable transactional costs.
    (iv) Arm's length range.
    (3) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) Functional comparability.
    (B) Other comparability factors.
    (C) Adjustments for differences between the controlled and 
uncontrolled transactions.

[[Page 44481]]

    (iii) Data and assumptions.
    (A) In general.
    (B) Consistency in accounting.
    (4) Examples.
    (f) Comparable profits method.
    (1) In general.
    (2) Determination of arm's length result.
    (i) Tested party.
    (ii) Profit level indicators.
    (iii) Comparability and reliability considerations--Data and 
assumptions--Consistency in accounting.
    (3) Examples.
    (g) Profit split method.
    (1) In general.
    (2) Examples.
    (h) Unspecified methods.
    (i) Contingent-payment contractual terms for services.
    (1) Contingent-payment contractual terms recognized in general.
    (2) Contingent-payment arrangement.
    (i) General Requirements
    (A) Written contract.
    (B) Specified contingency.
    (C) Basis for payment.
    (ii) Economic Substance and Conduct
    (3) Commissioner's authority to impute contingent-payment terms.
    (4) Evaluation of arm's length charge.
    (5) Examples.
    (j) Total services costs.
    (k) Allocation of costs.
    (1) In general.
    (2) Appropriate method of allocation and apportionment.
    (i) Reasonable method standard.
    (ii) Use of general practices.
    (3) Examples.
    (l) Controlled services transaction.
    (1) In general.
    (2) Activity.
    (3) Benefit.
    (i) In general.
    (ii) Indirect or remote benefit.
    (iii) Duplicative activities.
    (iv) Shareholder activities.
    (v) Passive association.
    (4) Disaggregation of Transactions
    (5) Examples.
    (m) Coordination with transfer pricing rules for other 
transactions.
    (1) Services transactions that include other types of 
transactions.
    (2) Services transactions that effect a transfer of intangible 
property.
    (3) Services subject to a qualified cost sharing arrangement.
    (4) Other types of transactions that include controlled services 
transactions.
    (5) Examples.
    (n) Effective date.
    (1) In general.
    (2) Election to apply regulations to earlier taxable years.
    (3) Expiration date.


0
Par. 4. Section 1.482-1 is amended as follows:
0
1. Paragraphs (a)(1), (b)(2)(i), (d)(3)(ii)(C) Example 3, (d)(3)(v), 
(f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii) and paragraph (i) 
are revised.
0
2. Paragraph (d)(3)(ii)(C) Examples 4 through 6 are added.
0
3. Paragraph (j)(6) is added.
    The addition and revisions read as follows:


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

    (a)(1) [Reserved]. For further guidance, see Sec.  1.482-1T(a)(1).
* * * * *
    (b) * * * (1) * * *
    (b)(2)(i) [Reserved]. For further guidance, see Sec.  1.482-
1T(b)(2)(i).
* * * * *
    (d) * * *
    (3) * * *
    (ii) * * *
    (C) * * *
    Example 3. [Reserved]. For further guidance, see Sec.  1.482-
1T(d)(3)(ii)(C), Example 3.
    Examples 4 through 6. [Reserved]. For further guidance, see 1.482-
1T(d)(3)(ii)(C) Examples 4 through 6.
* * * * *
    (v) [Reserved]. For further guidance, see Sec.  1.482-1T(d)(3)(v).
* * * * *
    (f) * * *
    (2) * * *
    (ii)(A) [Reserved]. For further guidance, see Sec.  1.482-
1T(f)(2)(ii)(A).
* * * * *
    (iii) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.482-
1T(f)(3)(iii)(B).
* * * * *
    (g) * * *
    (4) * * * (i) * * * [Reserved]. For further guidance, see Sec.  
1.482-1T(g)(4)(i).
    (iii) * * *
    Example 1. [Reserved]. For further guidance, see Sec.  1.482-
1T(g)(4)(iii), Example 1.
* * * * *
    (i) [Reserved]. For further guidance, see Sec.  1.482-1T(i).
    (j) * * *
    (6) [Reserved]. For further guidance, see Sec.  1.482-1T(j)(6).
    Par. 5. Section 1.482-1T is added to read as follows:


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

    (a) In general--(1) Purpose and scope. The purpose of section 482 
is to ensure that taxpayers clearly reflect income attributable to 
controlled transactions and to prevent the avoidance of taxes with 
respect to such transactions. Section 482 places a controlled taxpayer 
on a tax parity with an uncontrolled taxpayer by determining the true 
taxable income of the controlled taxpayer. This section sets forth 
general principles and guidelines to be followed under section 482. 
Section 1.482-2 provides rules for the determination of the true 
taxable income of controlled taxpayers in specific situations, 
including controlled transactions involving loans or advances or the 
use of tangible property. Sections 1.482-3 through 1.482-6 provide 
rules for the determination of the true taxable income of controlled 
taxpayers in cases involving the transfer of property. Section 1.482-7T 
sets forth the cost sharing provisions applicable to taxable years 
beginning on or after October 6, 1994, and before January 1, 1996. 
Section 1.482-7 sets forth the cost sharing provisions applicable to 
taxable years beginning on or after January 1, 1996. Section 1.482-8 
provides examples illustrating the application of the best method rule. 
Finally, Sec.  1.482-9T provides rules for the determination of the 
true taxable income of controlled taxpayers in cases involving the 
performance of services.
    (a)(2) through (b)(1) [Reserved]. For further guidance, see Sec.  
1.482-1(a)(2) through (b)(1).
    (b)(2) Arm's length methods--(i) Methods. Sections 1.482-2 through 
1.482-6 and Sec.  1.482-9T provide specific methods to be used to 
evaluate whether transactions between or among members of the 
controlled group satisfy the arm's length standard and, if they do not, 
to determine the arm's length result. Section 1.482-7 provides the 
specific method to be used to evaluate whether a qualified cost sharing 
arrangement produces results consistent with an arm's length result.
    (b)(2)(ii) through (d)(3)(ii)(C), Examples 1, and 2 [Reserved]. For 
further guidance, see Sec.  1.482-1(b)(2)(ii) through (d)(3)(ii)(C), 
Examples 1 and 2.

    Example 3. Contractual terms imputed from economic substance. 
(i) FP, a foreign producer of wristwatches, is the registered holder 
of the YY trademark in the United States and in other countries 
worldwide. In year 1, FP enters the United States market by selling 
YY wristwatches to its newly organized United States subsidiary, 
USSub, for distribution in the United States market. USSub pays FP a 
fixed price per wristwatch. USSub and FP undertake, without separate 
compensation, marketing activities to establish the YY trademark in 
the United States market. Unrelated foreign producers of trademarked 
wristwatches and their authorized United States distributors 
respectively undertake similar marketing activities in independent 
arrangements involving distribution of trademarked wristwatches in 
the United States market. In years 1 through 6, USSub markets and 
sells YY wristwatches in the United States. Further, in years 1 
through 6, USSub undertakes incremental marketing activities in 
addition to the activities similar to those observed in the 
independent distribution transactions in the United States market. 
FP does not directly or indirectly compensate USSub for performing 
these incremental activities during years 1 through 6. Assume

[[Page 44482]]

that, aside from these incremental activities, and after any 
adjustments are made to improve the reliability of the comparison, 
the price paid per wristwatch by the independent, authorized 
distributors of wristwatches would provide the most reliable measure 
of the arm's length price paid per YY wristwatch by USSub.
    (ii) By year 7, the wristwatches with the YY trademark generate 
a premium return in the United States market, as compared to 
wristwatches marketed by the independent distributors. In year 7, 
substantially all the premium return from the YY trademark in the 
United States market is attributed to FP, for example through an 
increase in the price paid per watch by USSub, or by some other 
means.
    (iii) In determining whether an allocation of income is 
appropriate in year 7, the Commissioner may consider the economic 
substance of the arrangements between USSub and FP, and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that, ex 
ante, an uncontrolled taxpayer operating at arm's length would 
engage in the incremental marketing activities to develop or enhance 
an intangible owned by another party unless it received 
contemporaneous compensation or otherwise had a reasonable 
anticipation of receiving a future benefit from those activities. In 
this case, USSub's undertaking the incremental marketing activities 
in years 1 through 6 is a course of conduct that is inconsistent 
with the parties' attribution to FP in year 7 of substantially all 
the premium return from the enhanced YY trademark in the United 
States market. Therefore, the Commissioner may impute one or more 
agreements between USSub and FP, consistent with the economic 
substance of their course of conduct, which would afford USSub an 
appropriate portion of the premium return from the YY trademark 
wristwatches. For example, the Commissioner may impute a separate 
services agreement that affords USSub contingent-payment 
compensation for its incremental marketing activities in years 1 
through 6, which benefited FP by contributing to the value of the 
trademark owned by FP. In the alternative, the Commissioner may 
impute a long-term, exclusive agreement to exploit the YY trademark 
in the United States that allows USSub to benefit from the 
incremental marketing activities it performed. As another 
alternative, the Commissioner may require FP to compensate USSub for 
terminating USSub's imputed long-term, exclusive agreement to 
exploit the YY trademark in the United States, an agreement that 
USSub made more valuable at its own expense and risk. The taxpayer 
may present additional facts that could indicate which of these or 
other alternative agreements best reflects the economic substance of 
the underlying transactions, consistent with the parties' course of 
conduct in the particular case.
    Example 4. Contractual terms imputed from economic substance. 
(i) FP, a foreign producer of athletic gear, is the registered 
holder of the AA trademark in the United States and in other 
countries worldwide. In year 1, FP enters into a licensing agreement 
that affords its newly organized United States subsidiary, USSub, 
exclusive rights to certain manufacturing and marketing intangibles 
(including the AA trademark) for purposes of manufacturing and 
marketing athletic gear in the United States under the AA trademark. 
The contractual terms of this agreement obligate USSub to pay FP a 
royalty based on sales, and also obligate both FP and USSub to 
undertake without separate compensation specified types and levels 
of marketing activities. Unrelated foreign businesses license 
independent United States businesses to manufacture and market 
athletic gear in the United States, using trademarks owned by the 
unrelated foreign businesses. The contractual terms of these 
uncontrolled transactions require the licensees to pay royalties 
based on sales of the merchandise, and obligate the licensors and 
licensees to undertake without separate compensation specified types 
and levels of marketing activities. In years 1 through 6, USSub 
manufactures and sells athletic gear under the AA trademark in the 
United States. Assume that, after adjustments are made to improve 
the reliability of the comparison for any material differences 
relating to marketing activities, manufacturing or marketing 
intangibles, and other comparability factors, the royalties paid by 
independent licensees would provide the most reliable measure of the 
arm's length royalty owed by USSub to FP, apart from the additional 
facts in paragraph (ii) of this example.
    (ii) In years 1 through 6, USSub performs incremental marketing 
activities with respect to the AA trademark athletic gear, in 
addition to the activities required under the terms of the license 
agreement with FP, that are also incremental as compared to those 
observed in the comparables. FP does not directly or indirectly 
compensate USSub for performing these incremental activities during 
years 1 through 6. By year 7, AA trademark athletic gear generates a 
premium return in the United States, as compared to similar athletic 
gear marketed by independent licensees. In year 7, USSub and FP 
enter into a separate services agreement under which FP agrees to 
compensate USSub on a cost basis for the incremental marketing 
activities that USSub performed during years 1 through 6, and to 
compensate USSub on a cost basis for any incremental marketing 
activities it may perform in year 7 and subsequent years. In 
addition, the parties revise the license agreement executed in year 
1, and increase the royalty to a level that attributes to FP 
substantially all the premium return from sales of the AA trademark 
athletic gear in the United States.
    (iii) In determining whether an allocation of income is 
appropriate in year 7, the Commissioner may consider the economic 
substance of the arrangements between USSub and FP and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that, ex 
ante, an uncontrolled taxpayer operating at arm's length would 
engage in the incremental marketing activities to develop or enhance 
an intangible owned by another party unless it received 
contemporaneous compensation or otherwise had a reasonable 
anticipation of a future benefit. In this case, USSub's undertaking 
the incremental marketing activities in years 1 through 6 is a 
course of conduct that is inconsistent with the parties' adoption in 
year 7 of contractual terms by which FP compensates USSub on a cost 
basis for the incremental marketing activities that it performed. 
Therefore, the Commissioner may impute one or more agreements 
between USSub and FP, consistent with the economic substance of 
their course of conduct, which would afford USSub an appropriate 
portion of the premium return from the AA trademark athletic gear. 
For example, the Commissioner may impute a separate services 
agreement that affords USSub contingent-payment compensation for the 
incremental activities it performed during years 1 through 6, which 
benefited FP by contributing to the value of the trademark owned by 
FP. In the alternative, the Commissioner may impute a long-term, 
exclusive United States license agreement that allows USSub to 
benefit from the incremental activities. As another alternative, the 
Commissioner may require FP to compensate USSub for terminating 
USSub's imputed long-term United States license agreement, a license 
that USSub made more valuable at its own expense and risk. The 
taxpayer may present additional facts that could indicate which of 
these or other alternative agreements best reflects the economic 
substance of the underlying transactions, consistent with the 
parties' course of conduct in this particular case.
    Example 5. Non-arm's length compensation. (i) The facts are the 
same as in paragraph (i) of Example 4. As in Example 4, assume that, 
after adjustments are made to improve the reliability of the 
comparison for any material differences relating to marketing 
activities, manufacturing or marketing intangibles, and other 
comparability factors, the royalties paid by independent licensees 
would provide the most reliable measure of the arm's length royalty 
owed by USSub to FP, apart from the additional facts described in 
paragraph (ii) of this example.
    (ii) In years 1 through 4, USSub performs certain incremental 
marketing activities with respect to the AA trademark athletic gear, 
in addition to the activities required under the terms of the basic 
license agreement, that are also incremental as compared with those 
activities observed in the comparables. At the start of year 1, FP 
enters into a separate services agreement with USSub, which states 
that FP will compensate USSub quarterly, in an amount equal to 
specified costs plus X%, for these incremental marketing functions. 
Further, these written agreements reflect the intent of the parties 
that USSub receive such compensation from FP throughout the term of 
the agreement, without regard to the success or failure of the 
promotional activities. During years 1 though 4, USSub performs 
marketing activities pursuant to the separate services agreement and 
in each year USSub receives the specified compensation from FP on a 
cost of services plus basis.
    (iii) In evaluating year 4, the Commissioner performs an 
analysis of independent parties that perform promotional activities 
comparable to those performed by USSub

[[Page 44483]]

and that receive separately-stated compensation on a current basis 
without contingency. The Commissioner determines that the magnitude 
of the specified cost plus X% is outside the arm's length range in 
each of years 1 through 4. Based on an evaluation of all the facts 
and circumstances, the Commissioner makes an allocation to require 
payment of compensation to USSub for the promotional activities 
performed in year 4, based on the median of the interquartile range 
of the arm's length markups charged by the uncontrolled comparables 
described in Sec.  1.482-1(e)(3).
    (iv) Given that based on facts and circumstances, the terms 
agreed by the controlled parties were that FP would bear all risks 
associated with the promotional activities performed by USSub to 
promote the AA trademark product in the United States market, and 
given that the parties' conduct during the years examined was 
consistent with this allocation of risk, the fact that the cost of 
services plus markup on USSub's services was outside the arm's 
length range does not, without more, support imputation of 
additional contractual terms based on alternative views of the 
economic substance of the transaction, such as terms indicating that 
USSub, rather than FP, bore the risk associated with these 
activities. In other facts and circumstances, had the compensation 
paid to USSub been significantly outside the arm's length range, 
that might lead the Commissioner to examine further whether, despite 
the contractual terms that require cost-plus reimbursement of USSub, 
the economic substance of the transaction was not consistent with 
FP's bearing the risk associated with promotional activities in the 
United States market.
    Example 6. Contractual terms imputed from economic substance. 
(i) Company X is a member of a controlled group that has been in 
operation in the pharmaceutical sector for many years. In years 1 
through 4, Company X undertakes research and development activities. 
As a result of those activities, Company X developed a compound that 
may be more effective than existing medications in the treatment of 
certain conditions.
    (ii) Company Y is acquired in year 4 by the controlled group 
that includes Company X. Once Company Y is acquired, Company X makes 
available to Company Y a large amount of technical data concerning 
the new compound, which Company Y uses to register patent rights 
with respect to the compound in several jurisdictions, making 
Company Y the legal owner of such patents. Company Y then enters 
into licensing agreements with group members that afford Company Y 
100% of the premium return attributable to use of the intangible by 
its subsidiaries.
    (iii) In determining whether an allocation is appropriate in 
year 4, the Commissioner may consider the economic substance of the 
arrangements between Company X and Company Y, and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that an 
uncontrolled taxpayer operating at arm's length would make available 
the results of its research and development or perform services that 
resulted in transfer of valuable know how to another party unless it 
received contemporaneous compensation or otherwise had a reasonable 
anticipation of receiving a future benefit from those activities. In 
this case, Company X's undertaking the research and development 
activities and then providing technical data and know-how to Company 
Y in year 4 is inconsistent with the registration and subsequent 
exploitation of the patent by Company Y. Therefore, the Commissioner 
may impute one or more agreements between Company X and Company Y 
consistent with the economic substance of their course of conduct, 
which would afford Company X an appropriate portion of the premium 
return from the patent rights. For example, the Commissioner may 
impute a separate services agreement that affords Company X 
contingent-payment compensation for its services in year 4 for the 
benefit of Company Y, consisting of making available to Company Y 
technical data, know-how, and other fruits of research and 
development conducted in previous years. These services benefited 
Company Y by giving rise to and contributing to the value of the 
patent rights that were ultimately registered by Company Y. In the 
alternative, the Commissioner may impute a transfer of patentable 
intangible rights from Company X to Company Y immediately preceding 
the registration of patent rights by Company Y. The taxpayer may 
present additional facts that could indicate which of these or other 
alternative agreements best reflects the economic substance of the 
underlying transactions, consistent with the parties' course of 
conduct in the particular case.

    (d)(3)(iii) and (iv) [Reserved]. For further guidance, see Sec.  
1.482-1(d)(3)(iii) and (d)(3)(iv).
    (d)(3)(v) Property or services. Evaluating the degree of 
comparability between controlled and uncontrolled transactions requires 
a comparison of the property or services transferred in the 
transactions. This comparison may include any intangibles that are 
embedded in tangible property or services being transferred. The 
comparability of the embedded intangibles will be analyzed using the 
factors listed in Sec.  1.482-4(c)(2)(iii)(B)(1) (comparable intangible 
property). The relevance of product comparability in evaluating the 
relative reliability of the results will depend on the method applied. 
For guidance concerning the specific comparability considerations 
applicable to transfers of tangible and intangible property and 
performance of services, see Sec. Sec.  1.482-3 through 1.482-6 and 
Sec.  1.482-9T; see also Sec.  1.482-3(f), Sec.  1.482-4T(f)(4), and 
Sec.  1.482-9T(m), dealing with the coordination of the intangible and 
tangible property and performance of services rules.
    (d)(4) through (f)(2)(i) [Reserved]. For further guidance, see 
Sec.  1.482-1(d)(4) through (f)(2)(i).
    (f)(2)(ii) Allocation based on taxpayer's actual transactions--(A) 
In general. The Commissioner will evaluate the results of a transaction 
as actually structured by the taxpayer unless its structure lacks 
economic substance. However, the Commissioner may consider the 
alternatives available to the taxpayer in determining whether the terms 
of the controlled transaction would be acceptable to an uncontrolled 
taxpayer faced with the same alternatives and operating under 
comparable circumstances. In such cases the Commissioner may adjust the 
consideration charged in the controlled transaction based on the cost 
or profit of an alternative as adjusted to account for material 
differences between the alternative and the controlled transaction, but 
will not restructure the transaction as if the alternative had been 
adopted by the taxpayer. See Sec.  1.482-1(d)(3) (factors for 
determining comparability; contractual terms and risk); Sec. Sec.  
1.482-3(e), 1.482-4(d), and 1.482-9T(h) (unspecified methods).
    (f)(2)(ii)(B) through (f)(2)(iii)(A) [Reserved]. For further 
guidance, see Sec.  1.482-1(f)(2)(ii)(B) through (f)(2)(iii)(A).
    (f)(2)(iii)(B) Circumstances warranting consideration of multiple 
year data. The extent to which it is appropriate to consider multiple 
year data depends on the method being applied and the issue being 
addressed. Circumstances that may warrant consideration of data from 
multiple years include the extent to which complete and accurate data 
are available for the taxable year under review, the effect of business 
cycles in the controlled taxpayer's industry, or the effects of life 
cycles of the product or intangible being examined. Data from one or 
more years before or after the taxable year under review must 
ordinarily be considered for purposes of applying the provisions of 
paragraph (d)(3)(iii) of this section (risk), paragraph (d)(4)(i) of 
this section (market share strategy), Sec.  1.482-4(f)(2) (periodic 
adjustments), Sec.  1.482-5 (comparable profits method), Sec.  1.482-
9T(f) (comparable profits method for services), and Sec.  1.482-9T(i) 
(contingent-payment contractual terms for services). On the other hand, 
multiple year data ordinarily will not be considered for purposes of 
applying the comparable uncontrolled price method of Sec.  1.482-3(b) 
or the comparable uncontrolled services price method of Sec.  1.482-
9T(c) (except to the extent that risk or market share strategy issues 
are present).
    (f)(2)(iii)(C) through (g)(3) [Reserved]. For further guidance, see 
Sec.  1.482-1(f)(2)(iii)(C) through (g)(3).
    (g)(4) Setoffs--(i) In general. If an allocation is made under 
section 482 with respect to a transaction between

[[Page 44484]]

controlled taxpayers, the Commissioner will take into account the 
effect of any other non-arm's length transaction between the same 
controlled taxpayers in the same taxable year which will result in a 
setoff against the original section 482 allocation. Such setoff, 
however, will be taken into account only if the requirements of 
paragraph (g)(4)(ii) of this section are satisfied. If the effect of 
the setoff is to change the characterization or source of the income or 
deductions, or otherwise distort taxable income, in such a manner as to 
affect the U.S. tax liability of any member, adjustments will be made 
to reflect the correct amount of each category of income or deductions. 
For purposes of this setoff provision, the term arm's length refers to 
the amount defined in paragraph (b) of this section (Arm's length 
standard), without regard to the rules in Sec.  1.482-2(a) that treat 
certain interest rates as arm's length rates of interest.
    (g)(4)(ii) [Reserved]. For further guidance, see Sec.  1.482-
1(g)(4)(ii).
    (g)(4)(iii) Examples. The following examples illustrate this 
paragraph (g)(4):

    Example 1. P, a U.S. corporation, renders construction services 
to S, its foreign subsidiary in Country Y, in connection with the 
construction of S's factory. An arm's length charge for such 
services determined under Sec.  1.482-9T would be $100,000. During 
the same taxable year P makes available to S the use of a machine to 
be used in the construction of the factory, and the arm's length 
rental value of the machine is $25,000. P bills S $125,000 for the 
services, but does not charge S for the use of the machine. No 
allocation will be made with respect to the undercharge for the 
machine if P notifies the district director of the basis of the 
claimed setoff within 30 days after the date of the letter from the 
district director transmitting the examination report notifying P of 
the proposed adjustment, establishes that the excess amount charged 
for services was equal to an arm's length charge for the use of the 
machine and that the taxable income and income tax liabilities of P 
are not distorted, and documents the correlative allocations 
resulting from the proposed setoff.

    (g)(4)(iii) Example 2 through (h) [Reserved]. For further guidance, 
see Sec.  1.482-1(g)(4)(iii) Example 2 through (h).
    (i) Definitions. The definitions set forth in paragraphs (i)(1) 
through (i)(10) of this section apply to this section and Sec. Sec.  
1.482-2T through 1.482-9T.
    (j)(1) through (j)(5) [Reserved]. For further guidance, see 1.482-
1(j)(1) through (j)(5).
    (j)(6)(i) The provisions of paragraphs (a)(1), (b)(2)(i), 
(d)(3)(ii)(C) Example 3, Example 4, Example 5, and Example 6, 
(d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and 
(i) of this section are generally applicable for taxable years 
beginning after December 31, 2006.
    (ii) A person may elect to apply the provisions of paragraphs 
(a)(1), (b)(2)(i), (d)(3)(ii)(C) Example 3, Example 4, Example 5, and 
Example 6, (d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), 
(g)(4)(iii), and (i) of this section to earlier taxable years in 
accordance with the rules set forth in Sec.  1.482-9T(n)(2).
    (iii) The applicability of Sec.  1.482-1T expires on or before July 
31, 2009.

0
Par. 6. Section 1.482-2 is amended as follows:
0
1. Paragraph (b) is revised.
0
2. Paragraph (e) is added.
    The addition and revision read as follows:


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

* * * * *
    (b) Rendering of services. [Reserved]. For further guidance, see 
Sec.  1.482-2T(b).
* * * * *
    (e) Effective date. [Reserved]. For further guidance, see Sec.  
1.482-2T(e).

0
Par. 7. Section 1.482-2T is added to read as follows:


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

    (a) [Reserved]. For further guidance, see Sec.  1.482-2(a).
    (b) Rendering of services. For rules governing allocations under 
section 482 to reflect an arm's length charge for controlled 
transactions involving the rendering of services, see Sec.  1.482-9T.
    (c) [Reserved]. For further guidance, see Sec.  1.482-2(c).
    (d) [Reserved]. For further guidance, see Sec.  1.482-2(d).
    (e) Effective date--(1) In general. The provision of paragraph (b) 
of this section is generally applicable for taxable years beginning 
after December 31, 2006.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraph (b) of this section to 
earlier taxable years in accordance with the rules set forth in Sec.  
1.482-9T(n)(2).
    (3) Expiration date. The applicability of Sec.  1.482-2T expires on 
or before July 31, 2009.

0
Par. 8. Section 1.482-4 is amended as follows:
0
1. Paragraph (f)(3) is revised.
0
2. Paragraphs (f)(4) and (f)(5) are redesignated as paragraphs (f)(5) 
and (f)(6), respectively.
0
3. New paragraphs (f)(4) and (f)(7) are added.
    The revision and additions read as follows:


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

* * * * *
    (f) * * *
    (3) [Reserved]. For further guidance, see Sec.  1.482-4T(f)(3).
    (4) [Reserved]. For further guidance, see Sec.  1.482-4T(f)(4).
* * * * *
    (7) [Reserved]. For further guidance, see Sec.  1.482-4T(f)(7).

0
Par. 9. Section 1.482-4T is added to read as follows:


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

    (a) through (f)(2) [Reserved]. For further guidance, see Sec.  
1.482-4(a) through (f)(2).
    (f)(3) Ownership of intangible property--(i) Identification of 
owner--(A) In general. The legal owner of an intangible pursuant to the 
intellectual property law of the relevant jurisdiction, or the holder 
of rights constituting an intangible pursuant to contractual terms 
(such as the terms of a license) or other legal provision, will be 
considered the sole owner of the respective intangible for purposes of 
this section unless such ownership is inconsistent with the economic 
substance of the underlying transactions. See Sec.  1.482-
1(d)(3)(ii)(B) (identifying contractual terms). If no owner of the 
respective intangible is identified under the intellectual property law 
of the relevant jurisdiction, or pursuant to contractual terms 
(including terms imputed pursuant to Sec.  1.482-1(d)(3)(ii)(B)) or 
other legal provision, then the controlled taxpayer who has control of 
the intangible, based on all the facts and circumstances, will be 
considered the sole owner of the intangible for purposes of this 
section.
    (B) Cost sharing arrangements. The rule in paragraph (f)(3)(i)(A) 
of this section will apply to interests in covered intangibles, as 
defined in Sec.  1.482-7(b)(4)(iv), only as provided in Sec.  1.482-7 
(sharing of costs).
    (ii) Examples. The principles of this paragraph (f)(3) are 
illustrated by the following examples:

    Example 1. FP, a foreign corporation, is the registered holder 
of the AA trademark in the United States. FP licenses to its U.S. 
subsidiary, USSub, the exclusive rights to manufacture and market 
products in the United States under the AA trademark. FP is the 
owner of the trademark pursuant to intellectual property law. USSub 
is the owner of the license pursuant to the terms of the license, 
but is not the owner of the trademark. See paragraphs (b)(3) and (4) 
of this section (defining an intangible as, among other things, a 
trademark or a license).

[[Page 44485]]

    Example 2. The facts are the same as in Example 1. As a result 
of its sales and marketing activities, USSub develops a list of 
several hundred creditworthy customers that regularly purchase AA 
trademarked products. Neither the terms of the contract between FP 
and USSub nor the relevant intellectual property law specify which 
party owns the customer list. Because USSub has knowledge of the 
contents of the list, and has practical control over its use and 
dissemination, USSub is considered the sole owner of the customer 
list for purposes of this paragraph (f)(3).

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

    Example 1. A, a member of a controlled group, allows B, another 
member of the controlled group, to use tangible property, such as 
laboratory equipment, in connection with B's development of an 
intangible that B owns. By furnishing tangible property, A makes a 
contribution to the development of an intangible owned by another 
controlled taxpayer, B. Pursuant to paragraph (f)(4)(i) of this 
section, the arm's length charge for A's furnishing of tangible 
property will be determined under the rules for use of tangible 
property in Sec.  1.482-2(c).
    Example 2. (i) Facts. FP, a foreign producer of wristwatches, is 
the registered holder of the YY trademark in the United States and 
in other countries worldwide. FP enters into an exclusive, five-
year, renewable agreement with its newly organized U.S. subsidiary, 
USSub. The contractual terms of the agreement grant USSub the 
exclusive right to re-sell trademark YY wristwatches in the United 
States, obligate USSub to pay a fixed price per wristwatch 
throughout the entire term of the contract, and obligate both FP and 
USSub to undertake without separate compensation specified types and 
levels of marketing activities.
    (ii) The consideration for FP's and USSub's marketing 
activities, as well as the consideration for the exclusive right to 
re-sell YY trademarked merchandise in the United States, are 
embedded in the transfer price paid for the wristwatches. 
Accordingly, pursuant to paragraph (f)(4)(i) of this section, 
ordinarily no separate allocation would be appropriate with respect 
to these embedded contributions.
    (iii) Whether an allocation is warranted with respect to the 
transfer price for the wristwatches is determined under Sec. Sec.  
1.482-1, 1.482-3, and this section through Sec.  1.482-6. The 
comparability analysis would include consideration of all relevant 
factors, including the nature of the intangible embedded in the 
wristwatches and the nature of the marketing activities required 
under the agreement. This analysis would also take into account that 
the compensation for the activities performed by USSub and FP, as 
well as the consideration for USSub's use of the YY trademark, is 
embedded in the transfer price for the wristwatches, rather than 
provided for in separate agreements. See Sec. Sec.  1.482-3(f) and 
1.482-9T(m)(4).
    Example 3. (i) Facts. FP, a foreign producer of athletic gear, 
is the registered holder of the AA trademark in the United States 
and in other countries. In year 1, FP licenses to a newly organized 
U.S. subsidiary, USSub, the exclusive rights to use certain 
manufacturing and marketing intangibles to manufacture and market 
athletic gear in the United States under the AA trademark. The 
license agreement obligates USSub to pay a royalty based on sales of 
trademarked merchandise. The license agreement also obligates FP and 
USSub to perform without separate compensation specified types and 
levels of marketing activities. In year 1, USSub manufactures and 
sells athletic gear under the AA trademark in the United States.
    (ii) The consideration for FP's and USSub's respective marketing 
activities is embedded in the contractual terms of the license for 
the AA trademark. Accordingly, pursuant to paragraph (f)(4)(i) of 
this section, ordinarily no separate allocation would be appropriate 
with respect to the embedded contributions in year 1. See Sec.  
1.482-9T(m)(4).
    (iii) Whether an allocation is warranted with respect to the 
royalty under the license agreement would be analyzed under Sec.  
1.482-1 and this section through Sec.  1.482-6. The comparability 
analysis would include consideration of all relevant factors, such 
as the term and geographical exclusivity of the license, the nature 
of the intangibles subject to the license, and the nature of the 
marketing activities required to be undertaken pursuant to the 
license. Pursuant to paragraph (f)(4)(i) of this section, the 
analysis would also take into account the fact that the compensation 
for the marketing services is embedded in the royalty paid for use 
of the AA trademark, rather than provided for in a separate services 
agreement. For illustrations of application of the best method rule, 
see Sec.  1.482-8T Example 10, Example 11, and Example 12.
    Example 4. (i) Facts. The year 1 facts are the same as in 
Example 3, with the following exceptions. In year 2, USSub 
undertakes certain incremental marketing activities, in addition to 
those required by the contractual terms of the license for the AA 
trademark executed in year 1. The parties do not execute a separate 
agreement with respect to these incremental marketing activities 
performed by USSub The license agreement executed in year 1 is of 
sufficient duration that it is reasonable to anticipate that USSub 
will obtain the benefit of its incremental activities, in the form 
of increased sales or revenues of trademarked products in the U.S. 
market.
    (ii) To the extent that it was reasonable to anticipate that 
USSub's incremental marketing activities would increase the value 
only of USSub's intangible (that is, USSub's license to use the AA 
trademark for a specified term), and not the value of the AA 
trademark owned by FP, USSub's incremental activities do not 
constitute a contribution for which an allocation is warranted under 
paragraph (f)(4)(i) of this section.
    Example 5. (i) Facts. The year 1 facts are the same as in 
Example 3. In year 2, FP and USSub enter into a separate services 
agreement that obligates USSub to perform certain incremental 
marketing activities to promote AA trademark athletic gear in the 
United States, above and beyond the activities specified in the 
license agreement executed in year 1. In year 2, USSub begins to 
perform these incremental activities, pursuant to the separate 
services agreement with FP.
    (ii) Whether an allocation is warranted with respect to USSub's 
incremental marketing activities covered by the separate services 
agreement would be evaluated under Sec. Sec.  1.482-1 and 1.482-9T, 
including a comparison of the compensation provided for the services 
with the results obtained under a method pursuant to Sec.  1.482-9T, 
selected and applied in accordance with the best method rule of 
Sec.  1.482-1(c).
    (iii) Whether an allocation is warranted with respect to the 
royalty under the license agreement is determined under Sec.  1.482-
1 and this section through Sec.  1.482-6. The comparability analysis 
would include consideration of all relevant factors, such as the 
term and geographical exclusivity of the license, the nature of the 
intangibles subject to the license, and the nature of the marketing 
activities required to be undertaken pursuant to the license. The 
comparability analysis would take into account that the compensation 
for the incremental activities by USSub is provided for in the 
separate services agreement, rather than embedded in the royalty 
paid for use of the AA trademark. For illustrations of application 
of the best method rule, see Sec.  1.482-8T Example 10, Example 11, 
and Example 12.
    Example 6. (i) Facts. The year 1 facts are the same as in 
Example 3. In year 2, FP and USSub enter into a separate services 
agreement that obligates FP to perform incremental marketing 
activities, not specified in the year 1 license, by advertising AA 
trademarked athletic gear in selected international sporting events, 
such as the Olympics and the soccer World Cup. FP's corporate 
advertising department develops and coordinates these special 
promotions. The separate services agreement obligates USSub to pay 
an amount to FP for the benefit

[[Page 44486]]

to USSub that may reasonably be anticipated as the result of FP's 
incremental activities. The separate services agreement is not a 
qualified cost sharing arrangement under Sec.  1.482-7. FP begins to 
perform the incremental activities in year 2 pursuant to the 
separate services agreement.
    (ii) Whether an allocation is warranted with respect to the 
incremental marketing activities performed by FP under the separate 
services agreement would be evaluated under Sec.  1.482-9T. Under 
the circumstances, it is reasonable to anticipate that FP's 
activities would increase the value of USSub's license as well as 
the value of FP's trademark. Accordingly, the incremental activities 
by FP may constitute in part a controlled services transaction for 
which USSub must compensate FP. The analysis of whether an 
allocation is warranted would include a comparison of the 
compensation provided for the services with the results obtained 
under a method pursuant to Sec.  1.482-9T, selected and applied in 
accordance with the best method rule of Sec.  1.482-1(c).
    (iii) Whether an allocation is appropriate with respect to the 
royalty under the license agreement would be evaluated under Sec.  
1.482-1 through Sec.  1.482-6 of this section. The comparability 
analysis would include consideration of all relevant factors, such 
as the term and geographical exclusivity of USSub's license, the 
nature of the intangibles subject to the license, and the marketing 
activities required to be undertaken by both FP and USSub pursuant 
to the license. This comparability analysis would take into account 
that the compensation for the incremental activities performed by FP 
was provided for in the separate services agreement, rather than 
embedded in the royalty paid for use of the AA trademark. For 
illustrations of application of the best method rule, see Sec.  
1.482-8T, Example 10, Example 11, and Example 12.

    (f)(5) and (f)(6) [Reserved]. For further guidance, see Sec.  
1.482-4(f)(5) and (f)(6).
    (f)(7) Effective date. (i) In general. The provisions of paragraphs 
(f)(3) and (f)(4) are generally applicable for taxable years beginning 
after December 31, 2006.
    (ii) Election to apply regulation to earlier taxable years. A 
person may elect to apply the provisions of paragraphs (f)(3) and 
(f)(4) of this section to earlier taxable years in accordance with the 
rules set forth in Sec.  1.482-9T(n)(2).
    (iii) Expiration date. The applicability of Sec.  1.482-4T expires 
on or before July 31, 2009.

0
Par. 10. Section 1.482-6 is amended by revising paragraphs 
(c)(2)(ii)(B)(1), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B), and 
(c)(3)(ii)(D) to read as follows:
    The revisions and addition read as follows:


Sec.  1.482-6  Profit split method.

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (B) * * * (1) * * * [Reserved]. For further guidance, see Sec.  
1.482-6T(c)(2)(ii)(B)(1).
* * * * *
    (D) [Reserved]. For further guidance, see Sec.  1.482-
6T(c)(2)(ii)(D).
* * * * *
    (3) * * *
    (i) * * *
    (A) [Reserved]. For further guidance, see Sec.  1.482-
6T(c)(3)(i)(A).
    (B) [Reserved]. For further guidance, see Sec.  1.482-
6T(c)(3)(i)(B).
    (ii) * * *
    (D) [Reserved]. For further guidance, see Sec.  1.482-
6T(c)(3)(ii)(D).
* * * * *

0
Par. 11. Section 1.482-6T is added to read as follows:


Sec.  1.482-6T  Profit split method (temporary).


    (a) through (c)(2)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.482-6(a) through (c)(2)(ii)(A).
    (c)(2)(ii)(B) Comparability--(1) In general. The degree of 
comparability between the controlled and uncontrolled taxpayers is 
determined by applying the comparability provisions of Sec.  1.482-
1(d). The comparable profit split compares the division of operating 
profits among the controlled taxpayers to the division of operating 
profits among uncontrolled taxpayers engaged in similar activities 
under similar circumstances. Although all of the factors described in 
Sec.  1.482-1(d)(3) must be considered, comparability under this method 
is particularly dependent on the considerations described under the 
comparable profits method in Sec.  1.482-5(c)(2) or Sec.  1.482-
9T(f)(2)(iii) because this method is based on a comparison of the 
operating profit of the controlled and uncontrolled taxpayers. In 
addition, because the contractual terms of the relationship among the 
participants in the relevant business activity will be a principal 
determinant of the allocation of functions and risks among them, 
comparability under this method also depends particularly on the degree 
of similarity of the contractual terms of the controlled and 
uncontrolled taxpayers. Finally, the comparable profit split may not be 
used if the combined operating profit (as a percentage of the combined 
assets) of the uncontrolled comparables varies significantly from that 
earned by the controlled taxpayers.
    (c)(2)(ii)(B)(2) through (C) [Reserved]. For further guidance, see 
Sec.  1.482-6(c)(2)(ii)(B)(2) through (C).
    (c)(2)(ii)(D) Other factors affecting reliability. Like the methods 
described in Sec. Sec.  1.482-3, 1.482-4, 1.482-5 and 1.482-9T, the 
comparable profit split relies exclusively on external market 
benchmarks. As indicated in Sec.  1.482-1(c)(2)(i), as the degree of 
comparability between the controlled and uncontrolled transactions 
increases, the relative weight accorded the analysis under this method 
will increase. In addition, the reliability of the analysis under this 
method may be enhanced by the fact that all parties to the controlled 
transaction are evaluated under the comparable profit split. However, 
the reliability of the results of an analysis based on information from 
all parties to a transaction is affected by the reliability of the data 
and the assumptions pertaining to each party to the controlled 
transaction. Thus, if the data and assumptions are significantly more 
reliable with respect to one of the parties than with respect to the 
others, a different method, focusing solely on the results of that 
party, may yield more reliable results.
    (c)(3)(i) [Reserved]. For further guidance, see Sec.  1.482-
6(c)(3)(i).
    (c)(3)(i)(A) Allocate income to routine contributions. The first 
step allocates operating income to each party to the controlled 
transactions to provide a market return for its routine contributions 
to the relevant business activity. Routine contributions are 
contributions of the same or a similar kind to those made by 
uncontrolled taxpayers involved in similar business activities for 
which it is possible to identify market returns. Routine contributions 
ordinarily include contributions of tangible property, services and 
intangibles that are generally owned by uncontrolled taxpayers engaged 
in similar activities. A functional analysis is required to identify 
these contributions according to the functions performed, risks 
assumed, and resources employed by each of the controlled taxpayers. 
Market returns for the routine contributions should be determined by 
reference to the returns achieved by uncontrolled taxpayers engaged in 
similar activities, consistent with the methods described in Sec. Sec.  
1.482-3, 1.482-4, 1.482-5 and 1.482-9T.
    (B) Allocate residual profit--(1) Nonroutine contributions 
generally. The allocation of income to the controlled taxpayer's 
routine contributions will not reflect profits attributable to each 
controlled taxpayer's contributions to the relevant business activity 
that are not routine (nonroutine contributions). A nonroutine 
contribution is a contribution that is not accounted for as a routine 
contribution. Thus, in cases where such nonroutine contributions are 
present there normally will be an unallocated residual profit after the 
allocation of income described in

[[Page 44487]]

paragraph (c)(3)(i)(A) of this section. Under this second step, the 
residual profit generally should be divided among the controlled 
taxpayers based upon the relative value of their nonroutine 
contributions to the relevant business activity. The relative value of 
the nonroutine contributions of each taxpayer should be measured in a 
manner that most reliably reflects each nonroutine contribution made to 
the controlled transaction and each controlled taxpayer's role in the 
nonroutine contributions. If the nonroutine contribution by one of the 
controlled taxpayers is also used in other business activities (such as 
transactions with other controlled taxpayers), an appropriate 
allocation of the value of the nonroutine contribution must be made 
among all the business activities in which it is used.
    (2) Nonroutine contributions of intangible property. In many cases, 
nonroutine contributions of a taxpayer to the relevant business 
activity may be contributions of intangible property. For purposes of 
paragraph (c)(3)(i)(B)(1) of this section, the relative value of 
nonroutine intangible property contributed by taxpayers may be measured 
by external market benchmarks that reflect the fair market value of 
such intangible property. Alternatively, the relative value of 
nonroutine intangible property contributions may be estimated by the 
capitalized cost of developing the intangible property and all related 
improvements and updates, less an appropriate amount of amortization 
based on the useful life of each intangible. Finally, if the intangible 
development expenditures of the parties are relatively constant over 
time and the useful life of the intangible property contributed by all 
parties is approximately the same, the amount of actual expenditures in 
recent years may be used to estimate the relative value of nonroutine 
intangible property contributions.
    (c)(3)(ii)(A) through (C) [Reserved]. For further guidance, see 
Sec.  1.482-6(c)(3)(ii)(A) through (C).
    (c)(3)(ii)(D) Other factors affecting reliability. Like the methods 
described in Sec. Sec.  1.482-3, 1.482-4, 1.482-5 and 1.482-9T, the 
first step of the residual profit split relies exclusively on external 
market benchmarks. As indicated in Sec.  1.482-1(c)(2)(i), as the 
degree of comparability between the controlled and uncontrolled 
transactions increases, the relative weight accorded the analysis under 
this method will increase. In addition, to the extent the allocation of 
profits in the second step is not based on external market benchmarks, 
the reliability of the analysis will be decreased in relation to an 
analysis under a method that relies on market benchmarks. Finally, the 
reliability of the analysis under this method may be enhanced by the 
fact that all parties to the controlled transaction are evaluated under 
the residual profit split. However, the reliability of the results of 
an analysis based on information from all parties to a transaction is 
affected by the reliability of the data and the assumptions pertaining 
to each party to the controlled transaction. Thus, if the data and 
assumptions are significantly more reliable with respect to one of the 
parties than with respect to the others, a different method, focusing 
solely on the results of that party, may yield more reliable results.
    (c)(3)(iii) [Reserved]. For further guidance, see Sec.  1.482-
6(c)(3)(iii).
    (d) Effective date--(1) In general. The provisions of paragraphs 
(c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of 
this section are generally applicable for taxable years beginning after 
December 31, 2006.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraphs (c)(2)(ii)(B)(1) and 
(D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section to earlier 
taxable years in accordance with the rules set forth in Sec.  1.482-
9T(n)(2).
    (3) Expiration date. The applicability of Sec.  1.482-6T expires on 
or before July 31, 2009.

0
Par. 12. Section 1.482-8 is amended as follows:
0
1. Designating the undesignated introductory text as paragraph (a) and 
adding a paragraph heading.
0
2. Adding paragraph (b) designation, heading, and Examples 10 through 
12.
    The additions read as follows:


Sec.  1.482-8  Examples of the best method rule.

    (a) Introduction. * * *
    (b) Examples. * * *
    Examples 10 through 12. [Reserved]. For further guidance, see 
1.482-8T(b) Examples 10 through 12.

0
Par. 13. Section 1.482-8T is added to read as follows:


Sec.  1.482-8T  Examples of the best method rule (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.482-8(a).
    (b) [Reserved]. For further guidance, see Sec.  1.482-8(b), 
Examples 1 through 9.

    Example 10. Cost of services plus method preferred to other 
methods. (i) FP designs and manufactures consumer electronic devices 
that incorporate advanced technology. In year 1, FP introduces 
Product X, an entertainment device targeted primarily at the youth 
market. FP's wholly-owned, exclusive U.S. distributor, USSub, sells 
Product X in the U.S. market. USSub hires an independent marketing 
firm, Agency A, to promote Product X in the U.S. market. Agency A 
has successfully promoted other electronic products on behalf of 
other uncontrolled parties. USSub executes a one-year, renewable 
contract with Agency A that requires it to develop the market for 
Product X, within an annual budget set by USSub. In years 1 through 
3, Agency A develops advertising, buys media, and sponsors events 
featuring Product X. Agency A receives a markup of 25% on all 
expenses of promoting Product X, with the exception of media buys, 
which are reimbursed at cost. During year 3, sales of Product X 
decrease sharply, as Product X is displaced by competitors' 
products. At the end of year 3, sales of Product X are discontinued.
    (ii) Prior to the start of year 4, FP develops a new 
entertainment device, Product Y. Like Product X, Product Y is 
intended for sale to the youth market, but it is marketed under a 
new trademark distinct from that used for Product X. USSub decides 
to perform all U.S. market promotion for Product Y. USSub hires key 
Agency A staff members who handled the successful Product X 
campaign. To promote Product Y, USSub intends to use methods similar 
to those used successfully by Agency A to promote Product X (print 
advertising, media, event sponsorship, etc.). FP and USSub enter 
into a one-year, renewable agreement concerning promotion of Product 
Y in the U.S. market. Under the agreement, FP compensates USSub for 
promoting Product Y, based on a cost of services plus markup of A%. 
Third-party media buys by USSub in connection with Product Y are 
reimbursed at cost.
    (iii) Assume that under the contractual arrangements between FP 
and USSub, the arm's length consideration for Product Y and the 
trademark or other intangibles may be determined reliably under one 
or more transfer pricing methods. At issue in this example is the 
separate evaluation of the arm's length compensation for the year 4 
promotional activities performed by USSub pursuant to its contract 
with FP.
    (iv) USSub's accounting records contain reliable data that 
separately state the costs incurred to promote Product Y. A 
functional analysis indicates that USSub's activities to promote 
Product Y in year 4 are similar to activities performed by Agency A 
during years 1 through 3 under the contract with FP. In other 
respects, no material differences exist in the market conditions or 
the promotional activities performed in year 4, as compared to those 
in years 1 through 3.
    (v) It is possible to identify uncontrolled distributors or 
licensees of electronic products that perform, as one component of 
their business activities, promotional activities similar to those 
performed by USSub. However, it is unlikely that publicly available 
accounting data from these companies would allow computation of the 
comparable transactional costs or total services costs associated 
with the marketing or promotional activities that these entities 
perform, as one component of business

[[Page 44488]]

activities. If that were possible, the comparable profits method for 
services might provide a reliable measure of an arm's length result. 
The functional analysis of the marketing activities performed by 
USSub in year 4 indicates that they are similar to the activities 
performed by Agency A in years 1 through 3 for Product X. Because 
reliable information is available concerning the markup on costs 
charged in a comparable uncontrolled transaction, the most reliable 
measure of an arm's length price is the cost of services plus method 
in Sec.  1.482-9T(e).
    Example 11. CPM for services preferred to other methods. (i) FP 
manufactures furniture and accessories for residential use. FP sells 
its products to retailers in Europe under the trademark, ``Moda.'' 
FP holds all worldwide rights to the trademark, including in the 
United States. USSub is FP's wholly-owned subsidiary in the U.S. 
market and the exclusive U.S. distributor of FP's merchandise. 
Historically, USSub dealt only with specialized designers in the 
U.S. market and advertised in trade publications targeted to this 
market. Although items sold in the U.S. and Europe are physically 
identical, USSub's U.S. customers generally resell the merchandise 
as non-branded merchandise.
    (ii) FP retains an independent firm to evaluate the feasibility 
of selling FP's trademarked merchandise in the general wholesale and 
retail market in the United States. The study concludes that this 
segment of the U.S. market, which is not exploited by USSub, may 
generate substantial profits. Based on this study, FP enters into a 
separate agreement with USSub, which provides that USSub will 
develop this market in the United States for the benefit of FP. 
USSub separately accounts for personnel expenses, overhead, and out-
of-pocket costs attributable to the initial stage of the marketing 
campaign (Phase I). USSub receives as compensation its costs, plus a 
markup of X%, for activities in Phase I. At the end of Phase I, FP 
will evaluate the program. If success appears likely, USSub will 
begin full-scale distribution of trademarked merchandise in the new 
market segment, pursuant to agreements negotiated with FP at that 
time.
    (iii) Assume that under the contractual arrangements in effect 
between FP and USSub, the arm's length consideration for the 
merchandise and the trademark or other intangibles may be determined 
reliably under one or more transfer pricing methods. At issue in 
this example is the separate evaluation of the arm's length 
compensation for the marketing activities conducted by USSub in 
years 1 and following.
    (iv) A functional analysis reveals that USSub's activities 
consist primarily of modifying the promotional materials created by 
FP, negotiating media buys, and arranging promotional events. FP 
separately compensates USSub for all Phase I activities, and 
detailed accounting information is available regarding the costs of 
these activities. The Phase I activities of USSub are similar to 
those of uncontrolled companies that perform, as their primary 
business activity, a range of advertising and media relations 
activities on a contract basis for uncontrolled parties.
    (v) No information is available concerning the comparable 
uncontrolled prices for services in transactions similar to those 
engaged in by FP and USSub. Nor is any information available 
concerning uncontrolled transactions that would allow application of 
the cost of services plus method. It is possible to identify 
uncontrolled distributors or licensees of home furnishings that 
perform, as one component of their business activities, promotional 
activities similar to those performed by USSub. However, it is 
unlikely that publicly available accounting data from these 
companies would allow computation of the comparable transactional 
costs or total services costs associated with the marketing or 
promotional activities that these entities performed, as one 
component of their business activities. On the other hand, it is 
possible to identify uncontrolled advertising and media relations 
companies, the principal business activities of which are similar to 
the Phase I activities of USSub. Under these circumstances, the most 
reliable measure of an arm's length price is the comparable profits 
method of Sec.  1.482-9T(f). The uncontrolled advertising 
comparables' treatment of material items, such as classification of 
items as cost of goods sold or selling, general, and administrative 
expenses, may differ from that of USSub. Such inconsistencies in 
accounting treatment between the uncontrolled comparables and the 
tested party, or among the comparables, are less important when 
using the ratio of operating profit to total services costs under 
the comparable profits method for services in Sec.  1.482-9T(f). 
Under this method, the operating profit of USSub from the Phase I 
activities is compared to the operating profit of uncontrolled 
parties that perform general advertising and media relations as 
their primary business activity.
    Example 12. Residual profit split preferred to other methods. 
(i) USP is a manufacturer of athletic apparel sold under the AA 
trademark, to which FP owns the worldwide rights. USP sells AA 
trademark apparel in countries throughout the world, but prior to 
year 1, USP did not sell its merchandise in Country X. In year 1, 
USP acquires an uncontrolled Country X company which becomes its 
wholly-owned subsidiary, XSub. USP enters into an exclusive 
distribution arrangement with XSub in Country X. Before being 
acquired by USP in year 1, XSub distributed athletic apparel 
purchased from uncontrolled suppliers and resold that merchandise to 
retailers. After being acquired by USP in year 1, XSub continues to 
distribute merchandise from uncontrolled suppliers and also begins 
to distribute AA trademark apparel. Under a separate agreement with 
USP, XSub uses its best efforts to promote the AA trademark in 
Country X, with the goal of maximizing sales volume and revenues 
from AA merchandise.
    (ii) Prior to year 1, USP executed long-term endorsement 
contracts with several prominent professional athletes. These 
contracts give USP the right to use the names and likenesses of the 
athletes in any country in which AA merchandise is sold during the 
term of the contract. These contracts remain in effect for five 
years, starting in year 1. Before being acquired by USP, XSub 
renewed a long-term agreement with SportMart, an uncontrolled 
company that owns a nationwide chain of sporting goods retailers in 
Country X. XSub has been SportMart's primary supplier from the time 
that SportMart began operations. Under the agreement, SportMart will 
provide AA merchandise preferred shelf-space and will feature AA 
merchandise at no charge in its print ads and seasonal promotions. 
In consideration for these commitments, USP and XSub grant SportMart 
advance access to new products and the right to use the professional 
athletes under contract with USP in SportMart advertisements 
featuring AA merchandise (subject to approval of content by USP).
    (iii) Assume that it is possible to segregate all transactions 
by XSub that involve distribution of merchandise acquired from 
uncontrolled distributors (non-controlled transactions). In 
addition, assume that, apart from the activities undertaken by USP 
and XSub to promote AA apparel in Country X, the arm's length 
compensation for other functions performed by USP and XSub in the 
Country X market in years 1 and following can be reliably 
determined. At issue in this Example 12 is the application of the 
residual profit split analysis to determine the appropriate division 
between USP and XSub of the balance of the operating profits from 
the Country X market, that is the portion attributable to nonroutine 
contributions to the marketing and promotional activities.
    (iv) A functional analysis of the marketing and promotional 
activities conducted in the Country X market, as described in this 
example, indicates that both USP and XSub made nonroutine 
contributions to the business activity. FP contributed the long-term 
endorsement contracts with professional athletes. XSub contributed 
its long-term contractual rights with SportMart, which were made 
more valuable by its successful, long-term relationship with 
SportMart.
    (v) Because both USP and XSub made valuable, nonroutine 
contributions to the marketing and promotional activities in Country 
X, neither the comparable uncontrolled services price method, the 
cost of services plus method, nor the comparable profits method for 
services will provide a reliable measure of an arm's length result. 
On account of the valuable, nonroutine contributions made by both 
parties, the most reliable measure of an arm's length result is the 
residual profit split method in Sec.  1.482-9T(g). The residual 
profit split analysis would take into account both routine and 
nonroutine contributions by USP and XSub, in order to determine an 
appropriate allocation of the combined operating profits in the 
Country X market from the sale of AA merchandise and from related 
promotional and marketing activities.

    (c) Effective date--(1) In general. The provisions of Sec.  1.482-
8T Example 10, Example 11, and Example 12 are generally applicable for 
taxable years beginning after December 31, 2006.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of Sec.  1.482-8T Example 10, Example 
11, and Example

[[Page 44489]]

12 to earlier taxable years in accordance with the rules set forth in 
Sec.  1.482-9T(n)(2).
    (3) Expiration date. The applicability of Sec.  1.482-8T expires on 
or before July 31, 2009.

0
Par. 14. Section 1.482-9T is added to read as follows:


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

    (a) In general. The arm's length amount charged in a controlled 
services transaction must be determined under one of the methods 
provided for in this section. Each method must be applied in accordance 
with the provisions of Sec.  1.482-1, including the best method rule of 
Sec.  1.482-1(c), the comparability analysis of Sec.  1.482-1(d), and 
the arm's length range of Sec.  1.482-1(e), except as those provisions 
are modified in this section. The methods are--
    (1) The services cost method, described in paragraph (b) of this 
section;
    (2) The comparable uncontrolled services price method, described in 
paragraph (c) of this section;
    (3) The gross services margin method, described in paragraph (d) of 
this section;
    (4) The cost of services plus method, described in paragraph (e) of 
this section;
    (5) The comparable profits method, described in Sec.  1.482-5 and 
in paragraph (f) of this section;
    (6) The profit split method, described in Sec.  1.482-6 and in 
paragraph (g) of this section; and
    (7) Unspecified methods, described in paragraph (h) of this 
section.
    (b) Services cost method--(1) In general. The services cost method 
evaluates whether the amount charged for covered services meeting the 
requirements of paragraphs (b)(2) and (b)(3) of this section is arm's 
length by reference to the total services costs (as defined in 
paragraph (j) of this section) with no markup. If covered services meet 
the conditions of this paragraph (b), then the services cost method 
will be considered the best method for purposes of Sec.  1.482-1(c), 
and the Commissioner's allocations will be limited to adjusting the 
amount charged for such services to the properly determined amount of 
such total services costs.
    (2) Not services that contribute significantly to fundamental risks 
of business success or failure. Services are not covered services 
unless the taxpayer reasonably concludes in its business judgment that 
the covered services do not contribute significantly to key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in one or more trades or businesses of the renderer, the 
recipient, or both. In evaluating the reasonableness of the conclusion 
required by this paragraph (b)(2), consideration will be given to all 
the facts and circumstances.
    (3) Other conditions on application of services cost method. The 
arm's length amount charged in a controlled services transaction may be 
evaluated under the services cost method if it meets the requirements 
of paragraph (b)(3)(i) of this section and is not described in 
paragraph (b)(3)(ii) of this section.
    (i) Adequate books and records. Permanent books of account and 
records are maintained for as long as the costs with respect to the 
covered services are incurred by the renderer. Such books and records 
must include a statement evidencing the taxpayer's intention to apply 
the services cost method to evaluate the arm's length charge for such 
services. Such books and records must be adequate to permit 
verification by the Commissioner of the total services costs incurred 
by the renderer, including a description of the services in question, 
identification of the renderer and the recipient of such services, and 
sufficient documentation to allow verification of the methods used to 
allocate and apportion such costs to the services in question in 
accordance with paragraph (k) of this section.
    (ii) Excluded transactions. The following categories of 
transactions, in whole or part, are not covered services:
    (A) Manufacturing;
    (B) Production;
    (C) Extraction, exploration or processing of natural resources;
    (D) Construction;
    (E) Reselling, distribution, acting as a sales or purchasing agent, 
or acting under a commission or other similar arrangement;
    (F) Research, development, or experimentation;
    (G) Engineering or scientific;
    (H) Financial transactions, including guarantees; and
    (I) Insurance or reinsurance.
    (4) Covered services. For purposes of this paragraph (b), covered 
services consist of a controlled transaction or a group of controlled 
service transactions (see Sec.  1.482-1(f)(2)(i) (aggregation of 
transactions)) that meets the definition of specified covered services 
or low margin covered services.
    (i) Specified covered services. Specified covered services are 
controlled services transactions that the Commissioner specifies by 
revenue procedure. Services will be included in such revenue procedure 
based upon the Commissioner's determination that the specified covered 
services are support services common among taxpayers across industry 
sectors and generally do not involve a significant median comparable 
markup on total services costs. For the definition of the median 
comparable markup on total services costs, see paragraph (b)(4)(ii) of 
this section. The Commissioner may add to, subtract from, or otherwise 
revise the specified covered services described in the revenue 
procedure by subsequent revenue procedure, which amendments will 
ordinarily be prospective only in effect.
    (ii) Low margin covered services. Low margin covered services are 
controlled services transactions for which the median comparable markup 
on total services costs is less than or equal to seven percent. For 
purposes of this paragraph (b), the median comparable markup on total 
services costs means the excess of the arm's length price of the 
controlled services transaction determined under the general section 
482 regulations without regard to this paragraph (b), using the 
interquartile range described in Sec.  1.482-1(e)(2)(iii)(C) and as 
necessary adjusting to the median of such interquartile range, over 
total services costs, expressed as a percentage of total services 
costs.
    (5) Shared services arrangement--(i) In general. If covered 
services are the subject of a shared services arrangement, then the 
arm's length charge to each participant for such services will be the 
portion of the total costs of the services otherwise determined under 
the services cost method of this paragraph (b) that is properly 
allocated to such participant pursuant to the arrangement.
    (ii) Requirements for shared services arrangement. A shared 
services arrangement must meet the requirements described in this 
paragraph (b)(5).
    (A) Eligibility. To be eligible for treatment under this paragraph 
(b)(5), a shared services arrangement must--
    (1) Include two or more participants;
    (2) Include as participants all controlled taxpayers that 
reasonably anticipate a benefit (as defined under paragraph (l)(3)(i) 
of this section) from one or more covered services specified in the 
shared services arrangement; and
    (3) Be structured such that each covered service (or each 
reasonable aggregation of services within the meaning of paragraph 
(b)(5)(iii)(B) of this section) confers a benefit on at least one 
participant in the shared services arrangement.

[[Page 44490]]

    (B) Allocation. The costs for covered services must be allocated 
among the participants based on their respective shares of the 
reasonably anticipated benefits from those services, without regard to 
whether the anticipated benefits are in fact realized. Reasonably 
anticipated benefits are benefits as defined in paragraph (l)(3)(i) of 
this section. The allocation of costs must provide the most reliable 
measure of the participants' respective shares of the reasonably 
anticipated benefits under the principles of the best method rule. See 
Sec.  1.482-1(c). The allocation must be applied on a consistent basis 
for all participants and services. The allocation to each participant 
in each taxable year must reasonably reflect that participant's 
respective share of reasonably anticipated benefits for such taxable 
year. If the taxpayer reasonably concluded that the shared services 
arrangement (including any aggregation pursuant to paragraph 
(b)(5)(iii)(B) of this section) allocated costs for covered services on 
a basis that most reliably reflects the participants' respective shares 
of the reasonably anticipated benefits attributable to such services, 
as provided for in this paragraph (b)(5), then the Commissioner may not 
adjust such allocation basis.
    (C) Documentation. The taxpayer must maintain sufficient 
documentation to establish that the requirements of this paragraph 
(b)(5) are satisfied, and include--
    (1) A statement evidencing the taxpayer's intention to apply the 
services cost method to evaluate the arm's length charge for covered 
services pursuant to a shared services arrangement;
    (2) A list of the participants and the renderer or renderers of 
covered services under the shared services arrangement;
    (3) A description of the basis of allocation to all participants, 
consistent with the participants' respective shares of reasonably 
anticipated benefits; and
    (4) A description of any aggregation of covered services for 
purposes of the shared services arrangement, and an indication whether 
this aggregation (if any) differs from the aggregation used to evaluate 
the median comparable markup for any low margin covered services 
described in paragraph (b)(4)(ii) of this section.
    (iii) Definitions and special rules--(A) Participant. A participant 
is a controlled taxpayer that reasonably anticipates benefits from 
covered services subject to a shared services arrangement that 
substantially complies with the requirements described in this 
paragraph (b)(5).
    (B) Aggregation. Two or more covered services may be aggregated in 
a reasonable manner taking into account all the facts and 
circumstances, including whether the relative magnitude of reasonably 
anticipated benefits of the participants sharing the costs of such 
aggregated services may be reasonably reflected by the allocation basis 
employed pursuant to paragraph (b)(5)(ii)(B) of this section. The 
aggregation of services under a shared services arrangement may differ 
from the aggregation used to evaluate the median comparable markup for 
any low margin covered services described in paragraph (b)(4)(ii) of 
this section, provided that such alternative aggregation can be 
implemented on a reasonable basis, including appropriately identifying 
and isolating relevant costs, as necessary.
    (C) Coordination with cost sharing arrangements. To the extent that 
an allocation is made to a participant in a shared services arrangement 
that is also a participant in a cost sharing arrangement subject to 
Sec.  1.482-7, such amount with respect to covered services is first 
allocated pursuant to the shared services arrangement under this 
paragraph (b)(5). Costs allocated pursuant to a shared services 
arrangement may (if applicable) be further allocated between the 
intangible development activity under Sec.  1.482-7 and other 
activities of the participant.
    (6) Examples. The application of this section is illustrated by the 
following examples. No inference is intended whether the presence or 
absence of one or more facts is determinative of the conclusion in any 
example. For purposes of Examples 1 through 14, assume that Company P 
and its subsidiaries, Company Q and Company R, are corporations and 
members of the same group of controlled entities (PQR Controlled 
Group). For purposes of Examples 15 through 17, assume that Company P 
and its subsidiary, Company S, are corporations and members of the same 
group of controlled entities (PS Controlled Group). For purposes of 
Examples 18 through 26, assume that Company P and its subsidiaries, 
Company X, Company Y, and Company Z, are corporations and members of 
the same group of controlled entities (PXYZ Group) and that Company P 
and its subsidiaries satisfy all of the requirements for a shared 
services arrangement specified in paragraphs (b)(5)(ii) and (iii) of 
this section.

    Example 1. Data entry services. (i) Company P, Company Q and 
Company R own and operate hospitals. Company P also owns and 
operates a computer system for maintaining medical information 
gathered by doctors and nurses during interviews and treatment of 
patients. Company P uses a scanning device to convert medical 
information from various paper records into a digital format. 
Company Q and Company R do not have a computer system that allows 
them to input or maintain this information, but they have access to 
this information through their computer systems. Since Company Q and 
Company R do not have the requisite computer infrastructure, Company 
P maintains this medical information for itself as well as for 
Company Q and Company R.
    (ii) Assume that these services relating to data entry are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of paragraph (b) of this 
section, Company P will be eligible to charge these services to 
Company Q and Company R in accordance with the services cost method.
    Example 2. Data entry services. (i) Company P owns and operates 
several gambling establishments. Company Q and Company R own and 
operate travel agencies. Company P provides its customers with a 
``player's card,'' which is a smart card device used in Company P's 
gambling establishments to track a player's bets, winnings, losses, 
hotel accommodations, and food and drink purchases. Using their 
customer lists, Company Q and Company R request marketing 
information about their customers that Company P has gathered from 
these player's cards. Company Q and Company R use the smart card 
data to sell customized vacation packages to their customers, taking 
into account their individual preferences and spending patterns. 
Annual reports for the PQR Controlled Group state that these smart 
card data constitute an important element of the group's overall 
strategic business planning, including advertising and 
accommodations.
    (ii) Assume that these services relating to data entry are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 3. Recruiting services. (i) Company P, Company Q and 
Company R are manufacturing companies that sell their products to 
unrelated retail establishments. Company P's human resources 
department recruits mid-level managers and engineers for itself as 
well as for Company Q and Company R by attending job fairs and other 
recruitment events. For recruiting higher-level managers and 
engineers, each of these companies uses

[[Page 44491]]

recruiters from unrelated executive search firms.
    (ii) Assume that these services relating to recruiting are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of paragraph (b) of this 
section, Company P will be eligible to charge these services to 
Company Q and Company R in accordance with the services cost method.
    Example 4. Recruiting services. (i) Company P, Company Q and 
Company R are agencies that represent celebrities in the 
entertainment industry. Among the most important resources of these 
companies are the highly compensated agents who have close personal 
relationships with celebrities in the entertainment industry. 
Company P implements a recruiting plan to hire highly compensated 
agents for itself, and other highly compensated agents for each of 
its wholly-owned subsidiaries in foreign countries, Company Q and 
Company R.
    (ii) Assume that these services relating to recruiting are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 5. Credit analysis services. (i) Company P is a 
manufacturer and distributor of clothing for retail stores. Company 
Q and Company R are distributors of clothing for retail stores. As 
part of its operations, personnel in Company P perform credit 
analysis on its customers. Most of the customers have a history of 
purchases from Company P, and the credit analysis involves a review 
of the recent payment history of the customer's account. For new 
customers, the personnel in Company P perform a basic credit check 
of the customer, using reports from a business credit reporting 
agency. On behalf of Company Q and Company R, Company P performs 
credit analysis on customers who order clothing from Company Q and 
Company R, using the same method as Company P uses for itself.
    (ii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of this paragraph (b), 
Company P will be eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 6. Credit analysis services. (i) Company P, Company Q 
and Company R lease furniture to retail customers who present a 
significant credit risk and are generally unable to lease furniture 
from other providers. As part of its leasing operations, personnel 
in Company P perform credit analysis on each of the potential 
lessees. The personnel have developed special expertise in 
determining whether a particular customer who presents a significant 
credit risk (as indicated by credit reporting agencies) will be 
likely to make the requisite lease payments on a timely basis. In 
order to compensate for the specialized analysis of a customer's 
default risk, as well as the default risk itself, Company P charges 
more than the market lease rate charged to customers with average 
credit ratings. Also, as part of its operations, Company P performs 
similar credit analysis services for Company Q and Company R, which 
charge correspondingly high monthly lease payments.
    (ii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 7. Credit analysis services. (i) Company P is a large 
full-service bank, which provides products and services to corporate 
and consumer markets, including unsecured loans, secured loans, 
lines of credit, letters of credit, conversion of foreign currency, 
consumer loans, trust services, and sales of certificates of 
deposit. Company Q makes routine consumer loans to individuals, such 
as auto loans and home equity loans. Company R makes only business 
loans to small businesses.
    (ii) Company P performs credit analysis and prepares credit 
reports for itself, as well as for Company Q and Company R. Company 
P, Company Q and Company R regularly employ these credit reports in 
the ordinary course of business in making decisions regarding 
extensions of credit to potential customers (including whether to 
lend, rate of interest, and loan terms).
    (iii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances, the credit 
analysis services constitute part of a ``financial transaction'' 
described in paragraph (b)(3)(ii)(H) of this section. Company P is 
not eligible to charge these services to Company Q and Company R in 
accordance with the services cost method.
    Example 8. Data verification services. (i) Company P, Company Q 
and Company R are manufacturers of industrial supplies. Company P's 
accounting department performs periodic reviews of the accounts 
payable information of Company P, Company Q and Company R, and 
identifies any inaccuracies in the records, such as double-payments 
and double-charges.
    (ii) Assume that these services relating to verification of data 
are specified covered services within the meaning of paragraph 
(b)(4)(i) of this section. Under the facts and circumstances of the 
business of the PQR Controlled Group, the taxpayer could reasonably 
conclude that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of this paragraph (b), 
Company P will be eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 9. Data verification services. (i) Company P gathers 
from unrelated customers information regarding accounts payable and 
accounts receivable and utilizes its own computer system to analyze 
that information for purposes of identifying errors in payment and 
receipts (data mining). Company P is compensated for these services 
based on a fee that reflects a percentage of amounts collected by 
customers as a result of the data mining services. These activities 
constitute a significant portion of Company P's business. Company P 
performs similar activities for Company Q and Company R by analyzing 
their accounts payable and accounts receivable records.
    (ii) Assume that these services relating to data mining are 
specified covered services within the meaning of paragraph (b)(4)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 10. Legal services. (i) Company P is a domestic 
corporation with two wholly-owned foreign subsidiaries, Company Q 
and Company R. Company P and its subsidiaries manufacture and 
distribute equipment used by industrial customers. Company P 
maintains an in-house legal department consisting of attorneys 
experienced in a wide range of business and commercial matters. 
Company Q and Company R maintain small legal departments, consisting 
of attorneys experienced in matters that most frequently arise in 
the normal course of business of Company Q and Company R in their 
respective jurisdictions.
    (ii) Company P seeks to maintain in-house legal staff with the 
ability to address the majority of legal matters that arise in the 
United States with respect to the operations of Company P, as well 
as any U.S. reporting or compliance obligations of Company Q or 
Company R. The in-house legal staffs of Company Q and Company R are 
much more limited. It is necessary for Company P to retain several 
local law firms to handle litigation and business disputes arising 
from the activities of Company Q and Company R.

[[Page 44492]]

Although Company Q and Company R pay the fees of these law firms, 
the hiring authority and general oversight of the firms' 
representation is in the legal department of Company P.
    (iii) In determining what portion of the legal expenses of 
Company P may be allocated to Company Q and Company R, Company P 
first excludes any expenses relating to legal services that 
constitute shareholder activities and other items that are not 
properly analyzed as controlled services. Assume that the remaining 
services relating to general legal functions performed by in-house 
legal counsel are specified covered services within the meaning of 
paragraph (b)(4)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these latter services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    Example 11. Legal services. (i) Company P is a domestic holding 
company whose operating companies generate electric power for 
consumers by operating nuclear plants. Company P has several 
domestic operating companies, including Companies Q and R. Assume 
that, although Company P owns 100% of the stock of Companies Q and 
R, the companies do not elect to file a consolidated Federal income 
tax return with Company P.
    (ii) Company P maintains an in-house legal department consisting 
of experienced attorneys in the areas of Federal utilities 
regulation, Federal labor and environmental law, securities law, and 
general commercial law. Companies Q and R maintain their own, 
smaller in-house legal staffs comprised of experienced attorneys in 
the areas of state and local utilities regulation, state labor and 
employment law, and general commercial law. The legal department of 
Company P performs general oversight of the legal affairs of the 
company and determines whether a particular matter would be more 
efficiently handled by the Company P legal department, by the legal 
staffs in the operating companies, or in rare cases, by retained 
outside counsel. In general, Company P has succeeded in minimizing 
duplication and overlap of functions between the legal staffs of the 
various companies or by retained outside counsel.
    (iii) The domestic nuclear power plant operations of Companies Q 
and R are subject to extensive regulation by the U.S. Nuclear 
Regulatory Commission (NRC). Operators are required to obtain pre-
construction approval, operating licenses, and, at the end of the 
operational life of the nuclear reactor, nuclear decommissioning 
certificates. Company P files consolidated financial statements on 
behalf of itself, as well as Companies Q and R, with the United 
States Securities and Exchange Commission (SEC). In these SEC 
filings, Company P discloses that failure to obtain any of these 
licenses (and the related periodic renewals) or agreeing to licenses 
on terms less favorable than those granted to competitors would have 
a material adverse impact on the operations of Company Q or Company 
R. Company P maintains a group of experienced attorneys that 
exclusively represents Company Q and Company R before the NRC. 
Although Company P occasionally hires an outside law firm or 
industry expert to assist on particular NRC matters, the majority of 
the work is performed by the specialized legal staff of Company P.
    (iv) Certain of the legal services performed by Company P 
constitute duplicative or shareholder activities that do not confer 
a benefit on the other companies and therefore do not need to be 
allocated to the other companies, while certain other legal services 
are eligible to be charged to Company Q and Company R in accordance 
with the services cost method.
    (v) Assume that the specialized legal services relating to 
nuclear licenses performed by in-house legal counsel of Company P 
are specified covered services within the meaning of paragraph 
(b)(4)(i) of this section. Under the facts and circumstances, the 
taxpayer is unable to reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. Company P is not eligible to charge 
these services to Company Q and Company R in accordance with the 
services cost method.
    Example 12. Group of services. (i) Company P, Company Q and 
Company R are manufacturing companies that sell their products to 
unrelated retail establishments. Company P has an enterprise 
resource planning (ERP) system that maintains data relating to 
accounts payable and accounts receivable information for all three 
companies. Company P's personnel perform the daily operations on 
this ERP system such as inputting data relating to accounts payable 
and accounts receivable into the system and extracting data relating 
to accounts receivable and accounts payable in the form of reports 
or electronic media and providing those data to all three companies. 
Periodically, Company P's computer specialists also modify the ERP 
system to adapt to changing business functions in all three 
companies. Company P's computer specialists make these changes by 
either modifying the underlying software program or by purchasing 
additional software or hardware from unrelated third party vendors.
    (ii) Assume that these services relating to accounts payable and 
accounts receivable are specified covered services within the 
meaning of paragraph (b)(4)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    (iii) Assume that the services performed by Company P's computer 
specialists that relate to modifying the ERP system are specifically 
excluded from the services described in a revenue procedure 
referenced in paragraph (b)(4) of this section as developing 
hardware or software solutions (such as systems integration, Web 
site design, writing computer programs, modifying general 
applications software, or recommending the purchase of commercially 
available hardware or software). Company P is not eligible to charge 
these services to Company Q and Company R in accordance with the 
services cost method.
    Example 13. Group of services. (i) Company P manufactures and 
sells widgets under an exclusive contract to Customer 1. Company Q 
and Company R sell widgets under exclusive contracts to Customer 2 
and Customer 3, respectively. At least one year in advance, each of 
these customers can accurately forecast its need for widgets. Using 
these forecasts, each customer over the course of the year places 
orders for widgets with the appropriate company, Company P, Company 
Q or Company R. A customer's actual need for widgets seldom deviates 
from that customer's forecasted need.
    (ii) It is most efficient for the PQR Controlled Group companies 
to manufacture and store an inventory of widgets in advance of 
delivery. Although all three companies sell widgets, only Company P 
maintains a centralized warehouse for widgets. Pursuant to a 
contract, Company P provides storage of these widgets to Company Q 
and Company R at an arm's length price.
    (iii) Company P's personnel also obtain orders from all three 
companies customers to draw up purchase orders for widgets as well 
as make payment to suppliers for widget replacement parts. In 
addition, Company P's personnel use data entry to input information 
regarding orders and sales of widgets and replacement parts for all 
three companies into a centralized computer system. Company P's 
personnel also maintain the centralized computer system and extract 
data for all three companies when necessary.
    (iv) Assume that these services relating to tracking purchases 
and sales of inventory are specified covered services within the 
meaning of paragraph (b)(4)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    Example 14. Group of services. (i) Company P, Company Q and 
Company R assemble and sell gadgets to unrelated customers. Each of 
these companies purchases the components necessary for assembly of 
the gadgets from unrelated suppliers. As a service to its 
subsidiaries, Company P's personnel obtain orders for components 
from all three companies, prepare purchase orders, and make payment

[[Page 44493]]

to unrelated suppliers for the components. In addition, Company P's 
personnel use data entry to input information regarding orders and 
sales of gadgets for all three companies into a centralized 
computer. Company P's personnel also maintain the centralized 
computer system and extract data for all three companies on an as-
needed basis. The services provided by Company P personnel, in 
conjunction with the centralized computer system, constitute a 
state-of-the-art inventory management system that allows Company P 
to order components necessary for assembly of the gadgets on a 
``just-in-time'' basis.
    (ii) Unrelated suppliers deliver the components directly to 
Company P, Company Q and Company R. Each of the companies stores the 
components in its own facilities for use in filling specific 
customer orders. The companies do not maintain any inventory that is 
not identified in specific customer orders. Because of the 
efficiencies associated with services provided by personnel of 
Company P, all three companies are able to significantly reduce 
their inventory-related costs. Company P's Chief Executive Officer 
makes a statement in one of its press conferences with industry 
analysts that its inventory management system is critical to the 
company's success.
    (iii) Assume that these services that relate to tracking 
purchase and sales of inventory are specified covered services 
within the meaning of paragraph (b)(4)(i) of this section. Under the 
facts and circumstances, the taxpayer is unable to reasonably 
conclude that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. 
Company P is not eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 15. Low margin covered services. Company P renders 
certain accounting services to Company S. Company P uses the 
services cost method for the accounting services, and determines the 
amount charged as Company P's total cost of rendering the services, 
with no markup. Based on an application of the section 482 
regulations without regard to this paragraph (b), the interquartile 
range of arm's length markups on total services costs is between 3% 
and 6%, and the median is 4%. Because the median comparable markup 
on total services costs is 4%, which is less than 7%, the accounting 
services constitute low margin covered services within the meaning 
of paragraph (b)(4)(ii) of this section.
    Example 16. Low margin covered services. Company P performs 
logistics-coordination services for its subsidiaries, including 
Company S. Company P uses the services cost method for the logistics 
services, and determines the amount charged as Company P's total 
cost of rendering the services, with no markup. Based on an 
application of the section 482 regulations without regard to this 
paragraph (b), the interquartile range of arm's length markups on 
total services costs is between 6% and 13%, and the median is 9%. 
Because the median comparable markup on total services costs is 9%, 
which exceeds 7%, the logistics-coordination services do not 
constitute low margin covered services within the meaning of 
paragraph (b)(4)(ii) of this section. With respect to the 
determination and application of the interquartile range, see Sec.  
1.482-1(e)(2)(iii)(C).
    Example 17. Low margin covered services. Company P performs 
certain custodial and maintenance services for certain office 
properties owned by Company S. Company P uses the services cost 
method for the services, and determines the amount charged as 
Company P's total cost of providing the services plus no markup. 
Uncontrolled comparables perform a similar range of custodial and 
maintenance services for uncontrolled parties and charge those 
parties an annual fee based on the total square footage of the 
property. These transactions meet the criteria for application of 
the comparable uncontrolled services price method of paragraph (c) 
of this section. The arm's length price for the custodial and 
maintenance services is determined under the general section 482 
regulations without regard to this paragraph (b), using the 
interquartile range described in Sec.  1.482-1(e)(2)(iii)(C) and as 
necessary adjusting to the median of such interquartile range. Based 
on reliable accounting information, the total services costs (as 
defined in paragraph (j) of this section) attributable to the 
custodial and maintenance services are subtracted from such price. 
The resulting excess of such price of the controlled services 
transaction over total services costs, as expressed as a percentage 
of total services costs, is determined to be 4%. Because the median 
comparable markup on total services costs as determined by an 
application of the section 482 regulations without regard to this 
paragraph (b) is 4%, which is less than 7%, the custodial and 
maintenance services constitute low margin covered services within 
the meaning of paragraph (b)(4)(ii) of this section.
    Example 18. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
operates a centralized data processing facility that performs 
automated invoice processing and order generation for all of its 
subsidiaries, Companies X, Y, Z, pursuant to a shared services 
arrangement.
    (ii) In evaluating the shares of reasonably anticipated benefits 
from the centralized data processing services, the total value of 
the merchandise on the invoices and orders may not provide the most 
reliable measure of reasonably anticipated benefits shares, because 
value of merchandise sold does not bear a relationship to the 
anticipated benefits from the underlying covered services.
    (iii) The total volume of orders and invoices processed may 
provide a more reliable basis for evaluating the shares of 
reasonably anticipated benefits from the data processing services. 
Alternatively, depending on the facts and circumstances, total 
central processing unit time attributable to the transactions of 
each subsidiary may provide a more reliable basis on which to 
evaluate the shares of reasonably anticipated benefits.
    Example 19. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
operates a centralized center that performs human resources 
functions, such as administration of pension, retirement, and health 
insurance plans that are made available to employees of its 
subsidiaries, Companies X, Y, Z, pursuant to a shared services 
arrangement.
    (ii) In evaluating the shares of reasonably anticipated benefits 
from these centralized services, the total revenues of each 
subsidiary may not provide the most reliable measure of reasonably 
anticipated benefit shares, because total revenues do not bear a 
relationship to the shares of reasonably anticipated benefits from 
the underlying services.
    (iii) Employee headcount or total compensation paid to employees 
may provide a more reliable basis for evaluating the shares of 
reasonably anticipated benefits from the covered services.
    Example 20. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
performs human resource services (service A) on behalf of the PXYZ 
Group that qualify for the services cost method. Under that method, 
Company P determines the amount charged for these services pursuant 
to a shared services arrangement based on an application of 
paragraph (b)(5) of this section. Service A constitutes a specified 
covered service described in a revenue procedure pursuant to 
paragraph (b)(4)(i) of this section. The total services costs for 
service A otherwise determined under the services cost method is 
300.
    (ii) Companies X, Y and Z reasonably anticipate benefits from 
service A. Company P does not reasonably anticipate benefits from 
service A. Assume that if relative reasonably anticipated benefits 
were precisely known, the appropriate allocation of charges pursuant 
to Sec.  1.482-9T(k) to Company X, Y and Z for service A is as 
follows:

                                Service A
                            [Total cost 300]
------------------------------------------------------------------------
                            Company
------------------------------------------------------------------------
X.............................................................       150
Y.............................................................        75
Z.............................................................        75
------------------------------------------------------------------------

    (iii) The total number of employees (employee headcount) in each 
company is as follows:
     Company X--600 employees.
     Company Y--250 employees.
     Company Z--250 employees.
    (iv) Company P allocates the 300 total services costs of service 
A based on employee headcount as follows:

                                Service A
                            [Total cost 300]
------------------------------------------------------------------------
                                                         Company
                Allocation key                 -------------------------
                                                 Headcount      Amount
------------------------------------------------------------------------
X.............................................          600          164
Y.............................................          250           68

[[Page 44494]]

 
Z.............................................          250           68
------------------------------------------------------------------------

    (v) Based on these facts, Company P may reasonably conclude that 
the employee headcount allocation basis most reliably reflects the 
participants' respective shares of the reasonably anticipated 
benefits attributable to service A.
    Example 21. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
performs accounts payable services (service B) on behalf of the PXYZ 
Group and determines the amount charged for the services under such 
method pursuant to a shared services arrangement based on an 
application of paragraph (b)(5) of this section. Service B is a 
specified covered service described in a revenue procedure pursuant 
to paragraph (b)(4)(i) of this section. The total services costs for 
service B otherwise determined under the services cost method is 
500.
    (ii) Companies X, Y and Z reasonably anticipate benefits from 
service B. Company P does not reasonably anticipate benefits from 
service B. Assume that if relative reasonably anticipated benefits 
were precisely known, the appropriate allocation of charges pursuant 
to Sec.  1.482-9T(k) to Companies X, Y and Z for service B is as 
follows:

                                Service B
                            [Total cost 500]
------------------------------------------------------------------------
                            Company
------------------------------------------------------------------------
X.............................................................       125
Y.............................................................       205
Z.............................................................       170
------------------------------------------------------------------------

    (iii) The total number of employees (employee headcount) in each 
company is as follows:
     Company X--600.
     Company Y--200.
     Company Z--200.
    (iv) The total number of transactions (transaction volume) with 
uncontrolled customers by each company is as follows:
     Company X--2,000.
     Company Y--4,000.
     Company Z--3,500.
    (v) If Company P allocated the 500 total services costs of 
service B based on employee headcount, the resulting allocation 
would be as follows:

                                Service B
                            [Total cost 500]
------------------------------------------------------------------------
                                                         Company
                Allocation key                 -------------------------
                                                 Headcount      Amount
------------------------------------------------------------------------
X.............................................          600          300
Y.............................................          200          100
Z.............................................          200          100
------------------------------------------------------------------------

    (vi) In contrast, if Company P used volume of transactions with 
uncontrolled customers as the allocation basis under the shared 
services arrangement, the allocation would be as follows:

                                Service B
                            [Total cost 500]
------------------------------------------------------------------------
                                                         Company
                                               -------------------------
                Allocation key                  Transaction
                                                   volume       Amount
------------------------------------------------------------------------
X.............................................        2,000          105
Y.............................................        4,000          211
Z.............................................        3,500          184
------------------------------------------------------------------------

    (vi) Based on these facts, Company P may reasonably conclude 
that the transaction volume, but not the employee headcount, 
allocation basis most reliably reflects the participants' respective 
shares of the reasonably anticipated benefits attributable to 
service B.
    Example 22. Shared services arrangement and aggregation. (i) 
Company P performs human resource services (service A) and accounts 
payable services (service B) on behalf of the PXYZ Group that 
qualify for the services cost method. Company P determines the 
amount charged for these services under such method pursuant to a 
shared services arrangement based on an application of paragraph 
(b)(5) of this section. Service A and service B are specified 
covered services described in a revenue procedure pursuant to 
paragraph (b)(4)(i) of this section. The total services costs 
otherwise determined under the services cost method for service A is 
300 and for service B is 500; total services costs for services A 
and B are 800. Company P determines that aggregation of services A 
and B for purposes of the arrangement is appropriate.
    (ii) Companies X, Y and Z reasonably anticipate benefits from 
services A and B. Company P does not reasonably anticipate benefits 
from services A and B. Assume that if relative reasonably 
anticipated benefits were precisely known, the appropriate 
allocation of total charges pursuant to Sec.  1.482-9T(k) to 
Companies X, Y and Z for services A and B is as follows:

                            Services A and B
                            [Total cost 800]
------------------------------------------------------------------------
                            Company
------------------------------------------------------------------------
X.............................................................       350
Y.............................................................       100
Z.............................................................       350
------------------------------------------------------------------------

    (iii) The total volume of transactions with uncontrolled 
customers in each company is as follows:
     Company X--2,000.
     Company Y--4,000.
     Company Z--4,000.
    (iv) The total number of employees in each company is as 
follows:
     Company X--600.
     Company Y--200.
     Company Z--200.
    (v) If Company P allocated the 800 total services costs of 
services A and B based on transaction volume or employee headcount, 
the resulting allocation would be as follows:

                                             Aggregated Services AB
                                                [Total cost 800]
----------------------------------------------------------------------------------------------------------------
                                                                   Allocation key            Allocation key
                                                             ---------------------------------------------------
                           Company                            Transaction
                                                                 volume       Amount     Headcount      Amount
----------------------------------------------------------------------------------------------------------------
X...........................................................        2,000          160          600          480
Y...........................................................        4,000          320          200          160
Z...........................................................        4,000          320          200          160
----------------------------------------------------------------------------------------------------------------


[[Page 44495]]

    (vi) In contrast, if aggregated services AB were allocated 
reference to the total U.S. dollar value of sales to uncontrolled 
parties (trade sales) by each company, the following results would 
obtain:

                         Aggregated Services AB
                            [Total costs 800]
------------------------------------------------------------------------
                                                  Allocation key
                                         -------------------------------
                 Company                    Trade sales
                                            (millions)        Amount
------------------------------------------------------------------------
X.......................................            $400             314
Y.......................................             120              94
Z.......................................             500             392
------------------------------------------------------------------------

    (vii) Based on these facts, Company P may reasonably conclude 
that the trade sales, but not the transaction volume or the employee 
headcount, allocation basis most reliably reflects the participants' 
respective shares of the reasonably anticipated benefits 
attributable to services AB.
    Example 23. Shared services arrangement and aggregation. (i) 
Company P performs services A through P on behalf of the PXYZ Group 
that qualify for the services cost method. Company P determines the 
amount charged for these services under such method pursuant to a 
shared services arrangement based on an application of paragraph 
(b)(5) of this section. All of these services A through Z constitute 
either specified covered services or low margin covered services 
described in paragraph (b)(4) of this section. The total services 
costs for services A through Z otherwise determined under the 
services cost method is 500. Company P determines that aggregation 
of services A through Z for purposes of the arrangement is 
appropriate.
    (ii) Companies X and Y reasonably anticipate benefits from 
services A through Z and Company Z reasonably anticipates benefits 
from services A through X but not from services Y or Z (Company Z 
performs services similar to services Y and Z on its own behalf). 
Company P does not reasonably anticipate benefits from services A 
through Z. Assume that if relative reasonably anticipated benefits 
were precisely known, the appropriate allocation of total charges 
pursuant to Sec.  1.482-9T(k) to Company X, Y and Z for services A 
through Z is as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                   Services A-P
                             Company                               Services A-M    Services N-P     (total cost
                                                                    (cost 490)       (cost 10)         500)
----------------------------------------------------------------------------------------------------------------
X...............................................................              90               5              95
Y...............................................................             240               5             245
Z...............................................................             160  ..............             160
----------------------------------------------------------------------------------------------------------------

    (iii) The total volume of transactions with uncontrolled 
customers in each company is as follows:
     Company X--2,000.
     Company Y--4,500.
     Company Z--3,500.
    (iv) Company P allocates the 500 total services costs of 
services A through Z based on transaction volume as follows:

                         Aggregated Services A-Z
                            [Total costs 500]
------------------------------------------------------------------------
                                                     Allocation key
                                               -------------------------
                    Company                     Transaction
                                                   volume       Amount
------------------------------------------------------------------------
X.............................................        2,000          100
Y.............................................        4,500          225
Z.............................................        3,500          175
------------------------------------------------------------------------

    (v) Based on these facts, Company P may reasonably conclude that 
the transaction volume allocation basis most reliably reflects the 
participants' respective shares of the reasonably anticipated 
benefits attributable to services A through Z.
    Example 24. Renderer reasonably anticipates benefits. (i) 
Company P renders services on behalf of the PXYZ Group that qualify 
for the services cost method. Company P determines the amount 
charged for these services under such method. Company P's share of 
reasonably anticipated benefits from services A, B, C, and D is 20% 
of the total reasonably anticipated benefits of all participants. 
Company P's total services cost for services A, B, C, and D charged 
within the Group is 100.
    (ii) Based on an application of paragraph (b)(5) of this 
section, Company P charges 80 which is allocated among Companies X, 
Y and Z. No charge is made to Company P under the shared services 
arrangement for activities that it performs on its own behalf.
    Example 25.  Coordination with cost sharing arrangement. (i) 
Company P performs human resource services (service A) on behalf of 
the PXYZ Group that qualify for the services cost method. Company P 
determines the amount charged for these services under such method 
pursuant to a shared services arrangement based on an application of 
paragraph (b)(5) of this section. Service A constitutes a specified 
covered service described in a revenue procedure pursuant to 
paragraph (b)(4)(i) of this section. The total services costs for 
service A otherwise determined under the services cost method is 
300.
    (ii) Company X, Y, Z and P reasonably anticipate benefits from 
service A. Using a basis of allocation that is consistent with the 
controlled participants' respective shares of the reasonably 
anticipated benefits from the shared services, the total charge of 
300 is allocated as follows:
     X--100.
     Y--50.
     Z--25.
     P--125.
    (iii) In addition to performing services, P undertakes 500 of 
R&D and incurs manufacturing and other costs of 1,000.
    (iv) Companies P and X enter into a cost sharing arrangement in 
accordance with Sec.  1.482-7. Under the arrangement, Company P will 
undertake all intangible development activities. All of Company P's 
research and development (R&D) activity is devoted to the intangible 
development activity under the cost sharing arrangement. Company P 
will manufacture, market, and otherwise exploit the product in its 
defined territory. Companies P and X will share intangible 
development costs in accordance with their reasonably anticipated 
benefits from the intangibles, and Company X will make payments to 
Company P as required under Sec.  1.482-7. Company X will 
manufacture, market, and otherwise exploit the product in the rest 
of the world.
    (v) A portion of the charge under the shared services 
arrangement is in turn allocable to the intangible development 
activity undertaken by Company P. The most reliable estimate of the 
proportion allocable to the intangible development activity is 
determined to be 500 (Company P's R&D expenses) divided by 1,500 
(Company P's total non-covered services costs), or one-third. 
Accordingly, one-third of Company P's charge of 125, or 42, is 
allocated to the intangible development activity. Companies P and X 
must share the intangible development costs of the cost shared 
intangibles (including the charge of 42 that is allocated under the 
shared services arrangement) in proportion to their respective 
shares of reasonably anticipated benefits under the cost sharing 
arrangement. That is, the reasonably anticipated benefit shares 
under the cost sharing arrangement are determined separately from 
reasonably anticipated benefit shares under the shared services 
arrangement.
    Example 26. Coordination with cost sharing arrangement. (i) The 
facts and analysis are the same as in Example 25, except that 
Company X also performs intangible development activities related to 
the cost sharing arrangement. Using a basis of allocation that is 
consistent with the controlled participants' respective shares of 
the reasonably anticipated benefits from the shared services, the 
300 of service costs is allocated as follows:
     X--100.
     Y--50.
     Z--25.
     P--125.
    (ii) In addition to performing services, Company P undertakes 
500 of R&D and incurs manufacturing and other costs of 1,000. 
Company X undertakes 400 of R&D and incurs manufacturing and other 
costs of 600.
    (iii) Companies P and X enter into a cost sharing arrangement in 
accordance with Sec.  1.482-7. Under the arrangement, both

[[Page 44496]]

Companies P and X will undertake intangible development activities. 
All of the research and development activity conducted by Companies 
P and X is devoted to the intangible development activity under the 
cost sharing arrangement. Both Companies P and X will manufacture, 
market, and otherwise exploit the product in their respective 
territories and will share intangible development costs in 
accordance with their reasonably anticipated benefits from the 
intangibles, and both will make payments as required under Sec.  
1.482-7.
    (iv) A portion of the charge under the shared services 
arrangement is in turn allocable to the intangible development 
activities undertaken by Companies P and X. The most reliable 
estimate of the portion allocable to Company P's intangible 
development activity is determined to be 500 (Company P's R&D 
expenses) divided by 1,500 (P's total non-covered services costs), 
or one-third. Accordingly, one-third of Company P's allocated 
services cost method charge of 125, or 42, is allocated to its 
intangible development activity.
    (v) In addition, it is necessary to determine the portion of the 
charge under the shared services arrangement to Company X that 
should be further allocated to Company X's intangible development 
activities under the cost sharing arrangement. The most reliable 
estimate of the portion allocable to Company X's intangible 
development activity is 400 (Company X's R&D expenses) divided by 
1,000 (Company X's costs), or 40%. Accordingly, 40% of the 100 that 
was allocated to Company X, or 40, is allocated in turn to Company 
X's intangible development activities. Company X makes a payment to 
Company P of 100 under the shared services arrangement and includes 
40 of services cost method charges in the pool of intangible 
development costs.
    (vi) The parties' respective contributions to intangible 
development costs under the cost sharing arrangement are as follows:
P: 500 + (0.333 * 125) = 542
X: 400 + (0.40 * 100) = 440

    (c) Comparable uncontrolled services price method--(1) In general. 
The comparable uncontrolled services price method evaluates whether the 
amount charged in a controlled services transaction is arm's length by 
reference to the amount charged in a comparable uncontrolled services 
transaction. The comparable uncontrolled services price method is 
ordinarily used where the controlled services either are identical to 
or have a high degree of similarity to the services in the uncontrolled 
transaction.
    (2) Comparability and reliability considerations--(i) In general. 
Whether results derived from application of this method are the most 
reliable measure of the arm's length result must be determined using 
the factors described under the best method rule in Sec.  1.482-1(c). 
The application of these factors under the comparable uncontrolled 
services price method is discussed in paragraphs (c)(2)(ii) and (iii) 
of this section.
    (ii) Comparability--(A) In general. The degree of comparability 
between controlled and uncontrolled transactions is determined by 
applying the provisions of Sec.  1.482-1(d). Although all of the 
factors described in Sec.  1.482-1(d)(3) must be considered, similarity 
of the services rendered, and of the intangibles (if any) used in 
performing the services, generally will have the greatest effects on 
comparability under this method. In addition, because even minor 
differences in contractual terms or economic conditions could 
materially affect the amount charged in an uncontrolled transaction, 
comparability under this method depends on close similarity with 
respect to these factors, or adjustments to account for any 
differences. The results derived from applying the comparable 
uncontrolled services price method generally will be the most direct 
and reliable measure of an arm's length price for the controlled 
transaction if an uncontrolled transaction has no differences from the 
controlled transaction that would affect the price, or if there are 
only minor differences that have a definite and reasonably 
ascertainable effect on price and for which appropriate adjustments are 
made. If such adjustments cannot be made, or if there are more than 
minor differences between the controlled and uncontrolled transactions, 
the comparable uncontrolled services price method may be used, but the 
reliability of the results as a measure of the arm's length price will 
be reduced. Further, if there are material differences for which 
reliable adjustments cannot be made, this method ordinarily will not 
provide a reliable measure of an arm's length result.
    (B) Adjustments for differences between controlled and uncontrolled 
transactions. If there are differences between the controlled and 
uncontrolled transactions that would affect price, adjustments should 
be made to the price of the uncontrolled transaction according to the 
comparability provisions of Sec.  1.482-1(d)(2). Specific examples of 
factors that may be particularly relevant to application of this method 
include--
    (1) Quality of the services rendered;
    (2) Contractual terms (for example, scope and terms of warranties 
or guarantees regarding the services, volume, credit and payment terms, 
allocation of risks, including any contingent-payment terms and whether 
costs were incurred without a provision for current reimbursement);
    (3) Intangibles (if any) used in rendering the services;
    (4) Geographic market in which the services are rendered or 
received;
    (5) Risks borne (for example, costs incurred to render the 
services, without provision for current reimbursement);
    (6) Duration or quantitative measure of services rendered;
    (7) Collateral transactions or ongoing business relationships 
between the renderer and the recipient, including arrangement for the 
provision of tangible property in connection with the services; and
    (8) Alternatives realistically available to the renderer and the 
recipient.
    (iii) Data and assumptions. The reliability of the results derived 
from the comparable uncontrolled services price method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply the method. See Sec.  1.482-1(c) (best 
method rule).
    (3) Arm's length range. See Sec.  1.482-1(e)(2) for the 
determination of an arm's length range.
    (4) Examples. The principles of this paragraph (c) are illustrated 
by the following examples:

    Example 1. Internal comparable uncontrolled services price. 
Company A, a United States corporation, performs shipping, 
stevedoring, and related services for controlled and uncontrolled 
parties on a short-term or as-needed basis. Company A charges 
uncontrolled parties in Country X a uniform fee of $60 per container 
to place loaded cargo containers in Country X on oceangoing vessels 
for marine transportation. Company A also performs identical 
services in Country X for its wholly-owned subsidiary, Company B, 
and there are no substantial differences between the controlled and 
uncontrolled transactions. In evaluating the appropriate measure of 
the arm's length price for the container-loading services performed 
for Company B, because Company A renders substantially identical 
services in Country X to both controlled and uncontrolled parties, 
it is determined that the comparable uncontrolled services price 
constitutes the best method for determining the arm's length price 
for the controlled services transaction. Based on the reliable data 
provided by Company A concerning the price charged for services in 
comparable uncontrolled transactions, a loading charge of $60 per 
cargo container will be considered the most reliable measure of the 
arm's length price for the services rendered to Company B. See 
paragraph (c)(2)(ii)(A) of this section.
    Example 2. External comparable uncontrolled services price. (i) 
The facts are the same as in Example 1, except that Company A 
performs services for Company B, but not for uncontrolled parties. 
Based on information obtained from unrelated parties (which is 
determined to be reliable under the comparability standards set 
forth in paragraph (c)(2) of this section), it is determined that 
uncontrolled parties in Country X perform services comparable to 
those rendered by Company A to Company

[[Page 44497]]

B, and that such parties charge $60 per cargo container.
    (ii) In evaluating the appropriate measure of an arm's length 
price for the loading services that Company A renders to Company B, 
the $60 per cargo container charge is considered evidence of a 
comparable uncontrolled services price. See paragraph (c)(2)(ii)(A) 
of this section.
    Example 3. External comparable uncontrolled services price. The 
facts are the same as in Example 2, except that uncontrolled parties 
in Country X render similar loading and stevedoring services, but 
only under contracts that have a minimum term of one year. If the 
difference in the duration of the services has a material effect on 
prices, adjustments to account for these differences must be made to 
the results of the uncontrolled transactions according to the 
provisions of Sec.  1.482-1(d)(2), and such adjusted results may be 
used as a measure of the arm's length result.
    Example 4. Use of valuable intangibles. (i) Company A, a United 
States corporation in the biotechnology sector, renders research and 
development services exclusively to its affiliates. Company B is 
Company A's wholly-owned subsidiary in Country X. Company A renders 
research and development services to Company B.
    (ii) In performing its research and development services 
function, Company A uses proprietary software that it developed 
internally. Company A uses the software to evaluate certain 
genetically engineered compounds developed by Company B. Company A 
owns the copyright on this software and does not license it to 
uncontrolled parties.
    (iii) No uncontrolled parties can be identified that perform 
services identical or with a high degree of similarity to those 
performed by Company A. Because there are material differences for 
which reliable adjustments cannot be made, the comparable 
uncontrolled services price method is unlikely to provide a reliable 
measure of the arm's length price. See paragraph (c)(2)(ii)(A) of 
this section.
    Example 5. Internal comparable. (i) Company A, a United States 
corporation, and its subsidiaries render computer consulting 
services relating to systems integration and networking to business 
clients in various countries. Company A and its subsidiaries render 
only consulting services, and do not manufacture computer hardware 
or software nor distribute such products. The controlled group is 
organized according to industry specialization, with key industry 
specialists working for Company A. These personnel typically form 
the core consulting group that teams with consultants from the 
local-country subsidiaries to serve clients in the subsidiaries' 
respective countries.
    (ii) Company A and its subsidiaries sometimes undertake 
engagements directly for clients, and sometimes work as 
subcontractors to unrelated parties on more extensive supply-chain 
consulting engagements for clients. In undertaking the latter 
engagements with third party consultants, Company A typically prices 
its services based on consulting hours worked multiplied by a rate 
determined for each category of employee. The company also charges, 
at no markup, for out-of-pocket expenses such as travel, lodging, 
and data acquisition charges. The Company has established the 
following schedule of hourly rates:

------------------------------------------------------------------------
                 Category                               Rate
------------------------------------------------------------------------
Project managers..........................  $400 per hour.
Technical staff...........................  $300 per hour.
------------------------------------------------------------------------

    (iii) Thus, for example, a project involving 100 hours of the 
time of project managers and 400 hours of technical staff time would 
result in the following project fees (without regard to any out-of-
pocket expenses): ([100 hrs. x $400/hr.] + [400 hrs. x $300/hr.]) = 
$40,000 + $120,000 = $160,000.
    (iv) Company B, a Country X subsidiary of Company A, contracts 
to perform consulting services for a Country X client in the banking 
industry. In undertaking this engagement, Company B uses its own 
consultants and also uses Company A project managers and technical 
staff that specialize in the banking industry for 75 hours and 380 
hours, respectively. In determining an arm's length charge, the 
price that Company A charges for consulting services as a 
subcontractor in comparable uncontrolled transactions will be 
considered evidence of a comparable uncontrolled services price. 
Thus, in this case, a payment of $144,000, (or [75 hrs. x $400/hr.] 
+ [380 hrs. x $300/hr.] = $30,000 + $114,000) may be used as a 
measure of the arm's length price for the work performed by Company 
A project mangers and technical staff. In addition, if the 
comparable uncontrolled services price method is used, then, 
consistent with the practices employed by the comparables with 
respect to similar types of expenses, Company B must reimburse 
Company A for appropriate out-of-pocket expenses. See paragraph 
(c)(2)(ii)(A) of this section.
    Example 6. Adjustments for differences. (i) The facts are the 
same as in Example 5, except that the engagement is undertaken with 
the client on a fixed fee basis. That is, prior to undertaking the 
engagement Company B and Company A estimate the resources required 
to undertake the engagement, and, based on hourly fee rates, charge 
the client a single fee for completion of the project. Company A's 
portion of the engagement results in fees of $144,000.
    (ii) The engagement, once undertaken, requires 20% more hours by 
each of Companies A and B than originally estimated. Nevertheless, 
the unrelated client pays the fixed fee that was agreed upon at the 
start of the engagement. Company B pays Company A $144,000, in 
accordance with the fixed fee arrangement.
    (iii) Company A often enters into similar fixed fee engagements 
with clients. In addition, Company A's records for similar 
engagements show that when it experiences cost overruns, it does not 
collect additional fees from the client for the difference between 
projected and actual hours. Accordingly, in evaluating whether the 
fees paid by Company B to Company A are arm's length, it is 
determined that no adjustments to the intercompany service charge 
are warranted. See Sec.  1.482-1(d)(3)(ii) and paragraph 
(c)(2)(ii)(A) of this section.

    (5) Indirect evidence of the price of a comparable uncontrolled 
services transaction--(i) In general. The price of a comparable 
uncontrolled services transaction may be derived based on indirect 
measures of the price charged in comparable uncontrolled services 
transactions, but only if--
    (A) The data are widely and routinely used in the ordinary course 
of business in the particular industry or market segment for purposes 
of determining prices actually charged in comparable uncontrolled 
services transactions;
    (B) The data are used to set prices in the controlled services 
transaction in the same way they are used to set prices in uncontrolled 
services transactions of the controlled taxpayer, or in the same way 
they are used by uncontrolled taxpayers to set prices in uncontrolled 
services transactions; and
    (C) The amount charged in the controlled services transaction may 
be reliably adjusted to reflect differences in quality of the services, 
contractual terms, market conditions, risks borne (including 
contingent-payment terms), duration or quantitative measure of services 
rendered, and other factors that may affect the price to which 
uncontrolled taxpayers would agree.
    (ii) Example. The following example illustrates this paragraph 
(c)(5):

    Example. Indirect evidence of comparable uncontrolled services 
price. (i) Company A is a United States insurance company. Company 
A's wholly-owned Country X subsidiary, Company B, performs 
specialized risk analysis for Company A as well as for uncontrolled 
parties. In determining the price actually charged to uncontrolled 
entities for performing such risk analysis, Company B uses a 
proprietary, multi-factor computer program, which relies on the 
gross value of the policies in the customer's portfolio, the 
relative composition of those policies, their location, and the 
estimated number of personnel hours necessary to complete the 
project. Uncontrolled companies that perform comparable risk 
analysis in the same industry or market-segment use similar 
proprietary computer programs to price transactions with 
uncontrolled customers (the competitors' programs may incorporate 
different inputs, or may assign different weights or values to 
individual inputs, in arriving at the price).
    (ii) During the taxable year subject to audit, Company B 
performed risk analysis for uncontrolled parties as well as for 
Company A. Because prices charged to uncontrolled customers 
reflected the composition of each customer's portfolio together with 
other factors, the prices charged in Company B's uncontrolled 
transactions do not provide a reliable basis for determining the 
comparable uncontrolled services price for the similar services 
rendered to Company A. However, in evaluating an arm's length price 
for the

[[Page 44498]]

studies performed by Company B for Company A, Company B's 
proprietary computer program may be considered as indirect evidence 
of the comparable uncontrolled services price that would be charged 
to perform the services for Company A. The reliability of the 
results obtained by application of this internal computer program as 
a measure of an arm's length price for the services will be 
increased to the extent that Company A used the internal computer 
program to generate actual transaction prices for risk-analysis 
studies performed for uncontrolled parties during the same taxable 
year under audit; Company A used data that are widely and routinely 
used in the ordinary course of business in the insurance industry to 
determine the price charged; and Company A reliably adjusted the 
price charged in the controlled services transaction to reflect 
differences that may affect the price to which uncontrolled 
taxpayers would agree.

    (d) Gross services margin method--(1) In general. The gross 
services margin method evaluates whether the amount charged in a 
controlled services transaction is arm's length by reference to the 
gross profit margin realized in comparable uncontrolled transactions. 
This method ordinarily is used in cases where a controlled taxpayer 
performs services or functions in connection with an uncontrolled 
transaction between a member of the controlled group and an 
uncontrolled taxpayer. This method may be used where a controlled 
taxpayer renders services (agent services) to another member of the 
controlled group in connection with a transaction between that other 
member and an uncontrolled taxpayer. This method also may be used in 
cases where a controlled taxpayer contracts to provide services to an 
uncontrolled taxpayer (intermediary function) and another member of the 
controlled group actually performs a portion of the services provided.
    (2) Determination of arm's length price--(i) In general. The gross 
services margin method evaluates whether the price charged or amount 
retained by a controlled taxpayer in the controlled services 
transaction in connection with the relevant uncontrolled transaction is 
arm's length by determining the appropriate gross profit of the 
controlled taxpayer.
    (ii) Relevant uncontrolled transaction. The relevant uncontrolled 
transaction is a transaction between a member of the controlled group 
and an uncontrolled taxpayer as to which the controlled taxpayer 
performs agent services or an intermediary function.
    (iii) Applicable uncontrolled price. The applicable uncontrolled 
price is the price paid or received by the uncontrolled taxpayer in the 
relevant uncontrolled transaction.
    (iv) Appropriate gross services profit. The appropriate gross 
services profit is computed by multiplying the applicable uncontrolled 
price by the gross services profit margin in comparable uncontrolled 
transactions. The determination of the appropriate gross services 
profit will take into account any functions performed by other members 
of the controlled group, as well as any other relevant factors 
described in Sec.  1.482-1(d)(3). The comparable gross services profit 
margin may be determined by reference to the commission in an 
uncontrolled transaction, where that commission is stated as a 
percentage of the price charged in the uncontrolled transaction.
    (v) Arm's length range. See Sec.  1.482-1(e)(2) for determination 
of the arm's length range.
    (3) Comparability and reliability considerations--(i) In general. 
Whether results derived from application of this method are the most 
reliable measure of the arm's length result must be determined using 
the factors described under the best method rule in Sec.  1.482-1(c). 
The application of these factors under the gross services margin method 
is discussed in paragraphs (d)(3)(ii) and (iii) of this section.
    (ii) Comparability--(A) Functional comparability. The degree of 
comparability between an uncontrolled transaction and a controlled 
transaction is determined by applying the comparability provisions of 
Sec.  1.482-1(d). A gross services profit provides compensation for 
services or functions that bear a relationship to the relevant 
uncontrolled transaction, including an operating profit in return for 
the investment of capital and the assumption of risks by the controlled 
taxpayer performing the services or functions under review. Therefore, 
although all of the factors described in Sec.  1.482-1(d)(3) must be 
considered, comparability under this method is particularly dependent 
on similarity of services or functions performed, risks borne, 
intangibles (if any) used in providing the services or functions, and 
contractual terms, or adjustments to account for the effects of any 
such differences. If possible, the appropriate gross services profit 
margin should be derived from comparable uncontrolled transactions by 
the controlled taxpayer under review, because similar characteristics 
are more likely found among different transactions by the same 
controlled taxpayer than among transactions by other parties. In the 
absence of comparable uncontrolled transactions involving the same 
controlled taxpayer, an appropriate gross services profit margin may be 
derived from transactions of uncontrolled taxpayers involving 
comparable services or functions with respect to similarly related 
transactions.
    (B) Other comparability factors. Comparability under this method is 
not dependent on close similarity of the relevant uncontrolled 
transaction to the related transactions involved in the uncontrolled 
comparables. However, substantial differences in the nature of the 
relevant uncontrolled transaction and the relevant transactions 
involved in the uncontrolled comparables, such as differences in the 
type of property transferred or service provided in the relevant 
uncontrolled transaction, may indicate significant differences in the 
services or functions performed by the controlled and uncontrolled 
taxpayers with respect to their respective relevant transactions. Thus, 
it ordinarily would be expected that the services or functions 
performed in the controlled and uncontrolled transactions would be with 
respect to relevant transactions involving the transfer of property 
within the same product categories or the provision of services of the 
same general type (for example, information-technology systems design). 
Furthermore, significant differences in the intangibles (if any) used 
by the controlled taxpayer in the controlled services transaction as 
distinct from the uncontrolled comparables may also affect the 
reliability of the comparison. Finally, the reliability of profit 
measures based on gross services profit may be adversely affected by 
factors that have less effect on prices. For example, gross services 
profit may be affected by a variety of other factors, including cost 
structures or efficiency (for example, differences in the level of 
experience of the employees performing the service in the controlled 
and uncontrolled transactions). Accordingly, if material differences in 
these factors are identified based on objective evidence, the 
reliability of the analysis may be affected.
    (C) Adjustments for differences between controlled and uncontrolled 
transactions. If there are material differences between the controlled 
and uncontrolled transactions that would affect the gross services 
profit margin, adjustments should be made to the gross services profit 
margin, according to the comparability provisions of Sec.  1.482-
1(d)(2). For this purpose, consideration of the total services costs 
associated with functions performed and risks assumed may be necessary 
because differences in functions performed are often reflected in these 
costs. If there are differences in functions performed, however, the 
effect on gross services

[[Page 44499]]

profit of such differences is not necessarily equal to the differences 
in the amount of related costs. Specific examples of factors that may 
be particularly relevant to this method include--
    (1) Contractual terms (for example, scope and terms of warranties 
or guarantees regarding the services or function, volume, credit and 
payment terms, and allocation of risks, including any contingent-
payment terms);
    (2) Intangibles (if any) used in performing the services or 
function;
    (3) Geographic market in which the services or function are 
performed or in which the relevant uncontrolled transaction takes 
place; and
    (4) Risks borne, including, if applicable, inventory-type risk.
    (D) Buy-sell distributor. If a controlled taxpayer that performs an 
agent service or intermediary function is comparable to a distributor 
that takes title to goods and resells them, the gross profit margin 
earned by such distributor on uncontrolled sales, stated as a 
percentage of the price for the goods, may be used as the comparable 
gross services profit margin.
    (iii) Data and assumptions--(A) In general. The reliability of the 
results derived from the gross services margin method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply this method. See Sec.  1.482-1(c) (best 
method rule).
    (B) Consistency in accounting. The degree of consistency in 
accounting practices between the controlled transaction and the 
uncontrolled comparables that materially affect the gross services 
profit margin affects the reliability of the results under this method.
    (4) Examples. The principles of this paragraph (d) are illustrated 
by the following examples:

    Example 1. Agent services. Company A and Company B are members 
of a controlled group. Company A is a foreign manufacturer of 
industrial equipment. Company B is a U.S. company that acts as a 
commission agent for Company A by arranging for Company A to make 
direct sales of the equipment it manufactures to unrelated 
purchasers in the U.S. market. Company B does not take title to the 
equipment but instead receives from Company A commissions that are 
determined as a specified percentage of the sales price for the 
equipment that is charged by Company A to the unrelated purchaser. 
Company B also arranges for direct sales of similar equipment by 
unrelated foreign manufacturers to unrelated purchasers in the U.S. 
market. Company B charges these unrelated foreign manufacturers a 
commission fee of 5% of the sales price charged by the unrelated 
foreign manufacturers to the unrelated U.S. purchasers for the 
equipment. Information regarding the comparable agent services 
provided by Company B to unrelated foreign manufacturers is 
sufficiently complete to conclude that it is likely that all 
material differences between the controlled and uncontrolled 
transactions have been identified and adjustments for such 
differences have been made. If the comparable gross services profit 
margin is 5% of the price charged in the relevant transactions 
involved in the uncontrolled comparables, then the appropriate gross 
services profit that Company B may earn and the arm's length price 
that it may charge Company A for its agent services is equal to 5% 
of the applicable uncontrolled price charged by Company A in sales 
of equipment in the relevant uncontrolled transactions.
    Example 2. Agent services. The facts are the same as in Example 
1, except that Company B does not act as a commission agent for 
unrelated parties and it is not possible to obtain reliable 
information concerning commission rates charged by uncontrolled 
commission agents that engage in comparable transactions with 
respect to relevant sales of property. It is possible, however, to 
obtain reliable information regarding the gross profit margins 
earned by unrelated parties that briefly take title to and then 
resell similar property in uncontrolled transactions, in which they 
purchase the property from foreign manufacturers and resell the 
property to purchasers in the U.S. market. Analysis of the facts and 
circumstances indicates that, aside from certain minor differences 
for which adjustments can be made, the uncontrolled parties that 
resell property perform similar functions and assume similar risks 
as Company B performs and assumes when it acts as a commission agent 
for Company A's sales of property. Under these circumstances, the 
gross profit margin earned by the unrelated distributors on the 
purchase and resale of property may be used, subject to any 
adjustments for any material differences between the controlled and 
uncontrolled transactions, as a comparable gross services profit 
margin. The appropriate gross services profit that Company B may 
earn and the arm's length price that it may charge Company A for its 
agent services is therefore equal to this comparable gross services 
margin, multiplied by the applicable uncontrolled price charged by 
Company A in its sales of equipment in the relevant uncontrolled 
transactions.
    Example 3. Agent services. (i) Company A and Company B are 
members of a controlled group. Company A is a U.S. corporation that 
renders computer consulting services, including systems integration 
and networking, to business clients.
    (ii) In undertaking engagements with clients, Company A in some 
cases pays a commission of 3% of its total fees to unrelated parties 
that assist Company A in obtaining consulting engagements. 
Typically, such fees are paid to non-computer consulting firms that 
provide strategic management services for their clients. When 
Company A obtains a consulting engagement with a client of a non-
computer consulting firm, Company A does not subcontract with the 
other consulting firm, nor does the other consulting firm play any 
role in Company A's consulting engagement.
    (iii) Company B, a Country X subsidiary of Company A, assists 
Company A in obtaining an engagement to perform computer consulting 
services for a Company B banking industry client in Country X. 
Although Company B has an established relationship with its Country 
X client and was instrumental in arranging for Company A's 
engagement with the client, Company A's particular expertise was the 
primary consideration in motivating the client to engage Company A. 
Based on the relative contributions of Companies A and B in 
obtaining and undertaking the engagement, Company B's role was 
primarily to facilitate the consulting engagement between Company A 
and the Country X client. Information regarding the commissions paid 
by Company A to unrelated parties for providing similar services to 
facilitate Company A's consulting engagements is sufficiently 
complete to conclude that it is likely that all material differences 
between these uncontrolled transactions and the controlled 
transaction between Company B and Company A have been identified and 
that appropriate adjustments have been made for any such 
differences. If the comparable gross services margin earned by 
unrelated parties in providing such agent services is 3% of total 
fees charged in the relevant transactions involved in the 
uncontrolled comparables, then the appropriate gross services profit 
that Company B may earn and the arm's length price that it may 
charge Company A for its agent services is equal to this comparable 
gross services margin (3%), multiplied by the applicable 
uncontrolled price charged by Company A in its relevant uncontrolled 
consulting engagement with Company B's client.
    Example 4. Intermediary function. (i) The facts are the same as 
in Example 3, except that Company B contracts directly with its 
Country X client to provide computer consulting services and Company 
A performs the consulting services on behalf of Company B. Company A 
does not enter into a consulting engagement with Company B's Country 
X client. Instead, Company B charges its Country X client an 
uncontrolled price for the consulting services, and Company B pays a 
portion of the uncontrolled price to Company A for performing the 
consulting services on behalf of Company B.
    (ii) Analysis of the relative contributions of Companies A and B 
in obtaining and undertaking the consulting contract indicates that 
Company B functioned primarily as an intermediary contracting party, 
and the gross services margin method is the most reliable method for 
determining the amount that Company B may retain as compensation for 
its intermediary function with respect to Company A's consulting 
services. In this case, therefore, because Company B entered into 
the relevant uncontrolled transaction to provide services, Company B 
receives the applicable uncontrolled price that is paid by the 
Country X client for the consulting services. Company A technically 
performs

[[Page 44500]]

services for Company B when it performs, on behalf of Company B, the 
consulting services Company B contracted to provide to the Country X 
client. The arm's length amount that Company A may charge Company B 
for performing the consulting services on Company B's behalf is 
equal to the applicable uncontrolled price received by Company B in 
the relevant uncontrolled transaction, less Company B's appropriate 
gross services profit, which is the amount that Company B may retain 
as compensation for performing the intermediary function.
    (iii) Reliable data concerning the commissions that Company A 
paid to uncontrolled parties for assisting it in obtaining 
engagements to provide consulting services similar to those it has 
provided on behalf of Company B provide useful information in 
applying the gross services margin method. However, consideration 
should be given to whether the third party commission data may need 
to be adjusted to account for any additional risk that Company B may 
have assumed as a result of its function as an intermediary 
contracting party, compared with the risk it would have assumed if 
it had provided agent services to assist Company A in entering into 
an engagement to provide its consulting service directly. In this 
case, the information regarding the commissions paid by Company A to 
unrelated parties for providing agent services to facilitate its 
performance of consulting services for unrelated parties is 
sufficiently complete to conclude that all material differences 
between these uncontrolled transactions and the controlled 
performance of an intermediary function, including possible 
differences in the amount of risk assumed in connection with 
performing that function, have been identified and that appropriate 
adjustments have been made. If the comparable gross services margin 
earned by unrelated parties in providing such agent services is 3% 
of total fees charged in Company B's relevant uncontrolled 
transactions, then the appropriate gross services profit that 
Company B may retain as compensation for performing an intermediary 
function (and the amount, therefore, that is deducted from the 
applicable uncontrolled price to arrive at the arm's length price 
that Company A may charge Company B for performing consulting 
services on Company B's behalf) is equal to this comparable gross 
services margin (3%), multiplied by the applicable uncontrolled 
price charged by Company B in its contract to provide services to 
the uncontrolled party.
    Example 5. External comparable. (i) The facts are the same as in 
Example 4, except that neither Company A nor Company B engages in 
transactions with third parties that facilitate similar consulting 
engagements.
    (ii) Analysis of the relative contributions of Companies A and B 
in obtaining and undertaking the contract indicates that Company B's 
role was primarily to facilitate the consulting arrangement between 
Company A and the Country X client. Although no reliable internal 
data are available regarding comparable transactions with 
uncontrolled entities, reliable data exist regarding commission 
rates for similar facilitating services between uncontrolled 
parties. These data indicate that a 3% commission (3% of total 
engagement fee) is charged in such transactions. Information 
regarding the uncontrolled comparables is sufficiently complete to 
conclude that it is likely that all material differences between the 
controlled and uncontrolled transactions have been identified and 
adjusted for. If the appropriate gross services profit margin is 3% 
of total fees, then an arm's length result of the controlled 
services transaction is for Company B to retain an amount equal to 
3% of total fees paid to it.

    (e) Cost of services plus method--(1) In general. The cost of 
services plus method evaluates whether the amount charged in a 
controlled services transaction is arm's length by reference to the 
gross services profit markup realized in comparable uncontrolled 
transactions. The cost of services plus method is ordinarily used in 
cases where the controlled service renderer provides the same or 
similar services to both controlled and uncontrolled parties. This 
method is ordinarily not used in cases where the controlled services 
transaction involves a contingent-payment arrangement, as described in 
paragraph (i)(2) of this section.
    (2) Determination of arm's length price--(i) In general. The cost 
of services plus method measures an arm's length price by adding the 
appropriate gross services profit to the controlled taxpayer's 
comparable transactional costs.
    (ii) Appropriate gross services profit. The appropriate gross 
services profit is computed by multiplying the controlled taxpayer's 
comparable transactional costs by the gross services profit markup, 
expressed as a percentage of the comparable transactional costs earned 
in comparable uncontrolled transactions.
    (iii) Comparable transactional costs. Comparable transactional 
costs consist of the costs of providing the services under review that 
are taken into account as the basis for determining the gross services 
profit markup in comparable uncontrolled transactions. Depending on the 
facts and circumstances, such costs typically include all compensation 
attributable to employees directly involved in the performance of such 
services, materials and supplies consumed or made available in 
rendering such services, and may include as well other costs of 
rendering the services. Comparable transactional costs must be 
determined on a basis that will facilitate comparison with the 
comparable uncontrolled transactions. For that reason, comparable 
transactional costs may not necessarily equal total services costs, as 
defined in paragraph (j) of this section, and in appropriate cases may 
be a subset of total services costs. Generally accepted accounting 
principles or Federal income tax accounting rules (where Federal income 
tax data for comparable transactions or business activities are 
available) may provide useful guidance but will not conclusively 
establish the appropriate comparable transactional costs for purposes 
of this method.
    (iv) Arm's length range. See Sec.  1.482-1(e)(2) for determination 
of an arm's length range.
    (3) Comparability and reliability considerations--(i) In general. 
Whether results derived from the application of this method are the 
most reliable measure of the arm's length result must be determined 
using the factors described under the best method rule in Sec.  1.482-
1(c).
    (ii) Comparability--(A) Functional comparability. The degree of 
comparability between controlled and uncontrolled transactions is 
determined by applying the comparability provisions of Sec.  1.482-
1(d). A service renderer's gross services profit provides compensation 
for performing services related to the controlled services transaction 
under review, including an operating profit for the service renderer's 
investment of capital and assumptions of risks. Therefore, although all 
of the factors described in Sec.  1.482-1(d)(3) must be considered, 
comparability under this method is particularly dependent on similarity 
of services or functions performed, risks borne, intangibles (if any) 
used in providing the services or functions, and contractual terms, or 
adjustments to account for the effects of any such differences. If 
possible, the appropriate gross services profit markup should be 
derived from comparable uncontrolled transactions of the same taxpayer 
participating in the controlled services transaction because similar 
characteristics are more likely to be found among services provided by 
the same service provider than among services provided by other service 
providers. In the absence of such services transactions, an appropriate 
gross services profit markup may be derived from comparable 
uncontrolled services transactions of other service providers. If the 
appropriate gross services profit markup is derived from comparable 
uncontrolled services transactions of other service providers, in 
evaluating comparability the controlled taxpayer must consider the 
results under this method expressed as a markup on total services costs 
of the controlled taxpayer, because differences in functions performed 
may be reflected in differences in service costs other than

[[Page 44501]]

those included in comparable transactional costs.
    (B) Other comparability factors. Comparability under this method is 
less dependent on close similarity between the services provided than 
under the comparable uncontrolled services price method. Substantial 
differences in the services may, however, indicate significant 
functional differences between the controlled and uncontrolled 
taxpayers. Thus, it ordinarily would be expected that the controlled 
and uncontrolled transactions would involve services of the same 
general type (for example, information-technology systems design). 
Furthermore, if a significant amount of the controlled taxpayer's 
comparable transactional costs consists of service costs incurred in a 
tax accounting period other than the tax accounting period under 
review, the reliability of the analysis would be reduced. In addition, 
significant differences in the value of the services rendered, due for 
example to the use of valuable intangibles, may also affect the 
reliability of the comparison. Finally, the reliability of profit 
measures based on gross services profit may be adversely affected by 
factors that have less effect on prices. For example, gross services 
profit may be affected by a variety of other factors, including cost 
structures or efficiency-related factors (for example, differences in 
the level of experience of the employees performing the service in the 
controlled and uncontrolled transactions). Accordingly, if material 
differences in these factors are identified based on objective 
evidence, the reliability of the analysis may be affected.
    (C) Adjustments for differences between the controlled and 
uncontrolled transactions. If there are material differences between 
the controlled and uncontrolled transactions that would affect the 
gross services profit markup, adjustments should be made to the gross 
services profit markup earned in the comparable uncontrolled 
transaction according to the provisions of Sec.  1.482-1(d)(2). For 
this purpose, consideration of the comparable transactional costs 
associated with the functions performed and risks assumed may be 
necessary, because differences in the functions performed are often 
reflected in these costs. If there are differences in functions 
performed, however, the effect on gross services profit of such 
differences is not necessarily equal to the differences in the amount 
of related comparable transactional costs. Specific examples of the 
factors that may be particularly relevant to this method include--
    (1) The complexity of the services;
    (2) The duration or quantitative measure of services;
    (3) Contractual terms (for example, scope and terms of warranties 
or guarantees provided, volume, credit and payment terms, allocation of 
risks, including any contingent-payment terms);
    (4) Economic circumstances; and
    (5) Risks borne.
    (iii) Data and assumptions--(A) In general. The reliability of the 
results derived from the cost of services plus method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply this method. See Sec.  1.482-1(c) (Best 
method rule).
    (B) Consistency in accounting. The degree of consistency in 
accounting practices between the controlled transaction and the 
uncontrolled comparables that materially affect the gross services 
profit markup affects the reliability of the results under this method. 
Thus, for example, if differences in cost accounting practices would 
materially affect the gross services profit markup, the ability to make 
reliable adjustments for such differences would affect the reliability 
of the results obtained under this method. Further, reliability under 
this method depends on the extent to which the controlled and 
uncontrolled transactions reflect consistent reporting of comparable 
transactional costs. For purposes of this paragraph (e)(3)(iii)(B), the 
term comparable transactional costs includes the cost of acquiring 
tangible property that is transferred (or used) with the services, to 
the extent that the arm's length price of the tangible property is not 
separately evaluated as a controlled transaction under another 
provision.
    (4) Examples. The principles of this paragraph (e) are illustrated 
by the following examples:

    Example 1. Internal comparable. (i) Company A designs and 
assembles information-technology networks and systems. When Company 
A renders services for uncontrolled parties, it receives 
compensation based on time and materials as well as certain other 
related costs necessary to complete the project. This fee includes 
the cost of hardware and software purchased from uncontrolled 
vendors and incorporated in the final network or system, plus a 
reasonable allocation of certain specified overhead costs incurred 
by Company A in providing these services. Reliable accounting 
records maintained by Company A indicate that Company A earned a 
gross services profit markup of 10% on its time, materials and 
specified overhead in providing design services during the year 
under examination on information technology projects for 
uncontrolled entities.
    (ii) Company A designed an information-technology network for 
its Country X subsidiary, Company B. The services rendered to 
Company B are similar in scope and complexity to services that 
Company A rendered to uncontrolled parties during the year under 
examination. Using Company A's accounting records (which are 
determined to be reliable under paragraph (e)(3) of this section), 
it is possible to identify the comparable transactional costs 
involved in the controlled services transaction with reference to 
the costs incurred by Company A in rendering similar design services 
to uncontrolled parties. Company A's records indicate that it does 
not incur any additional types of costs in rendering similar 
services to uncontrolled customers. The data available are 
sufficiently complete to conclude that it is likely that all 
material differences between the controlled and uncontrolled 
transactions have been identified and adjusted for. Based on the 
gross services profit markup data derived from Company A's 
uncontrolled transactions involving similar design services, an 
arm's length result for the controlled services transaction is equal 
to the price that will allow Company A to earn a 10% gross services 
profit markup on its comparable transactional costs.
    Example 2. Inability to adjust for differences in comparable 
transactional costs. The facts are the same as in Example 1, except 
that Company A's staff that rendered the services to Company B 
consisted primarily of engineers in training status or on temporary 
rotation from other Company A subsidiaries. In addition, the Company 
B network incorporated innovative features, including specially 
designed software suited to Company B's requirements. The use of 
less-experienced personnel and staff on temporary rotation, together 
with the special features of the Company B network, significantly 
increased the time and costs associated with the project as compared 
to time and costs associated with similar projects completed for 
uncontrolled customers. These factors constitute material 
differences between the controlled and the uncontrolled transactions 
that affect the determination of Company A's comparable 
transactional costs associated with the controlled services 
transaction, as well as the gross services profit markup. Moreover, 
it is not possible to perform reliable adjustments for these 
differences on the basis of the available accounting data. Under 
these circumstances, the reliability of the cost of services plus 
method as a measure of an arm's length price is substantially 
reduced.
    Example 3. Operating loss by reference to total services costs. 
The facts and analysis are the same as in Example 1, except that an 
unrelated Company C, instead of Company A, renders similar services 
to uncontrolled parties and publicly available information indicates 
that Company C earned a gross services profit markup of 10% on its 
time, materials and certain specified overhead in providing those 
services. As in Example 1, Company A still provides services for its 
Country X subsidiary, Company B. In accordance with the requirements 
in paragraph (e)(3)(ii) of this section, the

[[Page 44502]]

taxpayer performs additional analysis and restates the results of 
Company A's controlled services transaction with its Country X 
subsidiary, Company B, in the form of a markup on Company A's total 
services costs. This analysis by reference to total services costs 
shows that Company A generated an operating loss on the controlled 
services transaction, which indicates that functional differences 
likely exist between the controlled services transaction performed 
by Company A and uncontrolled services transactions performed by 
Company C, and that these differences may not be reflected in the 
comparable transactional costs. Upon further scrutiny, the presence 
of such functional differences between the controlled and 
uncontrolled transactions may indicate that the cost of services 
plus method does not provide the most reliable measure of an arm's 
length result under the facts and circumstances.
    Example 4. Internal comparable. (i) Company A, a U.S. 
corporation, and its subsidiaries perform computer consulting 
services relating to systems integration and networking for business 
clients in various countries. Company A and its subsidiaries render 
only consulting services and do not manufacture or distribute 
computer hardware or software to clients. The controlled group is 
organized according to industry specialization, with key industry 
specialists working for Company A. These personnel typically form 
the core consulting group that teams with consultants from the 
local-country subsidiaries to serve clients in the subsidiaries' 
respective countries.
    (ii) On some occasions, Company A and its subsidiaries undertake 
engagements directly for clients. On other occasions, they work as 
subcontractors for uncontrolled parties on more extensive consulting 
engagements for clients. In undertaking the latter engagements with 
third-party consultants, Company A typically prices its services at 
four times the compensation costs of its consultants, defined as the 
consultants' base salary plus estimated fringe benefits, as defined 
in this table:

------------------------------------------------------------------------
                 Category                               Rates
------------------------------------------------------------------------
Project managers..........................  $100 per hour.
Technical staff...........................  $75 per hour.
------------------------------------------------------------------------

    (iii) In uncontrolled transactions, Company A also charges the 
customer, at no markup, for out-of-pocket expenses such as travel, 
lodging, and data acquisition charges. Thus, for example, a project 
involving 100 hours of time from project managers, and 400 hours of 
technical staff time would result in total compensation costs to 
Company A of (100 hrs. x $100/hr.) + (400 hrs. x $75/hr.) = $10,000 
+ $30,000 = $40,000. Applying the markup of 300%, the total fee 
charged would thus be (4 x $40,000), or $160,000, plus out-of-pocket 
expenses.
    (iv) Company B, a Country X subsidiary of Company A, contracts 
to render consulting services to a Country X client in the banking 
industry. In undertaking this engagement, Company B uses its own 
consultants and also uses the services of Company A project managers 
and technical staff that specialize in the banking industry for 75 
hours and 380 hours, respectively. The data available are 
sufficiently complete to conclude that it is likely that all 
material differences between the controlled and uncontrolled 
transactions have been identified and adjusted for. Based on 
reliable data concerning the compensation costs to Company A, an 
arm's length result for the controlled services transaction is equal 
to $144,000. This is calculated as follows: [4 x (75 hrs. x $100/
hr.)] + [4 x (380 hrs. x $75/hr.)] = $30,000 + $114,000 = $144,000, 
reflecting a 4x markup on the total compensation costs for Company A 
project managers and technical staff. In addition, consistent with 
Company A's pricing of uncontrolled transactions, Company B must 
reimburse Company A for appropriate out-of-pocket expenses incurred 
in performing the services.

    (f) Comparable profits method--(1) In general. The comparable 
profits method evaluates whether the amount charged in a controlled 
transaction is arm's length, based on objective measures of 
profitability (profit level indicators) derived from uncontrolled 
taxpayers that engage in similar business activities under similar 
circumstances. The rules in Sec.  1.482-5 relating to the comparable 
profits method apply to controlled services transactions, except as 
modified in this paragraph (f).
    (2) Determination of arm's length result--(i) Tested party. This 
paragraph (f) applies where the relevant business activity of the 
tested party as determined under Sec.  1.482-5(b)(2) is the rendering 
of services in a controlled services transaction. Where the tested 
party determined under Sec.  1.482-5(b)(2) is instead the recipient of 
the controlled services, the rules under this paragraph (f) are not 
applicable to determine the arm's length result.
    (ii) Profit level indicators. In addition to the profit level 
indicators provided in Sec.  1.482-5(b)(4), a profit level indicator 
that may provide a reliable basis for comparing operating profits of 
the tested party involved in a controlled services transaction and 
uncontrolled comparables is the ratio of operating profit to total 
services costs (as defined in paragraph (j) of this section).
    (iii) Comparability and reliability considerations--Data and 
assumptions--Consistency in accounting. Consistency in accounting 
practices between the relevant business activity of the tested party 
and the uncontrolled service providers is particularly important in 
determining the reliability of the results under this method, but less 
than in applying the cost of services plus method. Adjustments may be 
appropriate if materially different treatment is applied to particular 
cost items related to the relevant business activity of the tested 
party and the uncontrolled service providers. For example, adjustments 
may be appropriate where the tested party and the uncontrolled 
comparables use inconsistent approaches to classify similar expenses as 
``cost of goods sold'' and ``selling, general, and administrative 
expenses.'' Although distinguishing between these two categories may be 
difficult, the distinction is less important to the extent that the 
ratio of operating profit to total services costs is used as the 
appropriate profit level indicator. Determining whether adjustments are 
necessary under these or similar circumstances requires thorough 
analysis of the functions performed and consideration of the cost 
accounting practices of the tested party and the uncontrolled 
comparables. Other adjustments as provided in Sec.  1.482-5(c)(2)(iv) 
may also be necessary to increase the reliability of the results under 
this method.
    (3) Examples. The principles of this paragraph (f) are illustrated 
by the following examples:

    Example 1. Ratio of operating profit to total services costs as 
the appropriate profit level indicator. (i) A Country T parent firm, 
Company A, and its Country Y subsidiary, Company B, both engage in 
manufacturing as their principal business activity. Company A also 
performs certain advertising services for itself and its affiliates. 
In year 1, Company A renders advertising services to Company B.
    (ii) Based on the facts and circumstances, it is determined that 
the comparable profits method will provide the most reliable measure 
of an arm's length result. Company A is selected as the tested 
party. No data are available for comparable independent 
manufacturing firms that render advertising services to third 
parties. Financial data are available, however, for ten independent 
firms that render similar advertising services as their principal 
business activity in Country X. The ten firms are determined to be 
comparable under Sec.  1.482-5(c). Neither Company A nor the 
comparable companies use valuable intangibles in rendering the 
services.
    (iii) Based on the available financial data of the comparable 
companies, it cannot be determined whether these comparable 
companies report costs for financial accounting purposes in the same 
manner as the tested party. The publicly available financial data of 
the comparable companies segregate total services costs into cost of 
goods sold and sales, general and administrative costs, with no 
further segmentation of costs provided. Due to the limited 
information available regarding the cost accounting practices used 
by the comparable companies, the ratio of operating profits to total 
services costs is determined to be the most appropriate profit level 
indicator. This ratio includes total services costs to minimize the 
effect of any inconsistency in accounting practices between Company 
A and the comparable companies.

[[Page 44503]]

    Example 2. Application of the operating profit to total services 
costs profit level indicator. (i) Company A is a foreign subsidiary 
of Company B, a U.S. corporation. Company B is under examination for 
its year 1 taxable year. Company B renders management consulting 
services to Company A. Company B's consulting function includes 
analyzing Company A's operations, benchmarking Company A's financial 
performance against companies in the same industry, and to the 
extent necessary, developing a strategy to improve Company A's 
operational performance. The accounting records of Company B allow 
reliable identification of the total services costs of the 
consulting staff associated with the management consulting services 
rendered to Company A. Company A reimburses Company B for its costs 
associated with rendering the consulting services, with no markup.

    (ii) Based on all the facts and circumstances, it is determined 
that the comparable profits method will provide the most reliable 
measure of an arm's length result. Company B is selected as the 
tested party, and its rendering of management consulting services is 
identified as the relevant business activity. Data are available 
from ten domestic companies that operate in the industry segment 
involving management consulting and that perform activities 
comparable to the relevant business activity of Company B. These 
comparables include entities that primarily perform management 
consulting services for uncontrolled parties. The comparables incur 
similar risks as Company B incurs in performing the consulting 
services and do not make use of valuable intangibles or special 
processes.
    (iii) Based on the available financial data of the comparables, 
it cannot be determined whether the comparables report their costs 
for financial accounting purposes in the same manner as Company B 
reports its costs in the relevant business activity. The available 
financial data for the comparables report only an aggregate figure 
for costs of goods sold and operating expenses, and do not segment 
the underlying services costs. Due to this limitation, the ratio of 
operating profits to total services costs is determined to be the 
most appropriate profit level indicator.
    (iv) For the taxable years 1 through 3, Company B shows the 
following results for the services performed for Company A:

----------------------------------------------------------------------------------------------------------------
                                                      Year 1          Year 2          Year 3          Average
----------------------------------------------------------------------------------------------------------------
Revenues........................................       1,200,000       1,100,000       1,300,000       1,200,000
Cost of Goods Sold..............................         100,000         100,000             (*)          66,667
Operating Expenses..............................       1,100,000       1,000,000       1,300,000       1,133,333
Operating Profit................................               0               0               0               0
----------------------------------------------------------------------------------------------------------------
* N/A.

    (v) After adjustments have been made to account for identified 
material differences between the relevant business activity of 
Company B and the comparables, the average ratio for the taxable 
years 1 through 3 of operating profit to total services costs is 
calculated for each of the uncontrolled service providers. Applying 
each ratio to Company B's average total services costs from the 
relevant business activity for the taxable years 1 through 3 would 
lead to the following comparable operating profit (COP) for the 
services rendered by Company B:

------------------------------------------------------------------------
                                             OP/total
      Uncontrolled service provider        service costs   Company B COP
                                                (%)
------------------------------------------------------------------------
Company 1...............................           15.75        $189,000
Company 2...............................           15.00         180,000
Company 3...............................           14.00         168,000
Company 4...............................           13.30         159,600
Company 5...............................           12.00         144,000
Company 6...............................           11.30         135,600
Company 7...............................           11.25         135,000
Company 8...............................           11.18         134,160
Company 9...............................           11.11         133,320
Company 10..............................           10.75         129,000
------------------------------------------------------------------------

    (vi) The available data are not sufficiently complete to 
conclude that it is likely that all material differences between the 
relevant business activity of Company B and the comparables have 
been identified. Therefore, an arm's length range can be established 
only pursuant to Sec.  1.482-1(e)(2)(iii)(B). The arm's length range 
is established by reference to the interquartile range of the 
results as calculated under Sec.  1.482-1(e)(2)(iii)(C), which 
consists of the results ranging from $168,000 to $134,160. Company 
B's reported average operating profit of zero ($0) falls outside 
this range. Therefore, an allocation may be appropriate.
    (vii) Because Company B reported income of zero, to determine 
the amount, if any, of the allocation, Company B's reported 
operating profit for year 3 is compared to the comparable operating 
profits derived from the comparables' results for year 3. The ratio 
of operating profit to total services costs in year 3 is calculated 
for each of the comparables and applied to Company B's year 3 total 
services costs to derive the following results:

------------------------------------------------------------------------
                                             OP/total
                                           service costs
      Uncontrolled service provider        (for year 3)    Company B COP
                                                (%)
------------------------------------------------------------------------
Company 1...............................           15.00        $195,000
Company 2...............................           14.75         191,750
Company 3...............................           14.00         182,000
Company 4...............................           13.50         175,500
Company 5...............................           12.30         159,900
Company 6...............................           11.05         143,650
Company 7...............................           11.03         143,390
Company 8...............................           11.00         143,000
Company 9...............................           10.50         136,500

[[Page 44504]]

 
Company 10..............................           10.25         133,250
------------------------------------------------------------------------

    (viii) Based on these results, the median of the comparable 
operating profits for year 3 is $151,775. Therefore, Company B's 
income for year 3 is increased by $151,775, the difference between 
Company B's reported operating profit for year 3 of zero and the 
median of the comparable operating profits for year 3.

    Example 3. Material difference in accounting for stock-based 
compensation. (i) Taxpayer, a U.S. corporation the stock of which is 
publicly traded, performs controlled services for its wholly-owned 
subsidiaries. The arm's length price of these controlled services is 
evaluated under the comparable profits method for services in this 
paragraph, by reference to the net cost plus profit level indicator 
(PLI). Taxpayer is the tested party under paragraph (f)(2)(i) of 
this section. The Commissioner identifies the most narrowly 
identifiable business activity of the tested party for which data 
are available that incorporate the controlled transaction (the 
relevant business activity). The Commissioner also identifies four 
uncontrolled domestic service providers, Companies A, B, C, and D, 
each of which performs exclusively activities similar to the 
relevant business activity of Taxpayer that is subject to analysis 
under this paragraph (f). The stock of Companies A, B, C, and D is 
publicly traded on a U.S. stock exchange. Assume that Taxpayer makes 
an election to apply these regulations to earlier taxable years.
    (ii) Stock options are granted to the employees of Taxpayer that 
engage in the relevant business activity. Assume that, as determined 
under a method in accordance with U.S. generally accepted accounting 
principles, the fair value of such stock options attributable to the 
employees' performance of the relevant business activity is 500 for 
the taxable year in question. In evaluating the controlled services, 
Taxpayer includes salaries, fringe benefits, and related 
compensation of these employees in ``total services costs,'' as 
defined in paragraph (j) of this section. Taxpayer does not include 
any amount attributable to stock options in total services costs, 
nor does it deduct that amount in determining ``reported operating 
profit'' within the meaning of Sec.  1.482-5(d)(5), for the year 
under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D. Under a fair value method in accordance with U.S. 
generally accepted accounting principles, the comparables include in 
total compensation the value of the stock options attributable to 
the employees' performance of the relevant business activity for the 
annual financial reporting period, and treat this amount as an 
expense in determining operating profit for financial accounting 
purposes. The treatment of employee stock options is summarized in 
the following table.

----------------------------------------------------------------------------------------------------------------
                                                                   Salaries  and
                                                                    other non-     Stock options   Stock options
                                                                      option        fair value       expensed
                                                                   compensation
----------------------------------------------------------------------------------------------------------------
Taxpayer........................................................           1,000             500               0
Company A.......................................................           7,000           2,000           2,000
Company B.......................................................           4,300             250             250
Company C.......................................................          10,000           4,500           4,500
Company D.......................................................          15,000           2,000           2,000
----------------------------------------------------------------------------------------------------------------

    (iv) A material difference exists in accounting for stock-based 
compensation, as defined in Sec.  1.482-7(d)(2)(i). Analysis 
indicates that this difference would materially affect the measure 
of an arm's length result under this paragraph (f). In making an 
adjustment to improve comparability under Sec. Sec.  1.482-1(d)(2) 
and 1.482-5(c)(2)(iv), the Commissioner includes in total services 
costs of the tested party the total compensation costs of 1,500 
(including stock option fair value). In addition, the Commissioner 
calculates the net cost plus PLI by reference to the financial-
accounting data of Companies A, B, C, and D, which take into account 
compensatory stock options.
    Example 4. Material difference in utilization of stock-based 
compensation.
    (i) The facts are the same as in paragraph (i) of Example 3.
    (ii) No stock options are granted to the employees of Taxpayer 
that engage in the relevant business activity. Thus, no deduction 
for stock options is made in determining ``reported operating 
profit'' within the meaning of Sec.  1.482-5(d)(5), for the taxable 
year under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D, but none of these companies expense stock options for 
financial accounting purposes. Under a method in accordance with 
U.S. generally accepted accounting principles, however, Companies A, 
B, C, and D disclose the fair value of the stock options for 
financial accounting purposes. The utilization and treatment of 
employee stock options is summarized in the following table.

----------------------------------------------------------------------------------------------------------------
                                                                   Salaries  and
                                                                    other non-     Stock options   Stock options
                                                                      option        fair value       expensed
                                                                   compensation
----------------------------------------------------------------------------------------------------------------
Taxpayer........................................................           1,000               0             (*)
Company A.......................................................           7,000           2,000               0
Company B.......................................................           4,300             250               0
Company C.......................................................          12,000           4,500               0
Company D.......................................................          15,000           2,000               0
----------------------------------------------------------------------------------------------------------------
* N/A.

    (iv) A material difference in the utilization of stock-based 
compensation exists within the meaning of Sec.  1.482-7(d)(2)(i). 
Analysis indicates that these differences would materially affect 
the measure of an arm's length result under this paragraph (f). In 
evaluating the comparable operating profits of the tested party, the 
Commissioner uses Taxpayer's total services costs, which include 
total compensation costs of 1,000. In considering whether an 
adjustment is necessary to improve comparability under

[[Page 44505]]

Sec. Sec.  1.482-1(d)(2) and 1.482-5(c)(2)(iv), the Commissioner 
recognizes that the total compensation provided to employees of 
Taxpayer is comparable to the total compensation provided to 
employees of Companies A, B, C, and D. Because Companies A, B, C, 
and D do not expense stock-based compensation for financial 
accounting purposes, their reported operating profits must be 
adjusted in order to improve comparability with the tested party. 
The Commissioner increases each comparable's total services costs, 
and also reduces its reported operating profit, by the fair value of 
the stock-based compensation incurred by the comparable company.
    (v) The adjustments to the data of Companies A, B, C, and D 
described in paragraph (iv) of this Example 4 are summarized in the 
following table:

----------------------------------------------------------------------------------------------------------------
                                   Salaries  and
                                    other non-                    Total services     Operating     Net cost plus
                                      option       Stock options    costs  (A)      profit  (B)     PLI  (B/A)
                                   compensation                                                         (%)
----------------------------------------------------------------------------------------------------------------
Per financial statements:
Company A.......................           7,000           2,000          25,000           6,000           24.00
    Company B...................           4,300             250          12,500           2,500           20.00
    Company C...................          12,000           4,500          36,000          11,000           30.56
    Company D...................          15,000           2,000          27,000           7,000           25.93
As adjusted:
    Company A...................           7,000           2,000          27,000           4,000           14.80
    Company B...................           4,300             250          12,750           2,250           17.65
    Company C...................          12,000           4,500          40,500           6,500           16.05
    Company D...................          15,000           2,000          29,000           5,000           17.24
----------------------------------------------------------------------------------------------------------------

    Example 5. Non-material difference in utilization of stock-based 
compensation.
    (i) The facts are the same as in paragraph (i) of Example 3.
    (ii) Stock options are granted to the employees of Taxpayer that 
engage in the relevant business activity. Assume that, as determined 
under a method in accordance with U.S. generally accepted accounting 
principles, the fair value of such stock options attributable to the 
employees' performance of the relevant business activity is 50 for 
the taxable year. Taxpayer includes salaries, fringe benefits, and 
all other compensation of these employees (including the stock 
option fair value) in ``total services costs,'' as defined in 
paragraph (j) of this section, and deducts these amounts in 
determining ``reported operating profit'' within the meaning of 
Sec.  1.482-5(d)(5), for the taxable year under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D, but none of these companies expense stock options for 
financial accounting purposes. Under a method in accordance with 
U.S. generally accepted accounting principles, however, Companies A, 
B, C, and D disclose the fair value of the stock options for 
financial accounting purposes. The utilization and treatment of 
employee stock options is summarized in the following table.

----------------------------------------------------------------------------------------------------------------
                                                                   Salaries and
                                                                    other non-     Stock options   Stock options
                                                                      option        fair value       expensed
                                                                   compensation
----------------------------------------------------------------------------------------------------------------
Taxpayer........................................................           1,000              50              50
Company A.......................................................           7,000             100               0
Company B.......................................................           4,300              40               0
Company C.......................................................          10,000             130               0
Company D.......................................................          15,000              75               0
----------------------------------------------------------------------------------------------------------------

    (iv) Analysis of the data reported by Companies A, B, C, and D 
indicates that an adjustment for differences in utilization of 
stock-based compensation would not have a material effect on the 
determination of an arm's length result.

----------------------------------------------------------------------------------------------------------------
                                   Salaries and
                                    other non-     Stock options  Total services     Operating     Net cost plus
                                      option        fair value      costs  (A)      profit  (B)   PLI  (B/A) (%)
                                   compensation
----------------------------------------------------------------------------------------------------------------
Per financial statements:
    Company A...................           7,000             100          25,000           6,000           24.00
    Company B...................           4,300              40          12,500           2,500           20.00
    Company C...................          12,000             130          36,000          11,000           30.56
    Company D...................          15,000              75          27,000           7,000           25.93
As adjusted:
    Company A...................           7,000             100          25,100           5,900           23.51
    Company B...................           4,300              40          12,540           2,460           19.62
    Company C...................          12,000             130          36,130          10,870           30.09
    Company D...................          15,000              75          27,075           6,925           25.58
----------------------------------------------------------------------------------------------------------------

    (v) Under the circumstances, the difference in utilization of 
stock-based compensation would not materially affect the 
determination of the arm's length result under this paragraph (f). 
Accordingly, in calculating the net cost plus PLI, no comparability 
adjustment is made to the data of Companies A, B, C, or D pursuant 
to Sec. Sec.  1.482-1(d)(2) and 1.482-5(c)(2)(iv).
    Example 6. Material difference in comparables' accounting for 
stock-based compensation. (i) The facts are the same as in paragraph 
(i) of Example 3.
    (ii) Stock options are granted to the employees of Taxpayer that 
engage in the relevant business activity. Assume that, as determined 
under a method in accordance

[[Page 44506]]

with U.S. generally accepted accounting principles, the fair value 
of such stock options attributable to employees' performance of the 
relevant business activity is 500 for the taxable year. Taxpayer 
includes salaries, fringe benefits, and all other compensation of 
these employees (including the stock option fair value) in ``total 
services costs,'' as defined in paragraph (j) of this section and 
deducts these amounts in determining ``reported operating profit'' 
within the meaning of Sec.  1.482-5(d)(5), for the taxable year 
under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D. Companies A and B expense the stock options for 
financial accounting purposes in accordance with U.S. generally 
accepted accounting principles. Companies C and D do not expense the 
stock options for financial accounting purposes. Under a method in 
accordance with U.S. generally accepted accounting principles, 
however, Companies C and D disclose the fair value of these options 
in their financial statements. The utilization and accounting 
treatment of options are depicted in the following table.

----------------------------------------------------------------------------------------------------------------
                                                                    Salary and
                                                                    other non-     Stock options   Stock options
                                                                      option        fair value       expensed
                                                                   compensation
----------------------------------------------------------------------------------------------------------------
Taxpayer........................................................           1,000             500             500
Company A.......................................................           7,000           2,000           2,000
Company B.......................................................           4,300             250             250
Company C.......................................................          12,000           4,500               0
Company D.......................................................          15,000           2,000               0
----------------------------------------------------------------------------------------------------------------

    (iv) A material difference in accounting for stock-based 
compensation exists, within the meaning of Sec.  1.482-7(d)(2)(i). 
Analysis indicates that this difference would materially affect the 
measure of the arm's length result under paragraph (f) of this 
section. In evaluating the comparable operating profits of the 
tested party, the Commissioner includes in total services costs 
Taxpayer's total compensation costs of 1,500 (including stock option 
fair value of 500). In considering whether an adjustment is 
necessary to improve comparability under Sec. Sec.  1.482-1(d)(2) 
and 1.482-5(c)(2)(iv), the Commissioner recognizes that the total 
employee compensation (including stock options provided by Taxpayer 
and Companies A, B, C, and D) provides a reliable basis for 
comparison. Because Companies A and B expense stock-based 
compensation for financial accounting purposes, whereas Companies C 
and D do not, an adjustment to the comparables' operating profit is 
necessary. In computing the net cost plus PLI, the Commissioner uses 
the financial-accounting data of Companies A and B, as reported. The 
Commissioner increases the total services costs of Companies C and D 
by amounts equal to the fair value of their respective stock 
options, and reduces the operating profits of Companies C and D 
accordingly.
    (v) The adjustments described in paragraph (iv) of this Example 
6 are depicted in the following table. For purposes of illustration, 
the unadjusted data of Companies A and B are also included.

----------------------------------------------------------------------------------------------------------------
                                   Salaries and
                                    other non-     Stock options  Total services     Operating     Net cost plus
                                      option        fair value      costs  (A)      profit  (B)     PLI  (B/A)
                                   compensation                                                         (%)
----------------------------------------------------------------------------------------------------------------
Per financial Statements:
    Company A...................           7,000           2,000          27,000           4,000           14.80
    Company B...................           4,300             250          12,750           2,250           17.65
As adjusted:
    Company C...................          12,000           4,500          40,500           6,500           16.05
    Company D...................          15,000           2,000          29,000           5,000           17.24
----------------------------------------------------------------------------------------------------------------

    (g) Profit split method--(1) In general. The profit split method 
evaluates whether the allocation of the combined operating profit or 
loss attributable to one or more controlled transactions is arm's 
length by reference to the relative value of each controlled taxpayer's 
contribution to that combined operating profit or loss. The relative 
value of each controlled taxpayer's contribution is determined in a 
manner that reflects the functions performed, risks assumed and 
resources employed by such controlled taxpayer in the relevant business 
activity. For application of the profit split method (both the 
comparable profit split and the residual profit split), see Sec.  
1.482-6. The residual profit split method is ordinarily used in 
controlled services transactions involving a combination of nonroutine 
contributions by multiple controlled taxpayers.
    (2) Examples. The principles of this paragraph (g) are illustrated 
by the following examples:

    Example 1. Residual profit split. (i) Company A, a corporation 
resident in Country X, auctions spare parts by means of an 
interactive database. Company A maintains a database that lists all 
spare parts available for auction. Company A developed the software 
used to run the database. Company A's database is managed by Company 
A employees in a data center located in Country X, where storage and 
manipulation of data also take place. Company A has a wholly-owned 
subsidiary, Company B, located in Country Y. Company B performs 
marketing and advertising activities to promote Company A's 
interactive database. Company B solicits unrelated companies to 
auction spare parts on Company A's database, and solicits customers 
interested in purchasing spare parts online. Company B owns and 
maintains a computer server in Country Y, where it receives 
information on spare parts available for auction. Company B has also 
designed a specialized communications network that connects its data 
center to Company A's data center in Country X. The communications 
network allows Company B to enter data from uncontrolled companies 
on Company A's database located in Country X. Company B's 
communications network also allows uncontrolled companies to access 
Company A's interactive database and purchase spare parts. Company B 
bore the risks and cost of developing this specialized 
communications network. Company B enters into contracts with 
uncontrolled companies and provides the companies access to Company 
A's database through the Company B network.
    (ii) Analysis of the facts and circumstances indicates that both 
Company A and Company B possess valuable intangibles that they use 
to conduct the spare parts auction business. Company A bore the 
economic risks of developing and maintaining software and the 
interactive database. Company B bore the economic risks of 
developing the necessary technology to transmit information from its 
server to Company A's data center, and to allow uncontrolled 
companies to access Company A's database. Company B helped to

[[Page 44507]]

enhance the value of Company A's trademark and to establish a 
network of customers in Country Y. In addition, there are no market 
comparables for the transactions between Company A and Company B to 
reliably evaluate them separately. Given the facts and 
circumstances, the Commissioner determines that a residual profit 
split method will provide the most reliable measure of an arm's 
length result.
    (iii) Under the residual profit split method, profits are first 
allocated based on the routine contributions of each taxpayer. 
Routine contributions include general sales, marketing or 
administrative functions performed by Company B for Company A for 
which it is possible to identify market returns. Any residual 
profits will be allocated based on the nonroutine contributions of 
each taxpayer. Since both Company A and Company B provided 
nonroutine contributions, the residual profits are allocated based 
on these contributions.
    Example 2. Residual profit split. (i) Company A, a Country 1 
corporation, provides specialized services pertaining to the 
processing and storage of Level 1 hazardous waste (for purposes of 
this example, the most dangerous type of waste). Under long-term 
contracts with private companies and governmental entities in 
Country 1, Company A performs multiple services, including 
transportation of Level 1 waste, development of handling and storage 
protocols, recordkeeping, and supervision of waste-storage 
facilities owned and maintained by the contracting parties. Company 
A's research and development unit has also developed new and unique 
processes for transport and storage of Level 1 waste that minimize 
environmental and occupational effects. In addition to this novel 
technology, Company A has substantial know-how and a long-term 
record of safe operations in Country 1.
    (ii) Company A's subsidiary, Company B, has been in operation 
continuously for a number of years in Country 2. Company B has 
successfully completed several projects in Country 2 involving Level 
2 and Level 3 waste, including projects with government-owned 
entities. Company B has a license in Country 2 to handle Level 2 
waste (Level 3 does not require a license). Company B has 
established a reputation for completing these projects in a 
responsible manner. Company B has cultivated contacts with 
procurement officers, regulatory and licensing officials, and other 
government personnel in Country 2.
    (iii) Country 2 government publishes invitations to bid on a 
project to handle the country's burgeoning volume of Level 1 waste, 
all of which is generated in government-owned facilities. Bidding is 
limited to companies that are domiciled in Country 2 and that 
possess a license from the government to handle Level 1 or Level 2 
waste. In an effort to submit a winning bid to secure the contract, 
Company B points to its Level 2 license and its record of successful 
completion of projects, and also demonstrates to these officials 
that it has access to substantial technical expertise pertaining to 
processing of Level 1 waste.
    (iv) Company A enters into a long-term technical services 
agreement with Company B. Under this agreement, Company A agrees to 
supply to Company B project managers and other technical staff who 
have detailed knowledge of Company A's proprietary Level 1 
remediation techniques. Company A commits to perform under any long-
term contracts entered into by Company B. Company B agrees to 
compensate Company A based on a markup on Company A's marginal costs 
(pro rata compensation and current expenses of Company A personnel). 
In the bid on the Country 2 for Level 1 waste, Company B proposes to 
use a multi-disciplinary team of specialists from Company A and 
Company B. Project managers from Company A will direct the team, 
which will also include employees of Company B and will make use of 
physical assets and facilities owned by Company B. Only Company A 
and Company B personnel will perform services under the contract. 
Country 2 grants Company B a license to handle Level 1 waste.
    (v) Country 2 grants Company B a five-year, exclusive contract 
to provide processing services for all Level 1 hazardous waste 
generated in County 2. Under the contract, Company B is to be paid a 
fixed price per ton of Level 1 waste that it processes each year. 
Company B undertakes that all services provided will meet 
international standards applicable to processing of Level 1 waste. 
Company B begins performance under the contract.
    (vi) Analysis of the facts and circumstances indicates that both 
Company A and Company B make nonroutine contributions to the Level 1 
waste processing activity in Country 2. In addition, it is 
determined that reliable comparables are not available for the 
services that Company A provides under the long-term contract, in 
part because those services incorporate specialized knowledge and 
process intangibles developed by Company A. It is also determined 
that reliable comparables are not available for the Level 2 license 
in Country 2, the successful track record, the government contacts 
with Country 2 officials, and other intangibles that Company B 
provided. In view of these facts, the Commissioner determines that 
the residual profit split method for services in paragraph (g) of 
this section provides the most reliable means of evaluating the 
arm's length results for the transaction. In evaluating the 
appropriate returns to Company A and Company B for their respective 
contributions, the Commissioner takes into account that the 
controlled parties incur different risks, because the contract 
between the controlled parties provides that Company A will be 
compensated on the basis of marginal costs incurred, plus a markup, 
whereas the contract between Company B and the government of Country 
2 provides that Company B will be compensated on a fixed-price basis 
per ton of Level 1 waste processed.
    (vii) In the first stage of the residual profit split, an arm's 
length return is determined for routine activities performed by 
Company B in Country 2, such as transportation, recordkeeping, and 
administration. In addition, an arm's length return is determined 
for routine activities performed by Company A (administrative, human 
resources, etc.) in connection with providing personnel to Company 
B. After the arm's length return for these functions is determined, 
residual profits may be present. In the second stage of the residual 
profit split, any residual profit is allocated by reference to the 
relative value of the nonroutine contributions made by each 
taxpayer. Company A's nonroutine contributions include its 
commitment to perform under the contract and the specialized 
technical knowledge made available through the project managers 
under the services agreement with Company B. Company B's nonroutine 
contributions include its licenses to handle Level 1 and Level 2 
waste in Country 2, its knowledge of and contacts with procurement, 
regulatory and licensing officials in the government of Country 2, 
and its record in Country 2 of successfully handling non-Level 1 
waste.

    (h) Unspecified methods. Methods not specified in paragraphs (b) 
through (g) of this section may be used to evaluate whether the amount 
charged in a controlled services transaction is arm's length. Any 
method used under this paragraph (h) must be applied in accordance with 
the provisions of Sec.  1.482-1. Consistent with the specified methods, 
an unspecified method should take into account the general principle 
that uncontrolled taxpayers evaluate the terms of a transaction by 
considering the realistic alternatives to that transaction, including 
economically similar transactions structured as other than services 
transactions, and only enter into a particular transaction if none of 
the alternatives is preferable to it. For example, the comparable 
uncontrolled services price method compares a controlled services 
transaction to similar uncontrolled transactions to provide a direct 
estimate of the price to which the parties would have agreed had they 
resorted directly to a market alternative to the controlled services 
transaction. Therefore, in establishing whether a controlled services 
transaction achieved an arm's length result, an unspecified method 
should provide information on the prices or profits that the controlled 
taxpayer could have realized by choosing a realistic alternative to the 
controlled services transaction (for example, outsourcing a particular 
service function, rather than performing the function itself). As with 
any method, an unspecified method will not be applied unless it 
provides the most reliable measure of an arm's length result under the 
principles of the best method rule. See Sec.  1.482-1(c). Therefore, in 
accordance with Sec.  1.482-1(d) (comparability), to the extent that an 
unspecified method relies on internal data rather than uncontrolled 
comparables, its reliability will be

[[Page 44508]]

reduced. Similarly, the reliability of a method will be affected by the 
reliability of the data and assumptions used to apply the method, 
including any projections used.

    Example. (i) Company T, a U.S. corporation, develops computer 
software programs including a real estate investment program that 
performs financial analysis of commercial real properties. The 
primary business activity of Companies U, V and W is commercial real 
estate development. For business reasons, Company T does not sell 
the computer program to its customers (on a compact disk or via 
download from Company T's server through the Internet). Instead, 
Company T maintains the software program on its own server and 
allows customers to access the program through the Internet by using 
a password. The transactions between Company T and Companies U, V 
and W are structured as controlled services transactions whereby 
Companies U, V and W obtain access via the Internet to Company T's 
software program for financial analysis. Each year, Company T 
provides a revised version of the computer program including the 
most recent data on the commercial real estate market, rendering the 
old version obsolete.
    (ii) In evaluating whether the consideration paid by Companies 
U, V and W to Company T was arm's length, the Commissioner may 
consider, subject to the best method rule of Sec.  1.482-1(c), 
Company T's alternative of selling the computer program to Companies 
U, V and W on a compact disk or via download through the Internet. 
The Commissioner determines that the controlled services 
transactions between Company T and Companies U, V and W are 
comparable to the transfer of a similar software program on a 
compact disk or via download through the Internet between 
uncontrolled parties. Subject to adjustments being made for material 
differences between the controlled services transactions and the 
comparable uncontrolled transactions, the uncontrolled transfers of 
tangible property may be used to evaluate the arm's length results 
for the controlled services transactions between Company T and 
Companies U, V and W.

    (i) Contingent-payment contractual terms for services--(1) 
Contingent-payment contractual terms recognized in general. In the case 
of a contingent-payment arrangement, the arm's length result for the 
controlled services transaction generally would not require payment by 
the recipient to the renderer in the tax accounting period in which the 
service is rendered if the specified contingency does not occur in that 
period. If the specified contingency occurs in a tax accounting period 
subsequent to the period in which the service is rendered, the arm's 
length result for the controlled services transaction generally would 
require payment by the recipient to the renderer on a basis that 
reflects the recipient's benefit from the services rendered and the 
risks borne by the renderer in performing the activities in the absence 
of a provision that unconditionally obligates the recipient to pay for 
the activities performed in the tax accounting period in which the 
service is rendered.
    (2) Contingent-payment arrangement. For purposes of this paragraph 
(i), an arrangement will be treated as a contingent-payment arrangement 
if it meets all of the requirements in paragraph (i)(2)(i) of this 
section and is consistent with the economic substance and conduct in 
paragraph (i)(2)(ii) of this section.
    (i) General requirements--(A) Written contract. The arrangement is 
set forth in a written contract entered into prior to, or 
contemporaneous with the start of the activity or group of activities 
constituting the controlled services transaction.
    (B) Specified contingency. The contract states that payment is 
contingent (in whole or in part) upon the happening of a future benefit 
(within the meaning of paragraph (l)(3) of this section) for the 
recipient directly related to the controlled services transaction.
    (C) Basis for payment. The contract provides for payment on a basis 
that reflects the recipient's benefit from the services rendered and 
the risks borne by the renderer. Whether the specified contingency 
bears a direct relationship to the controlled services transaction, and 
whether the basis for payment reflects the recipient's benefit and the 
renderer's risk, is evaluated based on all the facts and circumstances.
    (ii) Economic substance and conduct. The arrangement, including the 
contingency and the basis for payment, is consistent with the economic 
substance of the controlled transaction and the conduct of the 
controlled parties. See Sec.  1.482-1(d)(3)(ii)(B).
    (3) Commissioner's authority to impute contingent-payment terms. 
Consistent with the authority in Sec.  1.482-1(d)(3)(ii)(B), the 
Commissioner may impute contingent-payment contractual terms in a 
controlled services transaction if the economic substance of the 
transaction is consistent with the existence of such terms.
    (4) Evaluation of arm's length charge. Whether the amount charged 
in a contingent-payment arrangement is arm's length will be evaluated 
in accordance with this section and other applicable regulations under 
section 482. In evaluating whether the amount charged in a contingent-
payment arrangement for the manufacture, construction, or development 
of tangible or intangible property owned by the recipient is arm's 
length, the charge determined under the rules of Sec. Sec.  1.482-3 and 
1.482-4 for the transfer of similar property may be considered. See 
Sec.  1.482-1(f)(2)(ii).
    (5) Examples. The principles of this paragraph (i) are illustrated 
by the following examples:

    Example 1. (i) Company X is a member of a controlled group that 
has operated in the pharmaceutical sector for many years. In year 1, 
Company X enters into a written services agreement with Company Y, 
another member of the controlled group, whereby Company X will 
perform certain research and development activities for Company Y. 
The parties enter into the agreement before Company X undertakes any 
of the research and development activities covered by the agreement. 
At the time the agreement is entered into, the possibility that any 
new products will be developed is highly uncertain and the possible 
market or markets for any products that may be developed are not 
known and cannot be estimated with any reliability. Under the 
agreement, Company Y will own any patent or other rights that result 
from the activities of Company X under the agreement and Company Y 
will make payments to Company X only if such activities result in 
commercial sales of one or more derivative products. In that event, 
Company Y will pay Company X, for a specified period, x% of Company 
Y's gross sales of each of such products. Payments are required with 
respect to each jurisdiction in which Company Y has sales of such a 
derivative product, beginning with the first year in which the sale 
of a product occurs in the jurisdiction and continuing for six 
additional years with respect to sales of that product in that 
jurisdiction.
    (ii) As a result of research and development activities 
performed by Company X for Company Y in years 1 through 4, a 
compound is developed that may be more effective than existing 
medications in the treatment of certain conditions. Company Y 
registers the patent rights with respect to the compound in several 
jurisdictions in year 4. In year 6, Company Y begins commercial 
sales of the product in Jurisdiction A and, in that year, Company Y 
makes the payment to Company X that is required under the agreement. 
Sales of the product continue in Jurisdiction A in years 7 through 9 
and Company Y makes the payments to Company X in years 7 through 9 
that are required under the agreement.
    (iii) The years under examination are years 6 though 9. In 
evaluating whether the contingent-payment terms will be recognized, 
the Commissioner considers whether the conditions of paragraph 
(i)(2) of this section are met and whether the arrangement, 
including the specified contingency and basis of payment, is 
consistent with the economic substance of the controlled services 
transaction and with the conduct of the controlled parties. The 
Commissioner determines that the contingent-payment arrangement is 
reflected in the written agreement between Company X and Company Y; 
that commercial sales of products developed under the arrangement

[[Page 44509]]

represent future benefits for Company Y directly related to the 
controlled services transaction; and that the basis for the payment 
provided for in the event such sales occur reflects the recipient's 
benefit and the renderer's risk. Consistent with Sec.  1.482-
1(d)(3)(ii)(B) and (iii)(B), the Commissioner determines that the 
parties' conduct over the term of the agreement has been consistent 
with their contractual allocation of risk; that Company X has the 
financial capacity to bear the risk that its research and 
development services may be unsuccessful and that it may not receive 
compensation for such services; and that Company X exercises 
managerial and operational control over the research and 
development, such that it is reasonable for Company X to assume the 
risk of those activities. Based on all these facts, the Commissioner 
determines that the contingent-payment arrangement is consistent 
with economic substance.
    (iv) In determining whether the amount charged under the 
contingent-payment arrangement in each of years 6 through 9 is arm's 
length, the Commissioner evaluates under this section and other 
applicable rules under section 482 the compensation paid in each 
year for the research and development services. This analysis takes 
into account that under the contingent-payment terms Company X bears 
the risk that it might not receive payment for its services in the 
event that those services do not result in marketable products and 
the risk that the magnitude of its payment depends on the magnitude 
of product sales, if any. The Commissioner also considers the 
alternatives reasonably available to the parties in connection with 
the controlled services transaction. One such alternative, in view 
of Company X's willingness and ability to bear the risk and expenses 
of research and development activities, would be for Company X to 
undertake such activities on its own behalf and to license the 
rights to products successfully developed as a result of such 
activities. Accordingly, in evaluating whether the compensation of 
x% of gross sales that is paid to Company X during the first four 
years of commercial sales of derivative products is arm's length, 
the Commissioner may consider the royalties (or other consideration) 
charged for intangibles that are comparable to those incorporated in 
the derivative products and that resulted from Company X's research 
and development activities under the contingent-payment arrangement.
    Example 2. (i) The facts are the same as in Example 1, except 
that no commercial sales ever materialize with regard to the 
patented compound so that, consistent with the agreement, Company Y 
makes no payments to Company X in years 6 through 9.
    (ii) Based on all the facts and circumstances, the Commissioner 
determines that the contingent-payment arrangement is consistent 
with economic substance, and the result (no payments in years 6 
through 9) is consistent with an arm's length result.
    Example 3. (i) The facts are the same as in Example 1, except 
that, in the event that Company X's activities result in commercial 
sales of one or more derivative products by Company Y, Company Y 
will pay Company X a fee equal to the research and development costs 
borne by Company X plus an amount equal to x% of such costs, with 
the payment to be made in the first year in which any such sales 
occur. The x% markup on costs is within the range, ascertainable in 
year 1, of markups on costs of independent contract researchers that 
are compensated under terms that unconditionally obligate the 
recipient to pay for the activities performed in the tax accounting 
period in which the service is rendered. In year 6, Company Y makes 
the single payment to Company X that is required under the 
arrangement.
    (ii) The years under examination are years 6 though 9. In 
evaluating whether the contingent-payment terms will be recognized, 
the Commissioner considers whether the requirements of paragraph 
(i)(2) of this section were met at the time the written agreement 
was entered into and whether the arrangement, including the 
specified contingency and basis for payment, is consistent with the 
economic substance of the controlled services transaction and with 
the conduct of the controlled parties. The Commissioner determines 
that the contingent-payment terms are reflected in the written 
agreement between Company X and Company Y and that commercial sales 
of products developed under the arrangement represent future 
benefits for Company Y directly related to the controlled services 
transaction. However, in this case, the Commissioner determines that 
the basis for payment provided for in the event such sales occur 
(costs of the services plus x%, representing the markup for contract 
research in the absence of any nonpayment risk) does not reflect the 
recipient's benefit and the renderer's risks in the controlled 
services transaction. Based on all the facts and circumstances, the 
Commissioner determines that the contingent-payment arrangement is 
not consistent with economic substance.
    (iii) Accordingly, the Commissioner determines to exercise its 
authority to impute contingent-payment contractual terms that accord 
with economic substance, pursuant to paragraph (i)(3) of this 
section and Sec.  1.482-1(d)(3)(ii)(B). In this regard, the 
Commissioner takes into account that at the time the arrangement was 
entered into, the possibility that any new products would be 
developed was highly uncertain and the possible market or markets 
for any products that may be developed were not known and could not 
be estimated with any reliability. In such circumstances, it is 
reasonable to conclude that one possible basis of payment, in order 
to reflect the recipient's benefit and the renderer's risks, would 
be a charge equal to a percentage of commercial sales of one or more 
derivative products that result from the research and development 
activities. The Commissioner in this case may impute terms that 
require Company Y to pay Company X a percentage of sales of the 
products developed under the agreement in each of years 6 through 9.
    (iv) In determining an appropriate arm's length charge under 
such imputed contractual terms, the Commissioner conducts an 
analysis under this section and other applicable rules under section 
482, and considers the alternatives reasonably available to the 
parties in connection with the controlled services transaction. One 
such alternative, in view of Company X's willingness and ability to 
bear the risks and expenses of research and development activities, 
would be for Company X to undertake such activities on its own 
behalf and to license the rights to products successfully developed 
as a result of such activities. Accordingly, for purposes of its 
determination, the Commissioner may consider the royalties (or other 
consideration) charged for intangibles that are comparable to those 
incorporated in the derivative products that resulted from Company 
X's research and development activities under the contingent-payment 
arrangement.

    (j) Total services costs. For purposes of this section, total 
services costs means all costs of rendering those services for which 
total services costs are being determined. Total services costs include 
all costs in cash or in kind (including stock-based compensation) that, 
based on analysis of the facts and circumstances, are directly 
identified with, or reasonably allocated in accordance with the 
principles of paragraph (k)(2) of this section to, the services. In 
general, costs for this purpose should comprise provision for all 
resources expended, used, or made available to achieve the specific 
objective for which the service is rendered. Reference to generally 
accepted accounting principles or Federal income tax accounting rules 
may provide a useful starting point but will not necessarily be 
conclusive regarding inclusion of costs in total services costs. Total 
services costs do not include interest expense, foreign income taxes 
(as defined in Sec.  1.901-2(a)), or domestic income taxes.
    (k) Allocation of costs--(1) In general. In any case where the 
renderer's activity that results in a benefit (within the meaning of 
paragraph (l)(3) of this section) for one recipient in a controlled 
services transaction also generates a benefit for one or more other 
members of a controlled group (including the benefit, if any, to the 
renderer), and the amount charged under this section in the controlled 
services transaction is determined under a method that makes reference 
to costs, costs must be allocated among the portions of the activity 
performed for the benefit of the first mentioned recipient and such 
other members of the controlled group under this paragraph (k). The 
principles of this paragraph (k) must also be used whenever it is 
appropriate to allocate and apportion any class of costs (for example, 
overhead costs) in order to determine the total services costs of 
rendering the services. In no event will an allocation of costs based 
on a

[[Page 44510]]

generalized or non-specific benefit be appropriate.
    (2) Appropriate method of allocation and apportionment--(i) 
Reasonable method standard. Any reasonable method may be used to 
allocate and apportion costs under this section. In establishing the 
appropriate method of allocation and apportionment, consideration 
should be given to all bases and factors, including, for example, total 
services costs, total costs for a relevant activity, assets, sales, 
compensation, space utilized, and time spent. The costs incurred by 
supporting departments may be apportioned to other departments on the 
basis of reasonable overall estimates, or such costs may be reflected 
in the other departments' costs by applying reasonable departmental 
overhead rates. Allocations and apportionments of costs must be made on 
the basis of the full cost, as opposed to the incremental cost.
    (ii) Use of general practices. The practices used by the taxpayer 
to apportion costs in connection with preparation of statements and 
analyses for the use of management, creditors, minority shareholders, 
joint venturers, clients, customers, potential investors, or other 
parties or agencies in interest will be considered as potential 
indicators of reliable allocation methods, but need not be accorded 
conclusive weight by the Commissioner. In determining the extent to 
which allocations are to be made to or from foreign members of a 
controlled group, practices employed by the domestic members in 
apportioning costs among themselves will also be considered if the 
relationships with the foreign members are comparable to the 
relationships among the domestic members of the controlled group. For 
example, if for purposes of reporting to public stockholders or to a 
governmental agency, a corporation apportions the costs attributable to 
its executive officers among the domestic members of a controlled group 
on a reasonable and consistent basis, and such officers exercise 
comparable control over foreign members of the controlled group, such 
domestic apportionment practice will be considered in determining the 
allocations to be made to the foreign members.
    (3) Examples. The principles of this paragraph (k) are illustrated 
by the following examples:

    Example 1. Company A pays an annual license fee of 500x to an 
uncontrolled taxpayer for unlimited use of a database within the 
corporate group. Under the terms of the license with the 
uncontrolled taxpayer, Company A is permitted to use the database 
for its own use and in rendering research services to its 
subsidiary, Company B. Company B obtains benefits from the database 
that are similar to those that it would obtain if it had 
independently licensed the database from the uncontrolled taxpayer. 
Evaluation of the arm's length charge (under a method in which costs 
are relevant) to Company B for the controlled services that 
incorporate use of the database must take into account the full 
amount of the license fee of 500x paid by Company A, as reasonably 
allocated and apportioned to the relevant benefits, although the 
incremental use of the database for the benefit of Company B did not 
result in an increase in the license fee paid by Company A.
    Example 2. (i) Company A is a consumer products company located 
in the United States. Companies B and C are wholly-owned 
subsidiaries of Company A and are located in Countries B and C, 
respectively. Company A and its subsidiaries manufacture products 
for sale in their respective markets. Company A hires a consultant 
who has expertise regarding a manufacturing process used by Company 
A and its subsidiary, Company B. Company C, the Country C 
subsidiary, uses a different manufacturing process, and accordingly 
will not receive any benefit from the outside consultant hired by 
Company A. In allocating and apportioning the cost of hiring the 
outside consultant (100), Company A determines that sales constitute 
the most appropriate allocation key.
    (ii) Company A and its subsidiaries have the following sales:

----------------------------------------------------------------------------------------------------------------
                     Company                             A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Sales...........................................             400             100             200             700
----------------------------------------------------------------------------------------------------------------

    (iii) Because Company C does not obtain any benefit from the 
consultant, none of the costs are allocated to it. Rather, the costs 
of 100 are allocated and apportioned ratably to Company A and 
Company B as the entities that obtain a benefit from the campaign, 
based on the total sales of those entities (500). An appropriate 
allocation of the costs of the consultant is as follows:

----------------------------------------------------------------------------------------------------------------
                             Company                                     A               B             Total
----------------------------------------------------------------------------------------------------------------
Allocation......................................................         400/500         100/500  ..............
Amount..........................................................              80              20             100
----------------------------------------------------------------------------------------------------------------

    (l) Controlled services transaction--(1) In general. A controlled 
services transaction includes any activity (as defined in paragraph 
(l)(2) of this section) by one member of a group of controlled 
taxpayers (the renderer) that results in a benefit (as defined in 
paragraph (l)(3) of this section) to one or more other members of the 
controlled group (the recipient(s)).
    (2) Activity. An activity includes the performance of functions, 
assumptions of risks, or use by a renderer of tangible or intangible 
property or other resources, capabilities, or knowledge, such as 
knowledge of and ability to take advantage of particularly advantageous 
situations or circumstances. An activity also includes making available 
to the recipient any property or other resources of the renderer.
    (3) Benefit--(i) In general. An activity is considered to provide a 
benefit to the recipient if the activity directly results in a 
reasonably identifiable increment of economic or commercial value that 
enhances the recipient's commercial position, or that may reasonably be 
anticipated to do so. An activity is generally considered to confer a 
benefit if, taking into account the facts and circumstances, an 
uncontrolled taxpayer in circumstances comparable to those of the 
recipient would be willing to pay an uncontrolled party to perform the 
same or similar activity on either a fixed or contingent-payment basis, 
or if the recipient otherwise would have performed for itself the same 
activity or a similar activity. A benefit may result to the owner of an 
intangible if the renderer engages in an activity that is reasonably 
anticipated to result in an increase in the value of that intangible. 
Paragraphs (l)(3)(ii) through (v) of this section provide guidelines 
that indicate the presence or absence of a benefit for the activities 
in the controlled services transaction.
    (ii) Indirect or remote benefit. An activity is not considered to 
provide a benefit to the recipient if, at the time the activity is 
performed, the present or reasonably anticipated benefit from that 
activity is so indirect or remote that the recipient would not be 
willing to pay, on either a fixed or contingent-payment

[[Page 44511]]

basis, an uncontrolled party to perform a similar activity, and would 
not be willing to perform such activity for itself for this purpose. 
The determination whether the benefit from an activity is indirect or 
remote is based on the nature of the activity and the situation of the 
recipient, taking into consideration all facts and circumstances.
    (iii) Duplicative activities. If an activity performed by a 
controlled taxpayer duplicates an activity that is performed, or that 
reasonably may be anticipated to be performed, by another controlled 
taxpayer on or for its own account, the activity is generally not 
considered to provide a benefit to the recipient, unless the 
duplicative activity itself provides an additional benefit to the 
recipient.
    (iv) Shareholder activities. An activity is not considered to 
provide a benefit if the sole effect of that activity is either to 
protect the renderer's capital investment in the recipient or in other 
members of the controlled group, or to facilitate compliance by the 
renderer with reporting, legal, or regulatory requirements applicable 
specifically to the renderer, or both. Activities in the nature of day-
to-day management generally do not relate to protection of the 
renderer's capital investment. Based on analysis of the facts and 
circumstances, activities in connection with a corporate reorganization 
may be considered to provide a benefit to one or more controlled 
taxpayers.
    (v) Passive association. A controlled taxpayer generally will not 
be considered to obtain a benefit where that benefit results from the 
controlled taxpayer's status as a member of a controlled group. A 
controlled taxpayer's status as a member of a controlled group may, 
however, be taken into account for purposes of evaluating comparability 
between controlled and uncontrolled transactions.
    (4) Disaggregation of transactions. A controlled services 
transaction may be analyzed as two separate transactions for purposes 
of determining the arm's length consideration, if that analysis is the 
most reliable means of determining the arm's length consideration for 
the controlled services transaction. See the best method rule under 
Sec.  1.482-1(c).
    (5) Examples. The principles of this paragraph (l) are illustrated 
by the following examples. In each example, assume that Company X is a 
U.S. corporation and Company Y is a wholly-owned subsidiary of Company 
X in Country B.

    Example 1. In general. In developing a worldwide advertising and 
promotional campaign for a consumer product, Company X pays for and 
obtains designation as an official sponsor of the Olympics. This 
designation allows Company X and all its subsidiaries, including 
Company Y, to identify themselves as sponsors and to use the Olympic 
logo in advertising and promotional campaigns. The Olympic 
sponsorship campaign generates benefits to Company X, Company Y, and 
other subsidiaries of Company X.
    Example 2. Indirect or remote benefit. Based on recommendations 
contained in a study performed by its internal staff, Company X 
implements certain changes in its management structure and the 
compensation of managers of divisions located in the United States. 
No changes were recommended or considered for Company Y in Country 
B. The internal study and the resultant changes in its management 
may increase the competitiveness and overall efficiency of Company 
X. Any benefits to Company Y as a result of the study are, however, 
indirect or remote. Consequently, Company Y is not considered to 
obtain a benefit from the study.
    Example 3. Indirect or remote benefit. Based on recommendations 
contained in a study performed by its internal staff, Company X 
decides to make changes to the management structure and management 
compensation of its subsidiaries, in order to increase their 
profitability. As a result of the recommendations in the study, 
Company X implements substantial changes in the management structure 
and management compensation scheme of Company Y. The study and the 
changes implemented as a result of the recommendations are 
anticipated to increase the profitability of Company X and its 
subsidiaries. The increased management efficiency of Company Y that 
results from these changes is considered to be a specific and 
identifiable benefit, rather than remote or speculative.
    Example 4. Duplicative activities. At its corporate headquarters 
in the United States, Company X performs certain treasury functions 
for Company X and for its subsidiaries, including Company Y. These 
treasury functions include raising capital, arranging medium and 
long-term financing for general corporate needs, including cash 
management. Under these circumstances, the treasury functions 
performed by Company X do not duplicate the functions performed by 
Company Y's staff. Accordingly, Company Y is considered to obtain a 
benefit from the functions performed by Company X.
    Example 5. Duplicative activities. The facts are the same as in 
Example 4, except that Company Y's functions include ensuring that 
the financing requirements of its own operations are met. Analysis 
of the facts and circumstances indicates that Company Y 
independently administers all financing and cash-management 
functions necessary to support its operations, and does not utilize 
financing obtained by Company X. Under the circumstances, the 
treasury functions performed by Company X are duplicative of similar 
functions performed by Company Y's staff, and the duplicative 
functions do not enhance Company Y's position. Accordingly, Company 
Y is not considered to obtain a benefit from the duplicative 
activities performed by Company X.
    Example 6. Duplicative activities. Company X's in-house legal 
staff has specialized expertise in several areas, including 
intellectual property law. Company Y is involved in negotiations 
with an unrelated party to enter into a complex joint venture that 
includes multiple licenses and cross-licenses of patents and 
copyrights. Company Y retains outside counsel that specializes in 
intellectual property law to review the transaction documents. 
Outside counsel advises that the terms for the proposed transaction 
are advantageous to Company Y and that the contracts are valid and 
fully enforceable. Before Company Y executes the contracts, the 
legal staff of Company X also reviews the transaction documents and 
concurs in the opinion provided by outside counsel. The activities 
performed by Company X substantially duplicate the legal services 
obtained by Company Y, but they also reduce the commercial risk 
associated with the transaction in a way that confers an additional 
benefit on Company Y.
    Example 7. Shareholder activities. Company X is a publicly held 
corporation. U.S. laws and regulations applicable to publicly held 
corporations such as Company X require the preparation and filing of 
periodic reports that show, among other things, profit and loss 
statements, balance sheets, and other material financial information 
concerning the company's operations. Company X, Company Y and each 
of the other subsidiaries maintain their own separate accounting 
departments that record individual transactions and prepare 
financial statements in accordance with their local accounting 
practices. Company Y, and the other subsidiaries, forward the 
results of their financial performance to Company X, which analyzes 
and compiles these data into periodic reports in accordance with 
U.S. laws and regulations. Because Company X's preparation and 
filing of the reports relate solely to its role as an investor of 
capital or shareholder in Company Y or to its compliance with 
reporting, legal, or regulatory requirements, or both, these 
activities constitute shareholder activities and therefore Company Y 
is not considered to obtain a benefit from the preparation and 
filing of the reports.
    Example 8. Shareholder activities. The facts are the same as in 
Example 7, except that Company Y's accounting department maintains a 
general ledger recording individual transactions, but does not 
prepare any financial statements (such as profit and loss statements 
and balance sheets). Instead, Company Y forwards the general ledger 
data to Company X, and Company X analyzes and compiles financial 
statements for Company Y, as well as for Company X's overall 
operations, for purposes of complying with U.S. reporting 
requirements. Company Y is subject to reporting requirements in 
Country B similar to those applicable to Company X in the United 
States. Much of the data that Company X analyzes and compiles 
regarding Company Y's operations for purposes of complying with the 
U.S. reporting requirements are made available to Company

[[Page 44512]]

Y for its use in preparing reports that must be filed in Country B. 
Company Y incorporates these data, after minor adjustments for 
differences in local accounting practices, into the reports that it 
files in Country B. Under these circumstances, because Company X's 
analysis and compilation of Company Y's financial data does not 
relate solely to its role as an investor of capital or shareholder 
in Company Y, or to its compliance with reporting, legal, or 
regulatory requirements, or both, these activities do not constitute 
shareholder activities.
    Example 9. Shareholder activities. Members of Company X's 
internal audit staff visit Company Y on a semiannual basis in order 
to review the subsidiary's adherence to internal operating 
procedures issued by Company X and its compliance with U.S. anti-
bribery laws, which apply to Company Y on account of its ownership 
by a U.S. corporation. Because the sole effect of the reviews by 
Company X's audit staff is to protect Company X's investment in 
Company Y, or to facilitate Company X's compliance with U.S. anti-
bribery laws, or both, the visits are shareholder activities and 
therefore Company Y is not considered to obtain a benefit from the 
visits.
    Example 10. Shareholder activities. Country B recently enacted 
legislation that changed the foreign currency exchange controls 
applicable to foreign shareholders of Country B corporations. 
Company X concludes that it may benefit from changing the capital 
structure of Company Y, thus taking advantage of the new foreign 
currency exchange control laws in Country B. Company X engages an 
investment banking firm and a law firm to review the Country B 
legislation and to propose possible changes to the capital structure 
of Company Y. Because Company X's retention of the firms facilitates 
Company Y's ability to pay dividends and other amounts and has the 
sole effect of protecting Company X's investment in Company Y, these 
activities constitute shareholder activities and Company Y is not 
considered to obtain a benefit from the activities.
    Example 11. Shareholder activities. The facts are the same as in 
Example 10, except that Company Y bears the full cost of retaining 
the firms to evaluate the new foreign currency control laws in 
Country B and to make appropriate changes to its stock ownership by 
Company X. Company X is considered to obtain a benefit from the 
rendering by Company Y of these activities, which would be 
shareholder activities if conducted by Company X (see Example 10).
    Example 12. Shareholder activities. The facts are the same as in 
Example 10, except that the new laws relate solely to corporate 
governance in Country B, and Company X retains the law firm and 
investment banking firm in order to evaluate whether restructuring 
would increase Company Y's profitability, reduce the number of legal 
entities in Country B, and increase Company Y's ability to introduce 
new products more quickly in Country B. Because Company X retained 
the law firm and the investment banking firm primarily to enhance 
Company Y's profitability and the efficiency of its operations, and 
not solely to protect Company X's investment in Company Y or to 
facilitate Company X's compliance with Country B's corporate laws, 
or to both, these activities do not constitute shareholder 
activities.
    Example 13. Shareholder activities. Company X establishes 
detailed personnel policies for its subsidiaries, including Company 
Y. Company X also reviews and approves the performance appraisals of 
Company Y's executives, monitors levels of compensation paid to all 
Company Y personnel, and is involved in hiring and firing decisions 
regarding the senior executives of Company Y. Because this 
personnel-related activity by Company X involves day-to-day 
management of Company Y, this activity does not relate solely to 
Company X's role as an investor of capital or a shareholder of 
Company Y, and therefore does not constitute a shareholder activity.
    Example 14. Shareholder activities. Each year, Company X 
conducts a two-day retreat for its senior executives. The purpose of 
the retreat is to refine the long-term business strategy of Company 
X and its subsidiaries, including Company Y, and to produce a 
confidential strategy statement. The strategy statement identifies 
several potential growth initiatives for Company X and its 
subsidiaries and lists general means of increasing the profitability 
of the company as a whole. The strategy statement is made available 
without charge to Company Y and the other subsidiaries of Company X. 
Company Y independently evaluates whether to implement some, all, or 
none of the initiatives contained in the strategy statement. Because 
the preparation of the strategy statement does not relate solely to 
Company X's role as an investor of capital or a shareholder of 
Company Y, the expense of preparing the document is not a 
shareholder expense.
    Example 15. Passive association/benefit. Company X is the parent 
corporation of a large controlled group that has been in operation 
in the information-technology sector for ten years. Company Y is a 
small corporation that was recently acquired by the Company X 
controlled group from local Country B owners. Several months after 
the acquisition of Company Y, Company Y obtained a contract to 
redesign and assemble the information-technology networks and 
systems of a large financial institution in Country B. The project 
was significantly larger and more complex than any other project 
undertaken to date by Company Y. Company Y did not use Company X's 
marketing intangibles to solicit the contract, and Company X had no 
involvement in the solicitation, negotiation, or anticipated 
execution of the contract. For purposes of this section, Company Y 
is not considered to obtain a benefit from Company X or any other 
member of the controlled group because the ability of Company Y to 
obtain the contract, or to obtain the contract on more favorable 
terms than would have been possible prior to its acquisition by the 
Company X controlled group, was due to Company Y's status as a 
member of the Company X controlled group and not to any specific 
activity by Company X or any other member of the controlled group.
    Example 16. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X executes a performance 
guarantee with respect to the contract, agreeing to assist in the 
project if Company Y fails to meet certain mileposts. This 
performance guarantee allowed Company Y to obtain the contract on 
materially more favorable terms than otherwise would have been 
possible. Company Y is considered to obtain a benefit from Company 
X's execution of the performance guarantee.
    Example 17. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X began the process of 
negotiating the contract with the financial institution in Country B 
before acquiring Company Y. Once Company Y was acquired by Company 
X, the contract with the financial institution was entered into by 
Company Y. Company Y is considered to obtain a benefit from Company 
X's negotiation of the contract.
    Example 18. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X sent a letter to the 
financial institution in Country B, which represented that Company X 
had a certain percentage ownership in Company Y and that Company X 
would maintain that same percentage ownership interest in Company Y 
until the contract was completed. This letter allowed Company Y to 
obtain the contract on more favorable terms than otherwise would 
have been possible. Since this letter from Company X to the 
financial institution simply affirmed Company Y's status as a member 
of the controlled group and represented that this status would be 
maintained until the contract was completed, Company Y is not 
considered to obtain a benefit from Company X's furnishing of the 
letter.
    Example 19. Passive association/benefit. (i) S is a company that 
supplies plastic containers to companies in various industries. S 
establishes the prices for its containers through a price list that 
offers customers discounts based solely on the volume of containers 
purchased.
    (ii) Company X is the parent corporation of a large controlled 
group in the information technology sector. Company Y is a wholly-
owned subsidiary of Company X located in Country B. Company X and 
Company Y both purchase plastic containers from unrelated supplier 
S. In year 1, Company X purchases 1 million units and Company Y 
purchases 100,000 units. S, basing its prices on purchases by the 
entire group, completes the order for 1.1 million units at a price 
of $0.95 per unit, and separately bills and ships the orders to each 
company. Companies X and Y undertake no bargaining with supplier S 
with respect to the price charged, and purchase no other products 
from supplier S.
    (iii) R1 and its wholly-owned subsidiary R2 are a controlled 
group of taxpayers (unrelated to Company X or Company Y) each of 
which carries out functions comparable to those of Companies X and Y 
and undertakes purchases of plastic containers from supplier S, 
identical to those purchased from S by Company X and Company Y, 
respectively. S, basing its prices

[[Page 44513]]

on purchases by the entire group, charges R1 and R2 $0.95 per unit 
for the 1.1 million units ordered. R1 and R2 undertake no bargaining 
with supplier S with respect to the price charged, and purchase no 
other products from supplier S.
    (iv) U is an uncontrolled taxpayer that carries out comparable 
functions and undertakes purchases of plastic containers from 
supplier S identical to Company Y. U is not a member of a controlled 
group, undertakes no bargaining with supplier S with respect to the 
price charged, and purchases no other products from supplier S. U 
purchases 100,000 plastic containers from S at the price of $1.00 
per unit.
    (v) Company X charges Company Y a fee of $5,000, or $0.05 per 
unit of plastic containers purchased by Company Y, reflecting the 
fact that Company Y receives the volume discount from supplier S.
    (vi) In evaluating the fee charged by Company X to Company Y, 
the Commissioner considers whether the transactions between R1, R2, 
and S or the transactions between U and S provide a more reliable 
measure of the transactions between Company X, Company Y and S. The 
Commissioner determines that Company Y's status as a member of a 
controlled group should be taken into account for purposes of 
evaluating comparability of the transactions, and concludes that the 
transactions between R1, R2, and S are more reliably comparable to 
the transactions between Company X, Company Y, and S. The comparable 
charge for the purchase was $0.95 per unit. Therefore, obtaining the 
plastic containers at a favorable rate (and the resulting $5,000 
savings) is entirely due to Company Y's status as a member of the 
Company X controlled group and not to any specific activity by 
Company X or any other member of the controlled group. Consequently, 
Company Y is not considered to obtain a benefit from Company X or 
any other member of the controlled group.
    Example 20. Disaggregation of transactions. (i) X, a domestic 
corporation, is a pharmaceutical company that develops and 
manufactures ethical pharmaceutical products. Y, a Country B 
corporation, is a distribution and marketing company that also 
performs clinical trials for USP in Country X. Because Y does not 
possess the capability to conduct the trials, it contracts with a 
third party to undertake the trials at a cost of $100. Y also incurs 
$25 in expenses related to the third-party contract (for example, in 
hiring and working with the third party).
    (ii) Based on a detailed functional analysis, the Commissioner 
determines that Y performed functions beyond merely facilitating the 
clinical trials for X, such as audit controls of the third party 
performing those trials. In determining the arm's length price, the 
Commissioner may consider a number of alternatives. For example, for 
purposes of determining the arm's length price, the Commissioner may 
determine that the intercompany service is most reliably analyzed on 
a disaggregated basis as two separate transactions: in this case, 
the contract between Y and the third party could constitute an 
internal CUSP with a price of $100. Y would be further entitled to 
an arm's length remuneration for its facilitating services. If the 
most reliable method is one that provides a markup on Y's costs, 
then ``total services cost'' in this context would be $25. 
Alternatively, the Commissioner may determine that the intercompany 
service is most reliably analyzed as a single transaction, based on 
comparable uncontrolled transactions involving the facilitation of 
similar clinical trial services performed by third parties. If the 
most reliable method is one that provides a markup on all of Y's 
costs, and the base of the markup determined by the comparable 
companies includes the third-party clinical trial costs, then such a 
markup would be applied to Y's total services cost of $125.
    Examples 21.  Disaggregation of transactions. (i) X performs a 
number of administrative functions for its subsidiaries, including 
Y, a distributor of widgets in Country B. These services include 
those relating to working capital (inventory and accounts 
receivable/payable) management. To facilitate provision of these 
services, X purchases an ERP system specifically dedicated to 
optimizing working capital management. The system, which entails 
significant third-party costs and which includes substantial 
intellectual property relating to its software, costs $1000.
    (ii) Based on a detailed functional analysis, the Commissioner 
determines that in providing administrative services for Y, X 
performed functions beyond merely operating the ERP system itself, 
since X was effectively using the ERP as an input to the 
administrative services it was providing to Y. In determining arm's 
length price for the services, the Commissioner may consider a 
number of alternatives. For example, if the most reliable 
uncontrolled data is derived from companies that use similar ERP 
systems purchased from third parties to perform similar 
administrative functions for uncontrolled parties, the Commissioner 
may determine that a CPM is the best method for measuring the 
functions performed by X, and, in addition, that a markup on total 
services costs, based on the markup from the comparable companies, 
is the most reliable PLI. In this case, total services cost, and the 
basis for the markup, would include appropriate reflection of the 
ERP costs of $1000. Alternatively, X's functions may be most 
reliably measured based on comparable uncontrolled companies that 
perform similar administrative functions using their customers' own 
ERP systems. Under these circumstances, the total services cost 
would equal X's costs of providing the administrative services 
excluding the ERP cost of $1000.

    (m) Coordination with transfer pricing rules for other 
transactions--(1) Services transactions that include other types of 
transactions. A transaction structured as a controlled services 
transaction may include other elements for which a separate category or 
categories of methods are provided, such as a loan or advance, a 
rental, or a transfer of tangible or intangible property. See 
Sec. Sec.  1.482-1(b)(2) and 1.482-2(a), (c), and (d). Whether such an 
integrated transaction is evaluated as a controlled services 
transaction under this section or whether one or more elements should 
be evaluated separately under other sections of the section 482 
regulations depends on which approach will provide the most reliable 
measure of an arm's length result. Ordinarily, an integrated 
transaction of this type may be evaluated under this section and its 
separate elements need not be evaluated separately, provided that each 
component of the transaction may be adequately accounted for in 
evaluating the comparability of the controlled transaction to the 
uncontrolled comparables and, accordingly, in determining the arm's 
length result in the controlled transaction. See Sec.  1.482-1(d)(3).
    (2) Services transactions that effect a transfer of intangible 
property. A transaction structured as a controlled services transaction 
may in certain cases include an element that constitutes the transfer 
of intangible property or may result in a transfer, in whole or in 
part, of intangible property. Notwithstanding paragraph (m)(1) of this 
section, if such element relating to intangible property is material to 
the evaluation, the arm's length result for the element of the 
transaction that involves intangible property must be corroborated or 
determined by an analysis under Sec.  1.482-4.
    (3) Services subject to a qualified cost sharing arrangement. 
Services provided by a controlled participant under a qualified cost 
sharing arrangement are subject to Sec.  1.482-7.
    (4) Other types of transactions that include controlled services 
transactions. A transaction structured other than as a controlled 
services transaction may include one or more elements for which 
separate pricing methods are provided in this section. Whether such an 
integrated transaction is evaluated under another section of the 
section 482 regulations or whether one or more elements should be 
evaluated separately under this section depends on which approach will 
provide the most reliable measure of an arm's length result. 
Ordinarily, a single method may be applied to such an integrated 
transaction, and the separate services component of the transaction 
need not be separately analyzed under this section, provided that the 
controlled services may be adequately accounted for in evaluating the 
comparability of the controlled transaction to the uncontrolled 
comparables and, accordingly, in determining the arm's length results 
in the controlled transaction. See Sec.  1.482-1(d)(3).

[[Page 44514]]

    (5) Examples. The following examples illustrate paragraphs (m)(1) 
through (4) of this section:

    Example 1.  (i) U.S. parent corporation Company X enters into an 
agreement to maintain equipment of Company Y, a foreign subsidiary. 
The maintenance of the equipment requires the use of spare parts. 
The cost of the spare parts necessary to maintain the equipment 
amounts to approximately 25 percent of the total costs of 
maintaining the equipment. Company Y pays a fee that includes a 
charge for labor and parts.
    (ii) Whether this integrated transaction is evaluated as a 
controlled services transaction or is evaluated as a controlled 
services transaction and the transfer of tangible property depends 
on which approach will provide the most reliable measure of an arm's 
length result. If it is not possible to find comparable uncontrolled 
services transactions that involve similar services and tangible 
property transfers as the controlled transaction between Company X 
and Company Y, it will be necessary to determine the arm's length 
charge for the controlled services, and then to evaluate separately 
the arm's length charge for the tangible property transfers under 
Sec.  1.482-1 and Sec. Sec.  1.482-3 through 1.482-6. Alternatively, 
it may be possible to apply the comparable profits method of Sec.  
1.482-5, to evaluate the arm's length profit of Company X or Company 
Y from the integrated controlled transaction. The comparable profits 
method may provide the most reliable measure of measure of an arm's 
length result if uncontrolled parties are identified that perform 
similar, combined functions of maintaining and providing spare parts 
for similar equipment.
    Example 2. (i) U.S. parent corporation Company X sells 
industrial equipment to its foreign subsidiary, Company Y. In 
connection with this sale, Company X renders to Company Y services 
that consist of demonstrating the use of the equipment and assisting 
in the effective start-up of the equipment. Company X structures the 
integrated transaction as a sale of tangible property and determines 
the transfer price under the comparable uncontrolled price method of 
Sec.  1.482-3(b).
    (ii) Whether this integrated transaction is evaluated as a 
transfer of tangible property or is evaluated as a controlled 
services transaction and a transfer of tangible property depends on 
which approach will provide the most reliable measure of an arm's 
length result. In this case, the controlled services may be similar 
to services rendered in the transactions used to determine the 
comparable uncontrolled price, or they may appropriately be 
considered a difference between the controlled transaction and 
comparable transactions with a definite and reasonably ascertainable 
effect on price for which appropriate adjustments can be made. See 
Sec.  1.482-1(d)(3)(ii)(A)(6). In either case, application of the 
comparable uncontrolled price method to evaluate the integrated 
transaction may provide a reliable measure of an arm's length 
result, and application of a separate transfer pricing method for 
the controlled services element of the transaction is not necessary.
    Example 3.  (i) The facts are the same as in Example 2 except 
that, after assisting Company Y in start-up, Company X also renders 
ongoing services, including instruction and supervision regarding 
Company Y's ongoing use of the equipment. Company X structures the 
entire transaction, including the incremental ongoing services, as a 
sale of tangible property, and determines the transfer price under 
the comparable uncontrolled price method of Sec.  1.482-3(b).
    (ii) Whether this integrated transaction is evaluated as a 
transfer of tangible property or is evaluated as a controlled 
services transaction and a transfer of tangible property depends on 
which approach will provide the most reliable measure of an arm's 
length result. It may not be possible to identify comparable 
uncontrolled transactions in which a seller of merchandise renders 
services similar to the ongoing services rendered by Company X to 
Company Y. In such a case, the incremental services in connection 
with ongoing use of the equipment could not be taken into account as 
a comparability factor because they are not similar to the services 
rendered in connection with sales of similar tangible property. 
Accordingly, it may be necessary to evaluate separately the transfer 
price for such services under this section in order to produce the 
most reliable measure of an arm's length result. Alternatively, it 
may be possible to apply the comparable profits method of Sec.  
1.482-5 to evaluate the arm's length profit of Company X or Company 
Y from the integrated controlled transaction. The comparable profits 
method may provide the most reliable measure of an arm's length 
result if uncontrolled parties are identified that perform the 
combined functions of selling equipment and rendering ongoing after-
sale services associated with such equipment. In that case, it would 
not be necessary to separately evaluate the transfer price for the 
controlled services under this section.
    Example 4. (i) Company X, a U.S. corporation, and Company Y, a 
foreign corporation, are members of a controlled group. Both 
companies perform research and development activities relating to 
integrated circuits. In addition, Company Y manufactures integrated 
circuits. In years 1 through 3, Company X engages in substantial 
research and development activities, gains significant know-how 
regarding the development of a particular high-temperature resistant 
integrated circuit, and memorializes that research in a written 
report. In years 1 through 3, Company X generates overall net 
operating losses as a result of the expenditures associated with 
this research and development effort. At the beginning of year 4, 
Company X enters into a technical assistance agreement with Company 
Y. As part of this agreement, the researchers from Company X 
responsible for this project meet with the researchers from Company 
Y and provide them with a copy of the written report. Three months 
later, the researchers from Company Y apply for a patent for a high-
temperature resistant integrated circuit based in large part upon 
the know-how obtained from the researchers from Company X.
    (ii) The controlled services transaction between Company X and 
Company Y includes an element that constitutes the transfer of 
intangible property (such as, know-how). Because the element 
relating to the intangible property is material to the arm's length 
evaluation, the arm's length result for that element must be 
corroborated or determined by an analysis under Sec.  1.482-4.

    (n) Effective date--(1) In general. This section is generally 
applicable for taxable years beginning after December 31, 2006. In 
addition, a person may elect to apply the provisions of this section, 
Sec.  1.482-9T, to earlier taxable years. See paragraph (n)(2) of this 
section.
    (2) Election to apply regulations to earlier taxable years--(i) 
Scope of election. A taxpayer may elect to apply Sec. Sec.  1.482-1T, 
1.482-2T, 1.482-4T, 1.482-6T, 1.482-8T, and 9T, 1.861-8T, Sec.  
1.6038A-3T, Sec.  1.6662-6T and Sec.  31.3121(s)-1T of this chapter to 
any taxable year beginning after September 10, 2003. Such election 
requires that all of the provisions of this section, Sec. Sec.  1.482-
1T, 1.482-2T, 1.482-4T, 1.482-6T, 1.482-8T, and 1.482-9T, as well as 
the related provisions, Sec. Sec.  1.861-8T, 1.6038A-3T, 1.6662-6T and 
31.3121(s)-1T of this chapter be applied to such taxable year and all 
subsequent taxable years (earlier taxable years) of the taxpayer making 
the election.
    (ii) Effect of election. An election to apply the regulations to 
earlier taxable years has no effect on the limitations on assessment 
and collection or on the limitations on credit or refund (see Chapter 
66 of the Internal Revenue Code).
    (iii) Time and manner of making election. An election to apply the 
regulations to earlier taxable years must be made by attaching a 
statement to the taxpayer's timely filed U.S. tax return (including 
extensions) for its first taxable year after December 31, 2006.
    (iv) Revocation of election. An election to apply the regulations 
to earlier taxable years may not be revoked without the consent of the 
Commissioner.
    (3) In general. The applicability of Sec.  1.482-9T expires on or 
before July 31, 2009.

0
Par. 15. Section 1.861-8 is amended as follows:
0
1. Paragraph (a)(5)(ii) is redesignated as paragraph (a)(5)(iii).
0
2. A new paragraph (a)(5)(ii) is added.
0
3. Paragraph (e)(4) is revised.
0
4. Paragraph (f)(4)(i) is revised.
0
5. Paragraph (g), Example 17, Example 18, and Example 30 are revised.
    The addition and revisions read as follows:

[[Page 44515]]

Sec.  1.861-8  Computation of taxable income from sources within the 
United States and from other sources and activities.

    (a) * * *
    (5) * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.861-8T(a)(5) 
(ii).
* * * * *
    (e) * * *
    (4) [Reserved]. For further guidance, see Sec.  1.861-8T(e)(4).
    (f) * * *
    (4) * * * (i)[Reserved]. For further guidance, see Sec.  1.861-
8T(f)(4)(i).
* * * * *
    (g) * * *
    Example 17. [Reserved]. For further guidance, see Sec.  1.861-
8T(g), Example 17.
    Example 18. [Reserved]. For further guidance, see Sec.  1.861-
8T(g), Example 18.
* * * * *
    Example 30. [Reserved]. For further guidance, see Sec.  1.861-
8T(g), Example 30.
* * * * *

0
Par. 16. Section 1.861-8T is amended as follows:
0
1. Paragraphs (a)(3) and (a)(4) are removed and reserved and paragraph 
(a)(5)(ii) is revised.
0
2. Paragraphs (b)(3) are revised.
0
3. Paragraph (e)(4) is added.
0
4. Paragraph (f)(4)(i) is revised.
0
5. Paragraph (g), Example 17, Example 18, and Example 30 are added.
0
6. Paragraph (h) is revised.
    The addition and revisions read as follows:


Sec.  1.861-8T  Computation of taxable income from sources within the 
United States and from other sources and activities (temporary).

    (a) * * *
    (5) * * *
    (ii) Paragraph (e)(4), the last sentence of paragraph (f)(4)(i), 
and paragraph (g), Example 17, Example 18, and Example 30 of this 
section are generally applicable for taxable years beginning after 
December 31, 2006. In addition, a person may elect to apply the 
provisions of paragraph (e)(4) of this section to earlier years. Such 
election shall be made in accordance with the rules set forth in Sec.  
1.482-9T(n)(2).
    (b) * * *
    (3) Supportive functions. Deductions which are supportive in nature 
(such as overhead, general and administrative, and supervisory 
expenses) may relate to other deductions which can more readily be 
allocated to gross income. In such instance, such supportive deductions 
may be allocated and apportioned along with the deductions to which 
they relate. On the other hand, it would be equally acceptable to 
attribute supportive deductions on some reasonable basis directly to 
activities or property ordinarily be accomplished by allocating the 
supportive expenses to all gross income or to another broad class of 
gross income and apportioning the expenses in accordance with paragraph 
(c)(1) of this section. For this purpose, reasonable departmental 
overhead rates may be utilized. For examples of the application of the 
principles of this paragraph (b)(3) to expenses other than expenses 
attributable to stewardship activities, see Examples 19 through 21 of 
paragraph (g) of this section. See paragraph (e)(4)(ii) of this section 
for the allocation and apportionment of deductions attributable to 
stewardship expenses. However, supportive deductions that are described 
in 1.861-14T(e)(3) shall be allocated and apportioned by reference only 
to the gross income of a single member of an affiliated group of 
corporations as defined in 1.861-14T.
* * * * *
    (e) * * *
    (4) Stewardship and controlled services--(i) Expenses attributable 
to controlled services. If a corporation performs a controlled services 
transaction (as defined in Sec.  1.482-9T(l)(3)), which includes any 
activity by one member of a group of controlled taxpayers that results 
in a benefit to a related corporation, and the rendering corporation 
charges the related corporation for such services, section 482 and 
these regulations provide for an allocation where the charge is not 
consistent with an arm's length result as determined. The deductions 
for expenses of the corporation attributable to the controlled services 
transaction are considered definitely related to the amounts so charged 
and are to be allocated to such amounts.
    (ii) Stewardship expenses attributable to dividends received. 
Stewardship expenses, which result from ``overseeing'' functions 
undertaken for a corporation's own benefit as an investor in a related 
corporation, shall be considered definitely related and allocable to 
dividends received, or to be received, from the related corporation. 
For purposes of this section, stewardship expenses of a corporation are 
those expenses resulting from ``duplicative activities'' (as defined in 
Sec.  1.482-9T(l)(3)(iii)) or ``shareholder activities'' (as defined in 
Sec.  1.482-9T(l)(3)(iv)) of the corporation with respect to the 
related corporation. Thus, for example, stewardship expenses include 
expenses of an activity the sole effect of which is either to protect 
the corporation's capital investment in the related corporation or to 
facilitate compliance by the corporation with reporting, legal, or 
regulatory requirements applicable specifically to the corporation, or 
both. If a corporation has a foreign or international department which 
exercises overseeing functions with respect to related foreign 
corporations and, in addition, the department performs other functions 
that generate other foreign-source income (such as fees for services 
rendered outside of the United States for the benefit of foreign 
related corporations, foreign-source royalties, and gross income of 
foreign branches), some part of the deductions with respect to that 
department are considered definitely related to the other foreign-
source income. In some instances, the operations of a foreign or 
international department will also generate United States source income 
(such as fees for services performed in the United States). Permissible 
methods of apportionment with respect to stewardship expenses include 
comparisons of time spent by employees weighted to take into account 
differences in compensation, or comparisons of each related 
corporation's gross receipts, gross income, or unit sales volume, 
assuming that stewardship activities are not substantially 
disproportionate to such factors. See paragraph (f)(5) of this section 
for the type of verification that may be required in this respect. See 
Sec.  1.482-9T(l)(5) for examples that illustrate the principles of 
Sec.  1.482-9T(l)(3). See Example 17 and Example 18 of paragraph (g) of 
this section for the allocation and apportionment of stewardship 
expenses. See paragraph (b)(3) of this section for the allocation and 
apportionment of deductions attributable to supportive functions other 
than stewardship expenses, such as expenses in the nature of day-to-day 
management, and paragraph (e)(5) of this section generally for the 
allocation and apportionment of deductions attributable to legal and 
accounting fees and expenses.
    (f) * * *
    (4) Adjustments made under other provisions of the Code--(i) In 
general. If an adjustment which affects the taxpayer is made under 
section 482 or any other provision of the Code, it may be necessary to 
recompute the allocations and apportionments required by this section 
in order to reflect changes resulting from the adjustment. The 
recomputation made by the Commissioner shall be made using the same 
method of allocation and

[[Page 44516]]

apportionment as was originally used by the taxpayer, provided such 
method as originally used conformed with paragraph (a)(5) of this 
section and, in light of the adjustment, such method does not result in 
a material distortion. In addition to adjustments which would be made 
aside from this section, adjustments to the taxpayer's income and 
deductions which would not otherwise be made may be required before 
applying this section in order to prevent a distortion in determining 
taxable income from a particular source of activity. For example, if an 
item included as a part of the cost of goods sold has been improperly 
attributed to specific sales, and, as a result, gross income under one 
of the operative sections referred to in paragraph (f)(1) of this 
section is improperly determined, it may be necessary for the 
Commissioner to make an adjustment to the cost of goods sold, 
consistent with the principles of this section, before applying this 
section. Similarly, if a domestic corporation transfers the stock in 
its foreign subsidiaries to a domestic subsidiary and the parent 
corporation continues to incur expenses in connection with protecting 
its capital investment in the foreign subsidiaries (see paragraph 
(e)(4) of this section), it may be necessary for the Commissioner to 
make an allocation under section 482 with respect to such expenses 
before making allocations and apportionments required by this section, 
even though the section 482 allocation might not otherwise be made.
    (g) * * *

    Example 17. Stewardship Expenses (Consolidation). (i) (A) Facts. 
X, a domestic corporation, wholly owns M, N, and O, also domestic 
corporations. X, M, N, and O file a consolidated income tax return. 
All the income of X and O is from sources within the United States, 
all of M's income is general limitation income from sources within 
South America, and all of N's income is general limitation income 
from sources within Africa. X receives no dividends from M, N, or O. 
During the taxable year, the consolidated group of corporations 
earned consolidated gross income of $550,000 and incurred total 
deductions of $370,000 as follows:

------------------------------------------------------------------------
                                           Gross income     Deductions
------------------------------------------------------------------------
Corporations:
    X...................................        $100,000         $50,000
    M...................................         250,000         100,000
    N...................................         150,000         200,000
    O...................................          50,000          20,000
                                         -------------------------------
        Total...........................         550,000         370,000
------------------------------------------------------------------------

    (B) Of the $50,000 of deductions incurred by X, $15,000 relates 
to X's ownership of M; $10,000 relates to X's ownership of N; $5,000 
relates to X's ownership of O; and the sole effect of the entire 
$30,000 of deductions is to protect X's capital investment in M, N, 
and O. X properly categorizes the $30,000 of deductions as 
stewardship expenses. The remainder of X's deductions ($20,000) 
relates to production of United States source income from its plant 
in the United States.
    (ii) (A) Allocation. X's deductions of $50,000 are definitely 
related and thus allocable to the types of gross income to which 
they give rise, namely $25,000 wholly to general limitation income 
from sources outside the United States ($15,000 for stewardship of M 
and $10,000 for stewardship of N) and the remainder ($25,000) wholly 
to gross income from sources within the United States. Expenses 
incurred by M and N are entirely related and thus wholly allocable 
to general limitation income earned from sources without the United 
States, and expenses incurred by O are entirely related and thus 
wholly allocable to income earned within the United States. Hence, 
no apportionment of expenses of X, M, N, or O is necessary. For 
purposes of applying the foreign tax credit limitation; the 
statutory grouping is general limitation gross income from sources 
without the United States and the residual grouping is gross income 
from sources within the United States. As a result of the allocation 
of deductions, the X consolidated group has taxable income from 
sources without the United States in the amount of $75,000, computed 
as follows:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Foreign source general limitation gross income:
    ($250,000 from M + $150,000 from N).................        $400,000
Less: Deductions allocable to foreign source general
 limitation gross income:
    ($25,000 from X, $100,000 from M, and $200,000 from          325,000
     N).................................................
                                                         ---------------
        Total foreign-source taxable income.............          75,000
------------------------------------------------------------------------

    (B) Thus, in the combined computation of the general limitation, 
the numerator of the limiting fraction (taxable income from sources 
outside the United States) is $75,000.
    Example 18. Stewardship and Supportive Expenses. (i) (A) Facts. 
X, a domestic corporation, manufactures and sells pharmaceuticals in 
the United States. X's domestic subsidiary S, and X's foreign 
subsidiaries T, U, and V perform similar functions in the United 
States and foreign countries T, U, and V, respectively. Each 
corporation derives substantial net income during the taxable year 
that is general limitation income described in section 904(d)(1). 
X's gross income for the taxable year consists of:

 
 
 
Domestic sales income...................................     $32,000,000
Dividends from S (before dividends received deduction)..       3,000,000
Dividends from T........................................       2,000,000
Dividends from U........................................       1,000,000
Dividends from V........................................               0
Royalties from T and U..................................       1,000,000
Fees from U for services performed by X.................       1,000,000
                                                         ---------------
    Total gross income..................................      40,000,000
 

    (B) In addition, X incurs expenses of its supervision department 
of $1,500,000.
    (C) X's supervision department (the Department) is responsible 
for the supervision of its four subsidiaries and for rendering 
certain services to the subsidiaries,

[[Page 44517]]

and this Department provides all the supportive functions necessary 
for X's foreign activities. The Department performs three principal 
types of activities. The first type consists of services for the 
direct benefit of U for which a fee is paid by U to X. The cost of 
the services for U is $900,000 (which results in a total charge to U 
of $1,000,000). The second type consists of activities described in 
Sec.  1.482-9(l)(3)(iii) that are in the nature of shareholder 
oversight that duplicate functions performed by the subsidiaries' 
own employees and that do not provide an additional benefit to the 
subsidiaries. For example, a team of auditors from X's accounting 
department periodically audits the subsidiaries' books and prepares 
internal reports for use by X's management. Similarly, X's treasurer 
periodically reviews for the board of directors of X the 
subsidiaries' financial policies. These activities do not provide an 
additional benefit to the related corporations. The cost of the 
duplicative services and related supportive expenses is $540,000. 
The third type of activity consists of providing services which are 
ancillary to the license agreements which X maintains with 
subsidiaries T and U. The cost of the ancillary services is $60,000.
    (ii) Allocation. The Department's outlay of $900,000 for 
services rendered for the benefit of U is allocated to the 
$1,000,000 in fees paid by U. The remaining $600,000 in the 
Department's deductions are definitely related to the types of gross 
income to which they give rise, namely dividends from subsidiaries 
S, T, U, and V and royalties from T and U. However, $60,000 of the 
$600,000 in deductions are found to be attributable to the ancillary 
services and are definitely related (and therefore allocable) solely 
to royalties received from T and U, while the remaining $540,000 in 
deductions are definitely related (and therefore allocable) to 
dividends received from all the subsidiaries.
    (iii) (A) Apportionment. For purposes of applying the foreign 
tax credit limitation, the statutory grouping is general limitation 
gross income from sources outside the United States and the residual 
grouping is gross income from sources within the United States. X's 
deduction of $540,000 for the Department's expenses and related 
supportive expenses which are allocable to dividends received from 
the subsidiaries must be apportioned between the statutory and 
residual groupings before the foreign tax credit limitation may be 
applied. In determining an appropriate method for apportioning the 
$540,000, a basis other than X's gross income must be used since the 
dividend payment policies of the subsidiaries bear no relationship 
either to the activities of the Department or to the amount of 
income earned by each subsidiary. This is evidenced by the fact that 
V paid no dividends during the year, whereas S, T, and U paid 
dividends of $1 million or more each. In the absence of facts that 
would indicate a material distortion resulting from the use of such 
method, the stewardship expenses ($540,000) may be apportioned on 
the basis of the gross receipts of each subsidiary.
    (B) The gross receipts of the subsidiaries were as follows:

 
 
 
S.......................................................      $4,000,000
T.......................................................       3,000,000
U.......................................................         500,000
V.......................................................       1,500,000
                                                         ---------------
    Total...............................................       9,000,000
 

    (C) Thus, the expenses of the Department are apportioned for 
purposes of the foreign tax credit limitation as follows:

 
 
 
Apportionment of stewardship expenses to the statutory          $300,000
 grouping of gross income: $540,000 x [($3,000,000 +
 $500,000 + $1,500,000)/$9,000,000].....................
Apportionment of supervisory expenses to the residual            240,000
 grouping of gross income: $540,000 x [$4,000,000/
 9,000,000].............................................
                                                         ---------------
    Total: Apportioned stewardship expense..............         540,000
 

* * * * *
    Example 30. Income Taxes. (i) (A) Facts. As in Example 17 of 
this paragraph, X is a domestic corporation that wholly owns M, N, 
and O, also domestic corporations. X, M, N, and O file a 
consolidated income tax return. All the income of X and O is from 
sources within the United States, all of M's income is general 
limitation income from sources within South America, and all of N's 
income is general limitation income from sources within Africa. X 
receives no dividends from M, N, or O. During the taxable year, the 
consolidated group of corporations earned consolidated gross income 
of $550,000 and incurred total deductions of $370,000. X has gross 
income of $100,000 and deductions of $50,000, without regard to its 
deduction for state income tax. Of the $50,000 of deductions 
incurred by X, $15,000 relates to X's ownership of M; $10,000 
relates to X's ownership of N; $5,000 relates to X's ownership of O; 
and the entire $30,000 constitutes stewardship expenses. The 
remainder of X's $20,000 of deductions (which is assumed not to 
include state income tax) relates to production of U.S. source 
income from its plant in the United States. M has gross income of 
$250,000 and deductions of $100,000, which yield foreign-source 
general limitation taxable income of $150,000. N has gross income of 
$150,000 and deductions of $200,000, which yield a foreign-source 
general limitation loss of $50,000. O has gross income of $50,000 
and deductions of $20,000, which yield U.S. source taxable income of 
$30,000.
    (B) Unlike Example 17 of this paragraph (g), however, X also has 
a deduction of $1,800 for state A income taxes. X's state A taxable 
income is computed by first making adjustments to the Federal 
taxable income of X to derive apportionable taxable income for state 
A tax purposes. An analysis of state A law indicates that state A 
law also includes in its definition of the taxable business income 
of X which is apportionable to X's state A activities, the taxable 
income of M, N, and O, which is related to X's business. As in 
Example 25, the amount of apportionable taxable income attributable 
to business activities conducted in state A is determined by 
multiplying apportionable taxable income by a fraction (the ``state 
apportionment fraction'') that compares the relative amounts of 
payroll, property, and sales within state A with worldwide payroll, 
property, and sales. Assuming that X's apportionable taxable income 
equals $180,000, $100,000 of which is from sources without the 
United States, and $80,000 is from sources within the United States, 
and that the state apportionment fraction is equal to 10 percent, X 
has state A taxable income of $18,000. The state A income tax of 
$1,800 is then derived by applying the state A income tax rate of 10 
percent to the $18,000 of state A taxable income.
    (C)
    (i) Allocation and apportionment. Assume that under Example 29, 
it is determined that X's deduction for state A income tax is 
definitely related to a class of gross income consisting of income 
from sources both within and without the United States, and that the 
state A tax is apportioned $1,000 to sources without the United 
States, and $800 to sources within the United States. Under Example 
17, without regard to the deduction for X's state A income tax, X 
has a separate loss of ($25,000) from sources without the United 
States. After taking into account the deduction for state A income 
tax, X's separate loss from sources without the United States is 
increased by the $1,000 state A tax apportioned to sources without 
the United States, and equals a loss of ($26,000), for purposes of 
computing the numerator of the consolidated general limitation 
foreign tax credit limitation.

    (h) Effective dates--(1) In general. In general, the rules of this 
section, as well as the rules of Sec. Sec.  1.861-9T, 1.861-10T, 1.861-
11T, 1.861-12T, and 1.861-14T apply for taxable years beginning after 
December 31, 1986, except for paragraphs (a)(5)(ii), (b)(3), (e)(4), 
(f)(4)(i), paragraph (g) Example 17, Example 18, and Example 30, and 
paragraph (h) of this section, which are generally applicable for 
taxable years beginning after December 31, 2006. However, see 1.861-
8(e)(12)(iv) and 1.861-14(e)(6) for rules concerning the allocation and 
apportionment of deductions for charitable contributions. In the case 
of corporate taxpayers, transition rules set forth in 1.861-13T provide 
for the gradual phase-in of certain provisions of this and the 
foregoing sections. However, the following rules are effective for 
taxable years commencing after December 31, 1988:
    (i) Section 1.861-9T(b)(2) (concerning the treatment of certain 
foreign currency).
    (ii) Section 1.861-9T(d)(2) (concerning the treatment of interest 
incurred by nonresident aliens).
    (iii) Section 1.861-10T(b)(3)(ii) (providing an operating costs 
test for purposes of the nonrecourse indebtedness exception).

[[Page 44518]]

    (iv) Section 1.861-10T(b)(6) (concerning excess collaterilzation of 
nonrecourse borrowings).
    (2) In addition, 1.861-10T(e) (concerning the treatment of related 
controlled foreign corporation indebtedness) is applicable for taxable 
years commencing after December 31, 1987. For rules for taxable years 
beginning before January 1, 1987, and for later years to the extent 
permitted by 1.861-13T, see 1.861-8 (revised as of April 1, 1986).
    (3) Expiration date. The applicability of the paragraphs 
(a)(5)(ii), (b)(3), (e)(4), (f)(4)(i), paragraph (g) Example 17, 
Example 18, and Example 30, and paragraph (h) of this section, expires 
on or before July 31, 2009.

0
Par. 17. Section 1.6038A-3(a)(3) is amended by revising paragraph 
(a)(3),
    Example 4 to read:


Sec.  1.6038A-3  Record maintenance.

    (a) * * *
    (3) * * *
    Example 4. [Reserved]. For further guidance, see Sec.  1.6038A-3T, 
Example 4.
* * * * *

0
Par. 18. Section 1.6038A-3T is added to read as follows:


Sec.  1.6038A-3T  Record maintenance (temporary).

    (a)(1) through (3) Examples 1 through 3 [Reserved]. For further 
guidance, see Sec.  1.6038A-3(a)(1) through (3) Examples 1 through 3.

    Example 4. S, a U.S. reporting corporation, provides computer 
consulting services for its foreign parent, X. Based on the 
application of section 482 and the regulations, it is determined 
that the cost of services plus method, as described in Sec.  1.482-
9T(e), will provide the most reliable measure of an arm's length 
result, based on the facts and circumstances of the controlled 
transaction between S and X. S is required to maintain records to 
permit verification upon audit of the comparable transactional costs 
(as described in Sec.  1.482-9T(e)(2)(iii)) used to calculate the 
arm's length price. Based on the facts and circumstances, if it is 
determined that X's records are relevant to determine the correct 
U.S. tax treatment of the controlled transaction between S and X, 
the record maintenance requirements under section 6038A(a) and this 
section will be applicable to the records of X.

    (b)(1) through (h) [Reserved]. For further guidance, see Sec.  
1.6038A-3T(b)(1) through (h).
    (i) Effective date--(1) In general. This provision is generally 
applicable for taxable years beginning after December 31, 2006.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of this section to earlier taxable 
years in accordance with the rules set forth in Sec.  1.482-9T(n)(2).
    (3) Expiration date. The applicability of this section expires on 
or before July 31, 2009.

0
Par. 19. Section 1.6662-6 is amended as follows:
0
1. Paragraphs (d)(2)(ii)(A) through (d)(2)(ii)(G) are redesignated as 
paragraphs (d)(2)(ii)(A)(1) through (d)(2)(ii)(A)(7) and paragraph 
(d)(2)(ii) introductory text as paragraph (d)(2)(ii)(A), respectively.
0
2. A new paragraph (d)(2)(ii)(B) is added.
0
3. Paragraphs (d)(2)(iii)(B)(4) and (d)(2)(iii)(B)(6) are revised
0
4. Paragraph (g) is revised.
    The additions and revisions read as follows:


Sec.  1.6662-6  Transactions between persons described in section 482 
and net section 482 transfer price adjustments.

* * * * *
    (d) * * *
    (2) * * *
    (ii) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.6662-
6T(d)(2)(ii)(B).
* * * * *
    (iii) * * *
    (B) * * *
    (4) [Reserved]. For further guidance, see Sec.  1.6662-
6T(d)(2)(iii)(B)(4).
* * * * *
    (6) [Reserved]. For further guidance, see Sec.  1.6662-
6T(d)(2)(iii)(B)(6).
* * * * *
    (g) [Reserved]. For further guidance, see Sec.  1.6662-6T(g).

0
Par. 20. Section 1.6662-6T is added to read as follows:


Sec.  1.6662-6T  Transactions between parties described in section 482 
and net section 482 transfer price adjustments (temporary).

    (a) through (d)(2)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.6662-6(a) through (d)(2)(ii)(A).
    (d)(2)(ii)(B) Services cost method. A taxpayer's selection of the 
services cost method for certain services, described in Sec.  1.482-
9T(b), and its application of that method to a controlled services 
transaction will be considered reasonable for purposes of the specified 
method requirement only if the taxpayer reasonably allocated and 
apportioned costs in accordance with Sec.  1.482-9T(k), reasonably 
concluded that the controlled services transaction meets the conditions 
of Sec.  1.482-9T(b)(3), and reasonably concluded that the controlled 
services transaction is not described in paragraph Sec.  1.482-
9T(b)(2). Whether the taxpayer's conclusion was reasonable must be 
determined from all the facts and circumstances. The factors relevant 
to this determination include those described in paragraph 
(d)(2)(ii)(A) of this section, to the extent applicable.
    (d)(2)(iii)(A) through (d)(2)(iii)(B)(3) [Reserved]. For further 
guidance, see Sec.  1.6662-6(d)(2)(iii)(A) through (d)(2)(iii)(B)(3).
    (d)(2)(iii)(B)(4) A description of the method selected and an 
explanation of why that method was selected, including an evaluation of 
whether the regulatory conditions and requirements for application of 
that method, if any, were met;
    (d)(2)(iii)(B)(5) [Reserved]. For further guidance, see Sec.  
1.6662-6(d)(2)(iii)(B)(5).
    (d)(2)(iii)(B)(6) A description of the controlled transactions 
(including the terms of sale) and any internal data used to analyze 
those transactions. For example, if a profit split method is applied, 
the documentation must include a schedule providing the total income, 
costs, and assets (with adjustments for different accounting practices 
and currencies) for each controlled taxpayer participating in the 
relevant business activity and detailing the allocations of such items 
to that activity. Similarly, if a cost-based method (such as the cost 
plus method, the services cost method for certain services, or a 
comparable profits method with a cost-based profit level indicator) is 
applied, the documentation must include a description of the manner in 
which relevant costs are determined and are allocated and apportioned 
to the relevant controlled transaction.
    (d)(2)(iii)(B)(7) through (f) [Reserved]. For further guidance, see 
Sec.  1.6662-6(d)(2)(iii)(B)(7) through (f).
    (g) Effective date--(1) This section is generally effective 
February 9, 1996. However, taxpayers may elect to apply this section to 
all open taxable years beginning after December 31, 1993.
    (2)(i) The provisions of paragraphs (d)(2)(ii)(B), 
(d)(2)(iii)(B)(4) and (d)(2)(iii)(B)(6) of this section are applicable 
for taxable years beginning after December 31, 2006.
    (ii) Election to apply regulation to earlier taxable years. A 
person may elect to apply the provisions of this section to earlier 
taxable years in accordance with the rules set forth in Sec.  1.482-
9T(n)(2) of this chapter.
    (iii) Expiration date. The applicability of Sec.  1.6662-6T expires 
on or before July 31, 2009.

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT THE 
SOURCE

0
Par. 21. The authority citation for part 31 continues to read as 
follows:

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

[[Page 44519]]


0
Par. 22. Section 31.3121(s)-1 is amended by revising paragraphs 
(c)(2)(iii) and (d) to read as follows:


Sec.  31.3121(s)-1  Concurrent employment by related corporations with 
common paymaster.

* * * * *
    (c) * * *
    (2) * * *
    (iii) [Reserved]. For further guidance, see Sec.  31.3121(s)-
1T(c)(2)(iii).
* * * * *
    (d) [Reserved]. For further guidance, see Sec.  31.3121(s)-1T(d).

0
Par. 23. Section 31.3121(s)-1T is added to read as follows:


Sec.  31.3121(s)-1T  Concurrent employment by related corporations with 
common paymaster (temporary).

    (a) through (c)(2)(ii) [Reserved]. For further guidance, see Sec.  
31.3121(s)-1(a) through (c)(2)(ii).
    (c)(2)(iii) Group-wide allocation rules. Under the group-wide 
method of allocation, the district director may allocate the taxes 
imposed by sections 3102 and 3111 in an appropriate manner to a related 
corporation that remunerates an employee through a common paymaster if 
the common paymaster fails to remit the taxes to the Internal Revenue 
Service. Allocation in an appropriate manner varies according to the 
circumstances. It may be based on sales, property, corporate payroll, 
or any other basis that reflects the distribution of the services 
performed by the employee, or a combination of the foregoing bases. To 
the extent practicable, the Commissioner may use the principles of 
Sec.  1.482-2(b) of this chapter in making the allocations with respect 
to wages paid after December 31, 1978, and on or before December 31, 
2006. To the extent practicable, the Commissioner may use the 
principles of Sec.  1.482-9T of this chapter in making the allocations 
with respect to wages paid after December 31, 2006.
    (d) Effective date--(1) In general. This section is applicable with 
respect to wages paid after December 31, 1978. [Sec.  31.3121(s)-1]. 
The fourth sentence of paragraph (c)(2)(iii) of this section is 
applicable with respect to wages paid after December 31, 1978, and on 
or before December 31, 2006. The fifth sentence of paragraph 
(c)(2)(iii) of this section is applicable with respect to wages paid 
after December 31, 2006.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the fifth sentence of paragraph (c)(2)(iii) of this 
section to earlier taxable years in accordance with the rules set forth 
in Sec.  1.482-9T(n)(2).
    (3) The applicability of Sec.  31.3121(s)-1T expires on or before 
July 31, 2009.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: July 11, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 06-6497 Filed 7-31-06; 4:40 pm]
BILLING CODE 4830-01-P