[Federal Register Volume 74, Number 2 (Monday, January 5, 2009)]
[Rules and Regulations]
[Pages 339-391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-30715]



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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301, and 602



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

Federal Register / Vol. 74, No. 2 / Monday, January 5, 2009 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9441]
RIN 1545-BI46


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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

DATES: Effective Date: These regulations are effective on January 5, 
2009.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.482-1T(j)(6)(i), 1.482-2T(f), 1.482-4T(h), 1.482-7T(l), 1.482-8T(c), 
1.482-9T(n)(3), and 1.301-7701-1(f).

FOR FURTHER INFORMATION CONTACT: Kenneth P. Christman, (202) 435-5265 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and pending receipt and 
valuation of public comments, approved by the Office of Management and 
Budget under control number 1545-1364.
    The collections of information in these temporary regulations are 
in Sec.  1.482-7T(b)(2) and (k). Responses to the collections of 
information are required by the IRS to monitor compliance of controlled 
taxpayers with the provisions applicable to cost sharing arrangements.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    A notice of proposed rulemaking and notice of public hearing 
regarding additional guidance to improve compliance with, and 
administration of, the rules in connection with a cost sharing 
arrangement (CSA) were published in the Federal Register (70 FR 51116) 
on (REG-144615-02) August 29, 2005 (the 2005 proposed regulations). A 
correction to the notice of proposed rulemaking and notice of public 
hearing was published in the Federal Register (70 FR 56611) on 
September 28, 2005. A public hearing was held on December 16, 2005.
    The Treasury Department and the IRS received substantial comments 
on a wide range of issues addressed in the 2005 proposed regulations. 
In response to these comments, these temporary regulations make several 
significant changes to the rules of the 2005 proposed regulations. The 
temporary regulations are generally applicable for CSAs commencing on 
or after January 5, 2009, with transition rules for certain preexisting 
arrangements. These regulations are being issued in temporary and 
proposed form so that taxpayers and the IRS may apply the new cost 
sharing rules while maintaining the opportunity for further input and 
refinements before the issuance of final rules.

Explanation of Provisions

A. Overview

    The temporary regulations generally provide guidance regarding the 
application of section 482 and the arm's length method to cost sharing 
arrangements. Several comments on the proposed regulations questioned 
whether and how the proposed regulations conform to the arm's length 
standard, as well as its corollary, the commensurate with income (CWI) 
requirement added by the Tax Reform Act of 1986. In response, the 
temporary regulations provide further guidance on the evaluation of the 
arm's length results of cost sharing transactions (CSTs) and platform 
contribution transactions (PCTs). The regulations address the material 
functional and risk allocations in the context of a CSA, including the 
reasonably anticipated duration of the commitments, the intended scope 
of the intangible development, the degree and uncertainty of profit 
potential of the intangibles to be developed, and the extent of 
platform and other contributions of resources, capabilities, and rights 
to the development and exploitation of cost shared intangibles (CSA 
Activity).
    Under the temporary regulations, if available data of uncontrolled 
transactions reflect, or may be reliably adjusted to reflect, similar 
facts and circumstances to a CSA, they may be the basis for application 
of a comparable uncontrolled transaction method to value the CST and 
PCT results. Because of the difficulty of finding data that reliably 
reflects such facts and circumstances (even after adjustments), the 
temporary regulations also provide for other methods. These include the 
newly specified income, acquisition price, market capitalization, and 
residual profit split methods. The temporary regulations also make 
related changes to other sections of the regulations, including Temp. 
Treas. Reg. Sec. Sec.  1.482-1T, 1.482-4T, 1.482-8T, and 1.482-9T, and 
Treas. Reg. Sec.  1.6662-6.

B. Flexibility and Scope of CSA Coverage

    Commentators criticized the 2005 proposed regulations for lack of 
flexibility concerning the types and provisions of arrangements 
eligible for CSA treatment. Some comments also addressed non-conforming 
intangible development arrangements that would not be treated as CSAs.
    In response to these comments, the temporary regulations provide 
taxpayers with greater flexibility in designing certain aspects of 
CSAs. The temporary regulations also address the treatment of non-
conforming intangible development arrangements.
1. Intangible Development Arrangements Other Than CSAs--Temp. Treas. 
Reg. Sec. Sec.  1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), 1.482-
7T(b)(5), and 1.482-9T(m)(3)
    The 2005 proposed regulations defined the contractual terms, risk 
allocations, and other material provisions of a CSA covered by the cost 
sharing rules. While other intangible development arrangements might be 
referred to colloquially as cost sharing arrangements, they were not to 
be treated as CSAs by the 2005 proposed regulations unless either a 
taxpayer

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substantially complied with the CSA administrative requirements and 
reasonably concluded that its arrangement was a CSA, or a taxpayer 
substantially complied with the CSA administrative requirements and the 
Commissioner determined to apply the CSA rules to the arrangement.
    Commentators suggested broadening the scope of intangible 
development arrangements that meet the CSA definition. Some 
commentators urged the regulations not to define CSA terms and 
conditions but to extend CSA treatment to any arrangement that 
uncontrolled parties might call a cost sharing arrangement, even though 
such arrangement may involve materially different risk allocations and 
provisions than addressed in the cost sharing rules. Still other 
commentators, while accepting that the regulations should define the 
scope of arrangements treated under the cost sharing rules, suggested 
that non-conforming arrangements would be subject only to the general 
principles of Treas. Reg. Sec.  1.482-1 and would not be governed by 
the sections of the regulations addressed to specific transactional 
types. Some commentators also expressed concern that the Commissioner 
might treat a non-conforming arrangement as a CSA even in a situation 
where that result was not warranted.
    Because the cost sharing rules are designed to provide guidance for 
specific types of transactions and arrangements, the Treasury 
Department and the IRS continue to believe that the new rules set forth 
for CSAs should apply only to the transactions intended. From the 
standpoint of the purpose of the cost sharing rules and their 
administrability, it is important that the rules be applicable only to 
the defined scope of intangible development arrangements and apply no 
more broadly or narrowly than intended. In recognition of taxpayer 
concerns, however, the temporary regulations seek to provide taxpayers 
with greater flexibility and scope in the types and provisions of 
arrangements that may qualify as CSAs.
    Under Treas. Reg. Sec.  1.482-1(b)(2)(ii) (Selection of category of 
method applicable to transaction), non-conforming arrangements are 
governed by methods provided in other sections of the regulations under 
section 482, as applied in accordance with Treas. Reg. Sec.  1.482-1. 
See also Treas. Reg. Sec. Sec.  1.482-2(d), 3(a), and 4(a), and Temp. 
Treas. Reg. Sec.  1.482-9T(a). Thus, intangible development 
arrangements, including partnerships, outside the scope of the cost 
sharing rules are governed by the transfer of intangible rules of 
Treas. Reg. Sec.  1.482-4(a), or the controlled services provisions of 
Temp. Treas. Reg. Sec.  1.482-9T, as appropriate. The temporary 
regulations make clarifying amendments to Temp. Treas. Reg. Sec. Sec.  
1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), and 1.482-9T(m)(3). These 
amendments confirm that Treas. Reg. Sec.  1.482-1 provides principles, 
not methods. For methods, reference must be made to the other sections 
of the regulations under section 482. While treatment of a CSA is 
governed by Temp. Treas. Reg. Sec.  1.482-7T, Temp. Treas. Reg. 
Sec. Sec.  1.482-4T(g) and 1.482-9T(m)(3), as appropriate, govern 
intangible development arrangements other than CSAs, including 
partnerships.
    Nevertheless, the methods and best method considerations under the 
cost sharing rules may be adapted for purposes of the evaluation of 
non-conforming intangible development arrangements. Importantly, the 
temporary regulations provide that the analysis under the intangible 
transfer or controlled services provisions, as applicable, should take 
into account the principles, methods, comparability, and reliability 
considerations set forth in Temp. Treas. Reg. Sec.  1.482-7T in 
determining the best method for purposes of those provisions, including 
an unspecified method, as those methods and considerations may be 
appropriately adjusted in light of the differences in the facts and 
circumstances between the non-conforming arrangement and a CSA.
    Finally, Temp. Treas. Reg. Sec.  1.482-7(b)(5) clarifies the 
circumstances under which the Commissioner may treat an arrangement as 
a CSA, notwithstanding a technical failure to meet the substantive 
requirements of a CSA. Namely, the Commissioner must conclude that the 
taxpayer substantially complied with the CSA administrative 
requirements and that application of the CSA rules to such non-
conforming arrangement will provide the most reliable measure of an 
arm's length result. For these purposes, the temporary regulations also 
clarify that applicable contractual provisions will be interpreted by 
reference to economic substance and the parties' actual conduct, and 
the Commissioner may disregard terms lacking economic substance and 
impute terms consistent with the economic substance.
2. Territorial and Other Divisional Interests--Temp. Treas. Reg. Sec.  
1.482-7T(b)(1)(iii) and (4)
    The 2005 proposed regulations required the controlled participants 
in a CSA to receive non-overlapping territorial interests that entitled 
each controlled participant to the perpetual and exclusive right to the 
profits in its territory attributable cost shared intangibles. 
Commentators suggested that requiring territorial divisions of 
interests was overly restrictive and did not align with common business 
models. They also questioned the need for the non-overlapping, 
perpetual, and exclusivity conditions.
    To provide taxpayers with more flexibility in designing qualifying 
divisional interests, the temporary regulations permit use of a new 
basis--the field of use division of interests--in addition to the 
territorial basis. Further, the regulations also authorize other non-
overlapping divisional interests provided that the basis used meets 
four criteria: (1) The basis must clearly and unambiguously divide all 
interests in cost shared intangibles among the controlled participants; 
(2) the consistent use of such basis can be dependably verified from 
the records maintained by the controlled participants; (3) the rights 
of the controlled participants to exploit cost shared intangibles are 
non-overlapping, exclusive, and perpetual; and (4) the resulting 
benefits associated with each controlled participant's interest in cost 
shared intangibles are predictable with reasonable reliability. The 
temporary regulations illustrate instances in which divisional 
interests tied to specific manufacturing facilities, as an example, 
would, and would not, qualify under these criteria. See Temp. Treas. 
Reg. Sec.  1.482-7T(b)(4)(v), Examples 2 and 3.
3. Platform and Other Contributions--Temp. Treas. Reg. Sec.  1.482-
7T(c) and (g)(2)(ii)
    The 2005 proposed regulations described external contributions for 
which compensation was due from other controlled participants, that is, 
preliminary or contemporaneous transactions. A preliminary or 
contemporaneous transaction corresponded to the buy-in pursuant to 
Sec.  1.482-7(g) of the 1995 final regulations. Under the 2005 proposed 
regulations, an external contribution generally consisted of the rights 
in the reference transaction (RT) in any resource or capability 
reasonably anticipated to contribute to developing cost shared 
intangibles. The RT consisted of a transaction, to be designated in the 
CSA documentation, affording the perpetual and exclusive rights in the 
subject resource or capability. While the RT was relevant to valuing 
the compensation obligation under a PCT, the controlled participants 
were not required to actually enter into the RT. Although the RT 
assumed

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perpetual and exclusive rights, proration was required to the extent 
that the subject resource or capability was reasonably anticipated to 
contribute both to the CSA Activity and other business activities. 
Evaluation of the preliminary or contemporaneous transaction 
compensation obligation for the subject rights could be in the 
aggregate with preliminary or contemporaneous transaction compensation 
obligation with respect to other external contributions, or in the 
aggregate with the compensation obligations with respect to other 
rights, where valuation on an aggregate basis would provide the most 
reliable measure of an arm's length result for the aggregated 
preliminary or contemporaneous transactions and other transactions.
    Commentators objected to the RT as overbroad. Commentators further 
contended that external contributions included elements such as 
workforce, goodwill or going concern value, or business opportunity, 
which in the commentators' view either do not constitute intangibles, 
or are not being transferred, and so, in the commentators' view, are 
not compensable.
    The temporary regulations replace the term ``external 
contribution'' with the term ``platform contribution'' and replace the 
term ``preliminary or contemporaneous transaction'' with the term 
``platform contribution transaction.'' The temporary regulations, like 
the 2005 proposed regulations, do not limit platform contributions that 
must be compensated in PCTs to the transfer of intangibles defined in 
section 936(h)(3)(B). For example, to the extent a controlled 
participant (the PCT Payee) contributes the services of its research 
team for purposes of developing cost shared intangibles pursuant to the 
CSA, the other controlled participant (the PCT Payor) would owe 
compensation for the services of such team under Temp. Treas. Reg. 
Sec.  1.482-9T, just as would be the case in a contract research 
arrangement. Where there is a combined contribution of research 
services, intangibles in process, or other resources, capabilities, or 
rights, the temporary regulations provide for an aggregate valuation 
where that would provide the most reliable measure of an arm's length 
result for the aggregated PCTs and other transactions. The treatment 
available under the cost sharing rules of the contribution of the 
services of a research team as controlled services is without any 
inference concerning the potential status of workforce in place as an 
intangible within the meaning of section 936(h)(3)(B).
    On the other hand, the temporary regulations only require the PCT 
Payor to compensate the PCT Payee for platform contributions, or cross 
operating contributions, reasonably anticipated to contribute to the 
CSA Activity in the PCT Payor's division as defined in Temp. Treas. 
Reg. Sec.  1.482-7T(j)(1)(i). A PCT Payor is not obligated to 
compensate the PCT Payee for any of the PCT Payee's resources, 
capabilities, or rights that are reasonably anticipated to benefit only 
the PCT Payee's operations. Similarly, under the temporary regulations, 
the PCT Payee is also not entitled to compensation from the PCT Payor 
on account of any of the PCT Payor's own resources, capabilities, or 
rights, including any goodwill or going concern value of the PCT Payor. 
For example, where operations of parties involve undertaking functions 
and risks of scope and duration comparable to those of the PCT Payor, 
an application of the income method based on the comparable profits 
method would retain for the PCT Payor the returns reasonably 
anticipated to its own contributions to operations in its division, 
including any goodwill or going concern value associated with those 
operations, based on the returns to the comparable parties used in the 
CPM analysis. Similarly, the PCT Payor retains the ability to pursue 
its own business opportunities in its division, including through 
operating cost contributions to maintain or develop resources, 
capabilities, or rights to promote its operations.
    In response to comments that the concept of the RT was unnecessary 
and confusing, the temporary regulations do not use that concept. 
Instead, the temporary regulations adopt a presumption that a PCT Payee 
provides any resource, capability, or right to the intangible 
development activity (IDA) pursuant to the CSA on an exclusive basis. A 
taxpayer can rebut the presumption by showing to the satisfaction of 
the Commissioner that the subject resource, capability, or right is 
reasonably anticipated to contribute not just to the CSA, but to other 
business activities as well. For example, if the platform resource is a 
research tool, then the taxpayer could rebut the presumption of 
exclusivity by establishing to the satisfaction of the Commissioner 
that the tool is reasonably anticipated not only to be applied in the 
IDA, but also to be licensed to an uncontrolled taxpayer. The temporary 
regulations provide guidance on proration of PCT payments in cases 
where the taxpayer rebuts the presumption.
4. Intangible Development Activity and Costs--Temp. Treas. Reg. Sec.  
1.482-7T(d)
    Some commentators suggested that taxpayers can limit the 
application of the cost sharing rules by defining the IDA with 
reference only to specifically listed platform contributions. Without 
any inference intended as to the economic substance of such an 
approach, the temporary regulations are clarified to exclude this 
possibility. The scope of the IDA includes all activities that could 
reasonably be anticipated to contribute to developing the reasonably 
anticipated cost shared intangibles. The IDA cannot be described merely 
by a list of particular resources, capabilities, or rights that will be 
used in the CSA, since the IDA is a function of what are the reasonably 
anticipated cost shared intangibles and such a list might not identify 
reasonably anticipated cost shared intangibles. Also, the scope of the 
IDA may change as the nature or identity of the reasonably anticipated 
cost shared intangibles or the nature of the activities necessary for 
their development become clearer. For example, the relevance of certain 
ongoing work to developing reasonably anticipated cost shared 
intangibles or the need for additional work may only become clear over 
time.
    The Treasury Department and the IRS requested in Notice 2005-99, 
2005-52 CB 1214 comments regarding the valuation of stock options and 
other stock-based compensation. The Treasury Department and the IRS 
received comments and continue to consider the technical changes and 
issues described in Notice 2005-99 and intend to address those in a 
subsequent regulations project. See Treas. Reg. Sec.  
601.601(d)(2)(ii)(b).
5. Changes in Participation--Temp. Treas. Reg. Sec.  1.482-7T(f)
    The increased flexibility to adopt a divisional basis other than a 
territorial or field of use basis entails the need for provisions to 
prevent abuse and facilitate compliance. Capability fluctuations, 
whether market-driven or strategic, that materially alter the 
controlled participants' RAB shares as compared with their respective 
divisional interests create the equivalent of a controlled transfer of 
interests and should therefore equally occasion arm's length 
compensation. Accordingly, the temporary regulations modify the change 
of participation provision to classify such a material capability 
variation, in addition to a controlled transfer of interest, as a 
change in

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

C. Income and Other Specified and Unspecified Methods

1. Best Method Analysis Considerations--Temp. Treas. Reg. Sec.  1.482-
7T(g)(2)
    The 2005 proposed regulations articulated ``general principles''--
such as the realistic alternatives principle--applicable to any method 
to determine the arm's length charge in a PCT. Commentators expressed 
uncertainty about the role intended for these principles. For example, 
they wondered if these principles themselves dictated, or trumped, 
methods or applications of methods.
    The temporary regulations clarify that these principles were 
intended to provide supplementary guidance on the application of the 
best method rule to determine which method, or application of a method, 
provides the most reliable measure of an arm's length result in the CSA 
context. In other words, the principles provide best method 
considerations to aid the competitive evaluation of methods or 
applications, and are not themselves methods or trumping rules.
    a. Consistency with upfront terms and risk allocation--the investor 
model--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(ii).
    The investor model is a core principle of the 2005 proposed 
regulations. A PCT Payor, through cost sharing and payments made 
pursuant to the PCT (PCT Payments), is investing for the term of the 
CSA Activity and expects returns over time consistent with the 
riskiness of that investment.
    The upfront evaluation pursuant to the investor model of expected 
returns to particular risks assumed in intangible development and 
exploitation under the facts and circumstances is key to ensuring 
consistency of the results of a CSA with the arm's length standard. 
Commentators have criticized the investor model for stripping away 
risky returns from the PCT Payor. The temporary regulations provide 
additional guidance to explain that when the PCT Payor assumes risks, 
it accordingly enjoys the returns (or suffers the detriments) that may 
result from such risks.
    For example, in addition to its cost contributions to developing 
cost shared intangibles, a PCT Payor may also commit significant 
operating contributions, such as existing marketing or manufacturing 
process intangibles, to operations in its division as well as make 
significant operating cost contributions towards further developing 
such intangibles. To the extent parties to comparable transactions 
undertake similar risks of similar scope and duration, the PCT Payor 
will be appropriately awarded based on a method that relies in whole or 
part on the returns in such comparable transactions (including 
applications of the income method based on a CUT or the CPM). To the 
extent its operating contributions are nonroutine, that is, not 
reflected in available comparable transactions, then the PCT Payor may 
share in nonroutine divisional profit under the application of the 
residual profit split method (RPSM) provided in the temporary 
regulations.
    Moreover, the temporary regulations provide guidance on discount 
rates and arm's length ranges, so as to further clarify the ability of 
the PCT Payor to achieve results commensurate with its assumption of 
risks.
    b. Aggregation of transactions--Temp. Treas. Reg. Sec.  1.482-7T 
(g)(2)(iv).
    The temporary regulations make conforming changes to the guidance 
included in the 2005 proposed regulations on aggregate evaluation of 
multiple transactions. Thus, if the combined effect of transactions in 
connection with a CSA involving platform, operating, and other 
contributions of resources, capabilities, or rights are reasonably 
anticipated to be interrelated, then determination of the arm's length 
charge for PCTs and other transactions on an aggregate basis may 
provide the most reliable measure of an arm's length result.
    c. Discount rates--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(v).
    The 2005 proposed regulations provided general guidance that, where 
a present value is needed for a purpose in a cost sharing analysis, a 
discount rate should be used that most reliably reflects the risk of 
the particular set of activities or transactions based on all the 
information potentially available at the time for which the present 
value calculation is to be performed. Further, depending on the 
particular facts and circumstances, the discount rate may differ among 
a company's various activities and transactions. As examples, the 
proposed regulations indicated that a weighted average cost of capital 
(WACC) of the taxpayer, or an uncontrolled taxpayer, could provide the 
most reliable basis for a discount rate if the CSA Activity involves 
the same risk as projects undertaken by the taxpayer, or uncontrolled 
taxpayer, as a whole. As another example, in certain appropriate 
conditions, a company's internal hurdle rate for projects of comparable 
risk might provide a reliable basis for a discount rate in a cost 
sharing analysis.
    Commentators offered several criticisms of the discount rate 
guidance. Some comments concluded that the 2005 proposed regulations 
placed an inappropriate emphasis on a taxpayer's WACC as a basis for 
analysis. Other comments suggested a clarification be made that more 
than a single discount rate may be appropriate in a cost sharing 
analysis. Yet other comments addressed whether a discount rate in a 
cost sharing analysis should be before, or after, tax. Some 
commentators asserted that cash flows, rather than items entering into 
income, analytically are the more appropriate amounts to be discounted.
    The temporary regulations revise and elaborate upon the best method 
analysis considerations in regard to discount rates. Guidance is 
provided recognizing that the appropriate discount rate may, depending 
on the facts and circumstances, vary between realistic alternatives and 
forms of payment. As regards discount rate variation between realistic 
alternatives, for example, licensing intangibles needed for its 
operations would ordinarily be less risky for a licensee, and so 
require a lower discount rate, than entering into a CSA which would 
involve the licensee assuming the additional risk of funding its cost 
contributions to the IDA. As regards discount rate variation between 
forms of payment, for example, ordinarily a royalty computed on a 
profits base would be more volatile, and so require a higher discount 
rate to discount projected payments to present value, than a royalty 
computed on a sales base.
    The temporary regulations recognize that, in general, discount 
rates inferred from the operations of the capital markets are post-tax 
rates. An analysis applying post-tax discount rates would be expected 
to treat taxes like any other expense. However, the equivalent result 
may in certain circumstances be achieved by applying a post-tax 
discount rate to pre-tax net income multiplied by the difference of one 
minus the tax rate. If such an approach is adopted in applying the 
income method, to the extent that the controlled participants' 
respective tax rates are not materially affected by whether they enter 
into the cost sharing or licensing alternative (or if reliable 
adjustments may be made for varying tax rates), the mulitiplier (that 
is, one minus the tax rate) may be cancelled from both sides of the 
equation of the cost sharing and

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licensing alternative present values. Accordingly, in such circumstance 
it is sufficient to apply post-tax discount rates to pre-tax items for 
the purpose of equating the cost sharing and licensing alternatives. 
See also the discussion of the income method in this preamble.
    The specific reference to a WACC or to hurdle rates are eliminated 
as unnecessary, but without any inference as to a WACC or a hurdle rate 
being an appropriate discount rate, or an appropriate starting point in 
ascertaining a discount rate, depending on the particular facts.
    Certain methods in the temporary regulations (such as the income 
method under Temp. Treas Reg. Sec.  1.482-7T(g)(4)) are theoretically 
based on valuation techniques that use ``cash flow'' projections rather 
than income projections. While use of cash flow projections is 
permitted under these methods, for a number of practical and 
administrative reasons, detailed guidance on the specific applications 
of the methods are based on income, rather than cash flow, measures. 
The Treasury Department and the IRS considered whether to provide 
guidance on the use of cash flows, rather than income, as the 
appropriate amounts to be discounted in a cost sharing analysis. The 
Treasury Department and the IRS continue to consider, and solicit 
comments, on whether and how the cost sharing rules could reliably be 
administered on the basis of cash flows instead of operating income, 
and whether such a basis is consistent with the second sentence of 
section 482 and its CWI requirement.
    d. Projections--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(vi).
    The temporary regulations note that the reliability of an estimate 
will often depend upon the reliability of the projections used in 
making the estimate. Projections should reflect the best estimates of 
the items projected (for example, reflecting a probability weighted 
average of possible outcomes).
    e. Arm's length range--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(ix).
    The 2005 proposed regulations provided supplemental guidance on 
applying arm's length methods in the cost sharing context in accordance 
with the provisions of Treas. Reg. Sec.  1.482-1 including, inter alia, 
the arm's length range of Treas. Reg. Sec.  1.482-1(e). The proposed 
regulations did not, however, provide guidance on how to adapt an arm's 
length range for cost sharing.
    The temporary regulations adapt the guidance in Treas. Reg. Sec.  
1.482-1(e) for use with some of the methods for computing PCT Payments 
that are specified in the temporary regulation. The provisions 
elaborate, where the entire range of results cannot be regarded as of 
sufficient comparability and reliability, how to derive a statistically 
enhanced range of arm's length charges for a PCT.
    The guidance in Treas. Reg. Sec.  1.482-1(e) regarding arm's length 
ranges is most easily understood in the context of a method (for 
example, comparable uncontrolled price, cost plus, resale price, 
comparable uncontrolled transaction, comparable profits), in which the 
result of each comparable transaction directly provides an estimate for 
the result of the controlled transaction. Some of the methods specified 
in the temporary regulations (for example, the income method) have a 
different structure, in which an arm's length result is estimated by 
performing mathematical calculations that depend on two or more input 
parameters (for example, a relevant discount rate, certain financial 
projections, a return for routine activities) that must be determined. 
The additional guidance in this section addresses the arm's length 
range in the context of such methods.
    The temporary regulations distinguish certain input parameters 
(variable input parameters) that, for purposes of determining an arm's 
length range, may be assigned more than one possible value. Such input 
parameters are limited to those whose value is most reliably determined 
by considering two or more observations of market data (for example, 
profit levels or stock betas of two or more companies) that have, or 
with adjustment can be brought to, a similar reliability and 
comparability, as described in Treas. Reg. Sec.  1.482-1(e)(2)(ii). If 
there are two or more variable input parameters, the narrowing effect 
of the interquartile range is used twice: First, to narrow the 
variation of each input parameter, and again to narrow the resulting 
set of PCT Payment values. This double narrowing reflects that the use 
of two or more variable input parameters normally introduces additional 
unreliability into a method, even though that method may be the best 
method.
    Generally, Treas. Reg. Sec.  1.482-1(e)(3) governs the 
Commissioner's ability to make an adjustment to a PCT Payment due to 
the taxpayer's results being outside the arm's length range. Consistent 
with the principles expressed there, adjustment under the temporary 
regulations will normally be to the median, as defined in Treas. Reg. 
Sec.  1.482-1(e)(3). Also, the Commissioner is not required to 
establish an arm's length range prior to making an allocation under 
section 482.
    The Treasury Department and the IRS solicit comments on the design 
and mechanics of the supplemental guidance on determination of an arm's 
length range in paragraph (g)(2)(ix) of the temporary regulations, 
including the limitation of variable input parameters to market-based 
input parameters. Any alternative proposal should specify the design 
and mechanics in detail, and should discuss whether such an approach 
enhances the reliability of the analysis, is administrable, and is not 
so manipulable as to yield unrealistic ranges.
2. Comparable Uncontrolled Transaction Method--Temp. Treas. Reg. Sec.  
1.482-7T(g)(3)
    The 2005 proposed regulations provided for possible use of the 
comparable uncontrolled transaction (CUT) method to determine the arm's 
length charge in a PCT where appropriate in accordance with the 
standards of the intangibles transfer and controlled services 
provisions of the regulations under section 482. Some commentators 
asserted that any arrangement that uncontrolled parties might call a 
cost sharing arrangement could serve as a CUT, even though such 
arrangement may involve materially different risk allocations and 
provisions than addressed in the cost sharing rules.
    In response to these comments, the temporary regulations describe 
the relevant considerations for purposes of evaluating whether a 
putative CUT may, or may not, reflect the most reliable measure of an 
arm's length result. Although all of the factors entering into a best 
method analysis described in Treas. Reg. Sec. Sec.  1.482-1(c) and (d) 
must be considered, comparability and reliability under the CUT method 
in the CSA context are particularly dependent on similarity of 
contractual terms, degree to which allocation of risks is proportional 
to reasonably anticipated benefits from exploiting the results of 
intangible development, similar period of commitment as to the sharing 
of intangible development risks, and similar scope, uncertainty, and 
profit potential of the subject intangible development, including a 
similar allocation of the risks of any existing resources, 
capabilities, or rights, as well as of the risks of developing other 
resources, capabilities, or rights that would be reasonably anticipated 
to contribute to exploitation within the parties' divisions, that is 
consistent with the actual allocation of risks between the controlled 
participants as provided in the CSA in accordance with the cost sharing 
rules.

[[Page 345]]

3. Income Method--Temp. Treas. Reg. Sec.  1.482-7T(g)(4)
    The 2005 proposed regulations made the income method a specified 
method for purposes of evaluating the arm's length charge in a PCT. 
Under the general rule, the arm's length charge was an amount that 
equated a controlled participant's present value of entering into a CSA 
with the present value of the controlled participant 's best realistic 
alternative. Also provided were two applications of the income method. 
One, based on a CUT analysis, assumed that a PCT Payee's best realistic 
alternative would be to develop the cost shared intangibles on its own, 
bearing all the intangible development costs (IDCs) itself, and then 
license the cost shared intangibles. A second, based on a comparable 
profits method (CPM) analysis, assumed that the PCT Payor's best 
realistic alternative would be to acquire the rights to external 
contributions (renamed platform contributions under the temporary 
regulations) for payments with a present value equal to the PCT Payor's 
anticipated profit, after reward for its routine contributions to its 
operations, from the CSA Activity in its territory (the only division 
permitted under the 2005 proposed regulations). Both income method 
applications provided for a cost contribution adjustment in order to 
allocate to the PCT Payor the return to its additional risk, as 
compared to its realistic alternative, of bearing its reasonably 
anticipated benefits (RAB) share of the IDCs. As set forth in the 2005 
proposed regulations, both the CUT and CPM based applications of the 
income method built in a conversion to a royalty form of payment, 
either on sales or on operating profit.
    Commentators offered several criticisms with reference to the 
income method. As a general matter, some comments asserted that the 
income method stripped away risky returns from the PCT Payor. Other 
comments focused on technical aspects of the method and the 
applications. In particular, comments pointed to the potential risk 
differentials between cost sharing and the alternative arrangements. 
For example, cost sharing would generally be more risky than licensing 
for the PCT Payor as the result of its sharing with the PCT Payee the 
risks of the IDA. As a corollary, cost sharing would generally be less 
risky for the PCT Payee than licensing. The comments observed that 
these risk differentials would ordinarily be reflected in different 
discount rates being appropriate under the cost sharing and licensing 
alternatives. Other comments suggested the possible use of different 
discounts for different financial flows (sales, cost of sales, 
operating expenses, cost contributions, etc.).
    The temporary regulations provide further guidance on the income 
method and its applications. In general, they provide that the best 
realistic alternative of the PCT Payor to entering into the CSA would 
be to license intangibles to be developed by an uncontrolled licensor 
that undertakes the commitment to bear the entire risk of intangible 
development that would otherwise have been shared under the CSA. 
Similarly, the best realistic alternative of the PCT Payee to entering 
into the CSA would be to undertake the commitment to bear the entire 
risk of intangible development that would otherwise have been shared 
under the CSA and license the resulting intangibles to an uncontrolled 
licensee.
    The licensing alternative is derived on the basis of a functional 
and risk analysis of the cost sharing alternative, but with a shift of 
the risk of cost contributions to the licensor. Accordingly, the PCT 
Payor's licensing alternative consists of entering into a license with 
an uncontrolled party, for a term extending for what would be the 
duration of the CSA Activity, to license the make-or-sell rights in 
subsequently to be developed resources, capabilities, or rights of the 
licensor. Under such license, the licensor would undertake the 
commitment to bear the entire risk of intangible development that would 
otherwise have been shared under the CSA. Apart from the difference in 
the allocation of the risks of the IDA, the licensing alternative 
should assume contractual provisions with regard to non-overlapping 
divisional intangible interests, and with regard to allocations of 
other risks, that are consistent with the actual CSA in accordance with 
the cost sharing rules. For example, the analysis under the licensing 
alternative should assume a similar allocation of the risks of any 
existing resources, capabilities, or rights, as well as of the risks of 
developing other resources, capabilities, or rights that would be 
reasonably anticipated to contribute to exploitation within the 
parties' divisions, that is consistent with the actual allocation of 
risks between the controlled participants as provided in the CSA in 
accordance with the temporary regulations.
    The temporary regulations, like the 2005 proposed regulations, 
describe both CUT-based applications and CPM-based applications of the 
Income Method. However, they differ from the applications described in 
the 2005 proposed regulations by equating the cost sharing and 
licensing alternatives of the PCT Payor using discount rates 
appropriate to those alternatives. In circumstances where the market-
correlated risks as between the cost sharing and licensing alternatives 
are not materially different, a reliable analysis may be possible by 
using the same discount rate with respect to both alternatives. 
Otherwise, as recognized in the best method considerations concerning 
discount rates, realistic alternatives having the same reasonably 
anticipated present value may nevertheless involve varying risk 
exposure and, thus, generally are more reliably evaluated using 
different discount rates. To the extent that the controlled 
participants' respective tax rates are not materially affected by 
whether they enter into the cost sharing or licensing alternative (or 
reliable adjustments may be made for varying tax rates), it is 
appropriate to apply post-tax discount rates to pre-tax items for 
purpose of equating the cost sharing and licensing alternatives. The 
discount rate for the cost sharing alternative will generally depend on 
the form of PCT Payments assumed (for example, lump sum, royalty on 
sales, royalty on divisional profit).
    The income method may be applied to determine PCT Payments in any 
form of payment (for example, lump sum, royalty on sales, royalty on 
divisional profit). If an income method application is used to 
determine arm's length PCT Payments in a particular form, then the PCT 
Payments in that form may be converted to an alternative form in 
accordance with Temp. Treas. Reg. Sec.  1.482-7(h) (Form of payment 
rules).
    The temporary regulations clarify the opportunities, depending on 
the facts and circumstances, for the PCT Payor to assume risks and, 
accordingly, to enjoy the returns (or suffer the detriments) that may 
result from such risks. For example, in addition to its cost 
contributions to developing cost shared intangibles, a PCT Payor may 
also commit significant operating contributions, such as existing 
marketing or manufacturing process intangibles, to operations in its 
division as well as make significant operating cost contributions 
towards further developing such intangibles. To the extent parties to 
comparable transactions undertake risks of similar scope and duration, 
the PCT Payor will be appropriately rewarded based on a method that 
relies in whole or part on returns in such comparable transactions 
under an application of the income method whether based on a CUT or the

[[Page 346]]

CPM. Where its operating contributions are nonroutine, that is, not 
reflected in available comparable transactions, the PCT Payor may share 
in nonroutine divisional profit under the application of the RPSM 
provided in the temporary regulations. Similarly, while the income 
method is limited to cases in which only one of the controlled 
participants provides nonroutine platform contributions as the PCT 
Payee, the RPSM in the temporary regulations addresses the situation 
where more than one controlled participant furnishes nonroutine 
platform contributions.
    Yet other comments criticized the income method as positing an 
unrealistic ``perpetual life.'' The income method is premised on the 
assumption that, at arm's length, an investor will make a risky 
investment (for example, in a platform for developing additional 
technology) only if the investor reasonably anticipates that the 
present value of its reasonably anticipated operational results will be 
increased at least by a present value equal to the platform investment. 
It may be, depending on the facts and circumstances, that the 
technology is reasonably expected to achieve an incremental improvement 
in results for only a finite period (after which period, results are 
reasonably anticipated to return to the levels that would otherwise 
have been expected absent the investment). The period of enhanced 
results that justifies the platform investment in such circumstances 
effectively would correspond to a finite, not a perpetual, life.
4. Acquisition Price and Market Capitalization Methods--Temp. Treas. 
Reg. Sec.  1.482-7T(g)(5) and (6)
    The 2005 proposed regulations included guidance on the acquisition 
price and market capitalization methods for evaluating the arm's length 
charge in a PCT. Under the acquisition price method, the arm's length 
charge for a PCT is the adjusted acquisition price, that is, the 
acquisition price increased by the value of the target's liabilities on 
the date of acquisition, and decreased by the value on that date of 
target's tangible property and any other resources and capabilities not 
covered by the PCT. Under the market capitalization method, the arm's 
length charge for a PCT is the adjusted average market capitalization, 
that is, the average daily market capitalization over the 60 days 
ending with the date of the PCT, increased by the value of the PCT 
Payee's liabilities on such date, and decreased on account of tangible 
property and any other resources and capabilities of the PCT Payee not 
covered by the PCT.
    Commentators questioned the reliability of these methods in light 
of volatility of stock prices and lack of correlation between stock 
price and underlying assets, for example, owing to control premiums or 
economies of integration.
    The Treasury Department and the IRS recognize that these comments 
point to considerations that, depending on the facts and circumstances, 
will need to be taken into account in a best method analysis that 
compares the reliability of the results under application of these 
methods as against the results under application of other methods 
(which may themselves have aspects that reduce their reliability). The 
temporary regulations retain the best method considerations from the 
2005 proposed regulations that observe that reliability is reduced 
under these methods if a substantial portion of the target's, or PCT 
Payor's, nonroutine contributions to business activities is not 
required to be covered by a PCT and, in the case of the market 
capitalization method, if the facts and circumstances demonstrate the 
likelihood of a material divergence between the PCT Payee's average 
market capitalization and the value of its underlying resources, 
capabilities, and rights for which reliable adjustments cannot be made. 
The temporary regulations also provide that proximity in time between 
the acquisition of the target and the PCT Payment is an important 
comparability factor under the acquisition price method.
5. Residual Profit Split Method--Temp. Treas. Reg. Sec.  1.482-7T(g)(7)
    The temporary regulations conform the modified RPSM from the 
proposed regulations to the changes made to the income method.
6. Unspecified Methods--Temp. Treas. Reg. Sec.  1.482-7T(g)(8)
    Under the temporary regulations in order to use an unspecified 
method, a taxpayer must maintain documentation to describe and explain 
the method selected to determine the arm's length payment due in a PCT.

D. Form of Payment

1. Post Formation Acquisitions
    The 2005 proposed regulations generally provided taxpayers 
flexibility to provide for PCT Payments either in fixed amounts 
(whether in lump sums or installment payments with arm's length 
interest) or in contingent amounts. PCT Payments could not be paid in 
shares of stock of the PCT Payor. The form of payment selected for any 
PCT, including the basis and structure of the payments, had to be 
specified no later than the date of the PCT. In the case of a post 
formation acquisition (PFA)--that is, an external contribution (renamed 
platform contribution in the temporary regulations) that is acquired by 
a controlled participant in an uncontrolled transaction (either 
directly, or indirectly through the acquisition of an interest in an 
entity or tier of entities)--the consideration under the PCT for a PFA 
had to be paid in the same form as the consideration in the 
uncontrolled transaction in which the PFA was acquired. An example 
indicates that acquisitions for stock were considered to be for a fixed 
form of payment. One principal rationale for the special rules for PFAs 
was that PFAs stand in the place of IDCs and, therefore, reflect a risk 
allocation equivalent to that in the IDC context, which requires the 
sharing of outlays on a fixed form of payment basis. Another principal 
rationale was the difficulty the IRS has had in examining CSAs using a 
contingent form of payment for PFAs.
    Commentators criticized the same form of payment requirement for 
PFAs, especially the treatment of stock acquisitions as having a fixed 
form of payment. The comments pointed out that a purchaser paying with 
its own stock is selling a part of its business, and thus pays 
consideration that is ultimately contingent on the success of its 
business. Other comments objected to the timing mismatch caused by the 
same form of payment rule, because fixed PCT Payments would be 
immediately includable, but the PFA assets would be amortizable only 
over time. Still other comments asserted that taxpayers may choose 
their form of payment for PFAs, as with other external contributions, 
so long as the price (taking into account the form of payment) is arm's 
length.
    The temporary regulations do not retain the special rules for PFAs. 
Subsequent acquisitions remain an important source of platform 
contributions that occasion the requirement of PCT compensation. 
However, the temporary regulations no longer require a special form of 
payment for such compensation. Therefore, controlled participants may 
choose the form of payment for PCTs regardless of whether the PCTs 
occur at the outset of the CSA or later. Removal of the special rules 
for PFAs moots questions regarding whether stock consideration should 
be treated as contingent or fixed payment and whether (and how) the 
timing mismatch should be addressed. Nonetheless, the IRS will continue 
to

[[Page 347]]

scrutinize the contractual documentation, pricing, and implementation 
of contingent forms of payment for PFAs.
2. Contingent Payments--Temp. Treas. Reg. Sec.  1.482-7T(h)(2)(iv) and 
(v)
    The temporary regulations incorporate rules to ensure that the 
contingent form for PCT Payments is applied properly by both taxpayers 
and the IRS. In accordance with Treas. Reg. Sec.  1.482-
1(d)(3)(iii)(B), a CSA contractual provision that provides for payments 
for a PCT (or group of PCTs) to be contingent on the exploitation of 
cost shared intangibles will be respected as consistent with economic 
substance only if the allocation between the controlled participants of 
the risks attendant on such form of payment is determinable before the 
outcomes of such allocation that would have materially affected the PCT 
pricing are known or reasonably knowable. The temporary regulations 
require a contingent payment provision to clearly and unambiguously 
specify the basis on which the contingent payment obligations are to be 
determined. In particular, the contingent payment provision must 
clearly and unambiguously specify the events that give rise to an 
obligation to make PCT Payments, the royalty base (such as sales or 
revenues), and the computation used to determine the PCT Payments. The 
royalty base specified must permit verification of its proper use by 
reference to books and records maintained by the controlled 
participants in the normal course of business (for example, books and 
records maintained for financial accounting or business management 
purposes).
    The temporary regulations also provide that where a method yields a 
fixed value for PCT Payments, a conversion may be made to a contingent 
form of payments. Guidance is also provided on discount rates for 
purposes of such conversion. Certain forms of payment may involve 
different risks than others. For example, ordinarily a royalty computed 
on a profits base would be more volatile, and so require a higher 
discount rate to discount projected payments to present value, than a 
royalty computed on a sales base.

E. Periodic Adjustments

1. Determination of Periodic Adjustments--Temp. Treas. Reg. Sec.  
1.482-7T(i)(6)(v) and (vi)
    The 2005 proposed regulations addressed the CWI principle of the 
second sentence of section 482 in the context of cost sharing. The 
Commissioner could make periodic adjustments for an open taxable year 
(the Adjustment Year) and all subsequent years of the CSA Activity in 
the event of a Periodic Trigger. Under the 2005 proposed regulations, a 
Periodic Trigger arose if the PCT Payor realized, over the period 
beginning with the earliest date on which an IDC occurred through the 
end of the Adjustment Year, an actually experienced return ratio of the 
present value of its total territorial operating profits divided by the 
present value of its investment consisting of the sum of its cost 
contributions plus PCT Payments, outside the periodic return ratio 
range of between .5 and 2. In arriving at these present values, the 
Commissioner would use an applicable discount rate, which in the case 
of certain publicly traded entities would be their weighted average 
cost of capital, unless the Commissioner determines, or the controlled 
participants establish, that another discount rate better reflects the 
degree of risk of the CSA Activity. Periodic adjustments would be 
determined under a modified RPSM. Exceptions were provided, such as for 
an effective CUT or for results due to extraordinary events beyond the 
controlled participants' control and that could not have been 
reasonably anticipated. In determining whether to make any periodic 
adjustments, the Commissioner would consider whether the outcome as 
adjusted more reliably reflects an arm's length result under all the 
relevant facts and circumstances.
    Commentators offered several criticisms of the periodic adjustment 
rules. Some comments considered the periodic adjustment rules to be 
inconsistent with the arm's length standard and, through hindsight, to 
strip away returns to risk. Other comments claimed for taxpayers the 
same ability as the Commissioner to make periodic adjustments to 
implement the CWI principle where subsequent results diverge from 
original expectations. Comments also addressed the exceptions and means 
for taxpayers to demonstrate their results were arm's length so as to 
avoid periodic adjustments.
    The Treasury Department and the IRS reaffirm that the CWI principle 
is consistent, and periodic adjustments are to be administered 
consistently, with the arm's length standard. Congress adopted the CWI 
principle in 1986 out of concern about related-party long-term 
transfers of high-profit potential intangibles for relatively 
insignificant lump sum or royalty consideration justified by reference 
to putatively comparable transactions between unrelated parties that 
differed significantly in terms of the division of functionality and 
risks when compared to the transfers at issue. See H.R. Rep. 99-426, at 
424-25 (1985). See also Notice 88-123 (the White Paper), 1988-2 CB 458, 
472-74, 477-80. Congress intended that taxpayers be able to ``use 
certain bona fide cost-sharing arrangements as an appropriate method of 
allocating income attributable to intangibles among related parties, if 
and to the extent such agreements are consistent with the purposes of 
this provision that the income allocated among the parties reasonably 
reflect the actual economic activity undertaken by each.'' H.R. Conf. 
Rep. No. 99-841, at II-638 (1986). See Treas. Reg. Sec.  
601.601(d)(2)(ii)(b).
    Accordingly, the temporary regulations continue to provide for 
periodic adjustments along lines similar to those in the intangible 
transfer section of the regulations, as adapted for the cost sharing 
context. Compare Treas. Reg. Sec.  1.482-4(f)(2)(Periodic adjustments). 
The temporary regulations, however, adopt a smaller periodic return 
ratio range than the 2005 proposed regulations. Setting a Periodic 
Trigger to occur if the actually experienced return ratio falls outside 
the periodic return ratio range of between .667 and 1.5 (or between 0.8 
and 1.25, if the taxpayer has not substantially complied with the 
documentation requirements of Temp. Treas. Reg. Sec.  1.482-7T(k)) is 
intended to isolate situations in which actual results suggest the 
potential of an absence of arm's length pricing as of the date of the 
PCT. The Treasury Department and the IRS consider that the periodic 
return ratio range under the temporary regulations more realistically 
targets the threshold at which periodic adjustment scrutiny is 
appropriate. In determining whether to make any periodic adjustments, 
the Commissioner considers whether the outcome as adjusted more 
reliably reflects an arm's length result under all the relevant facts 
and circumstances.
    The temporary regulations also make conforming changes to the 
determination of periodic adjustments, in the event of a Periodic 
Trigger, in light of other changes in the temporary regulations, for 
example, in the RPSM and form of payment provisions.
2. Advance Pricing Agreement
    In addition, the Treasury Department and the IRS intend to issue by 
revenue procedure separate published guidance that provides an 
exception to periodic adjustments, similar to exceptions

[[Page 348]]

provided in Temp. Treas. Reg. Sec.  1.482-7T(i)(6)(vi), in the context 
of an advance pricing agreement (APA) entered into pursuant to Rev. 
Proc. 2006-9, 2006-1 CB 278 (as it may be amended or superseded by 
subsequent administrative pronouncement). The guidance would provide 
that no periodic adjustments will be made in any year based on a 
Trigger PCT that is a covered transaction under the APA. See Treas. 
Reg. Sec.  601.601(d)(2)(ii)(b).
    An APA process generally is contemporaneous with a taxpayer's 
original transactions and involves transparency concerning a taxpayer's 
upfront efforts to conform to the arm's length standard. Thus, the APA 
process may overcome the asymmetry in information addressed by the 
periodic adjustment provisions, eliminating a primary basis for a CWI 
adjustment. See generally 70 FR 51128-51130 (preamble to 2005 proposed 
regulations).
    The Treasury Department and the IRS considered the possibility of a 
further exception to periodic adjustments based on documentation that a 
taxpayer would maintain contemporaneously with a PCT. Compare Treas. 
Reg. Sec.  1.6662-6(d)(2)(iii). Such an exception was not incorporated 
into the temporary regulations in light of the concern that 
documentation prepared only by the taxpayer would not benefit from a 
similar degree of contemporaneous transparency and explanation as 
involved in an APA. The Treasury Department and the IRS continue to 
consider this matter and solicit comments on whether and how a 
documentation exception could be adapted to the purposes of the CWI 
principle.

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

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

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

    The 2005 proposed regulations included transition rules for 
existing qualified cost sharing arrangements so as not to disturb 
taxpayers' reliance on the prior regulations, while providing for 
appropriate prospective application of the new regulations. Grandfather 
treatment would have been terminated in certain events, including the 
occasion of a Periodic Trigger as the result of a subsequent PCT 
occurring after the regulations' effective date, a material change in 
the scope of the arrangement, such as a material expansion of the 
activities undertaken beyond the scope of the intangible development 
area, or a 50 percent or greater change in the ownership of interests 
in cost shared intangibles.
    Commentators objected to the grandfather termination events, in 
particular in the case of a subsequent Periodic Trigger or a 50 percent 
change of ownership, as defeating taxpayers' legitimate expectation 
under the prior regulations.
    The temporary regulations do not terminate grandfather treatment 
upon a 50 percent change of ownership or on account of a subsequent 
Periodic Trigger or a material change in scope of the arrangement. The 
temporary regulations instead adopt a targeted provision that applies 
the temporary regulations' periodic adjustment rules to PCTs that occur 
on or after the date of a material change in the scope of the 
grandfathered CSA. A material change in scope would include a material 
expansion of the activities undertaken beyond the scope of the 
intangible development area, as described in former Treas. Reg. Sec.  
1.482-7(b)(4)(iv). For this purpose, a contraction of the scope of a 
CSA, absent a material expansion into one or more lines of research and 
development beyond the scope of the intangible development area, does 
not constitute a material change in scope of the CSA. Whether a 
material change in scope has occurred is determined on a cumulative 
basis. Therefore, a series of expansions, any one of which is not a 
material expansion by itself, may collectively constitute a material 
expansion.

Special Analyses

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

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

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

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendment to the Regulations

0
Accordingly, 26 CFR parts 1, 301, and 602 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 as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.482-7A also issued under 26 U.S.C. 482. * * *


0
Par. 2. Section 1.367(a)-1 is added to read as follows:


Sec.  1.367(a)-1  Transfers to foreign corporations subject to section 
367(a): In general.

    (a) through (d)(2) [Reserved].
    (3) [Reserved] For further guidance, see Sec.  1.367(a)-1T(d)(3).
    (d)(4) through (g) [Reserved].
0
Par 3. Section 1.367(a)-1T is amended by revising the second sentence 
of paragraph (d)(3) to read as follows:


Sec.  1.367(a)-1T  Transfers to foreign corporations subject to section 
367(a): In general (temporary).

* * * * *
    (d) * * *
    (3) * * * A person's entering into a cost sharing arrangement under 
Sec.  1.482-7T or acquiring rights to intangible property under such an 
arrangement shall not be considered a transfer of property described in 
section 367(a)(1). * * *
* * * * *

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

[[Page 349]]

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


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

* * * * *


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

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


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

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


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

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


Sec.  1.482-7  Methods to determine taxable income in connection with a 
cost sharing arrangement.

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

0
Par. 5. Section 1.482-0T is amended as follows:
0
1. The entries for Sec. Sec.  1.482-1T(b)(2)(iii), (c), (d)(1), (d)(2), 
(d)(3)(ii)(A), and (d)(3)(ii)(B) are revised.
0
2. A new entry for Sec.  1.482-1T(b)(2)(iii) is added.
0
3. The entries for Sec.  1.482-2T(e) are revised, and new entries for 
Sec.  1.482-2T(f) are added.
0
4. The entries for Sec.  1.482-4T(f)(7) are removed, and the entries 
for Sec.  1.482-4T(g) and (h) are added.
0
5. The entries for Sec.  1.482-7T are added.
0
6. The entries for Sec.  1.482-9T(m)(3) and (n) are revised.
    The additions and revisions read as follows:


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

* * * * *


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

* * * * *
    (b) * * *
    (2) * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.482-0, the entry 
for Sec.  1.482-1(b)(2)(ii).
    (iii) Coordination of methods applicable to certain intangible 
development arrangements.
    (c) through (d)(3)(ii)(B) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entries for Sec.  1.482-1(c) through (d)(3)(iii)(B).
* * * * *


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

* * * * *
    (e) Cost sharing arrangement.
    (f) Effective/applicability Date.
    (1) In general.
    (2) Election to apply section paragraph (b) to earlier taxable 
years.
    (3) Expiration date.
* * * * *


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

* * * * *
    (g) Coordination with rules governing cost sharing arrangements.
    (h) Effective/applicability date.
    (1) In general.
    (2) Election to apply regulation to earlier taxable years.
    (3) Expiration date.
* * * * *


Sec.  1.482-7T  Methods to determine taxable income in connection with 
a cost sharing arrangement (temporary).

    (a) In general.
    (1) RAB share method for cost sharing transactions (CSTs).
    (2) Methods for platform contribution transactions (PCTs).
    (3) Methods for other controlled transactions.
    (i) Contribution to a CSA by a controlled taxpayer that is not a 
controlled participant.
    (ii) Transfer of interest in a cost shared intangible.
    (iii) Other controlled transactions in connection with a CSA.
    (iv) Controlled transactions in the absence of a CSA.
    (4) Coordination with the arm's length standard.
    (b) Cost sharing arrangement.
    (1) Substantive requirements.
    (i) CSTs.
    (ii) PCTs.
    (iii) Divisional interests.
    (iv) Examples.
    (2) Administrative requirements.
    (3) Date of a PCT.
    (4) Divisional interests.
    (i) In general.
    (ii) Territorial based divisional interests.
    (iii) Field of use based divisional interests.
    (iv) Other divisional bases.
    (v) Examples.
    (5) Treatment of certain arrangements as CSAs.
    (i) Situation in which Commissioner must treat arrangement as a 
CSA.
    (ii) Situation in which Commissioner may treat arrangement as a 
CSA.
    (iii) Examples.
    (6) Entity classification of CSAs.
    (c) Platform contributions.
    (1) In general.
    (2) Terms of platform contributions.
    (i) Presumed to be exclusive.
    (ii) Rebuttal of Exclusivity.
    (iii) Proration of PCT Payments to the extent allocable to other 
business activities.
    (A) In general.
    (B) Determining the proration of PCT Payments.
    (3) Categorization of the PCT.
    (4) Certain make-or-sell rights excluded.
    (i) In general.
    (ii) Examples.
    (5) Examples.
    (d) Intangible development costs.
    (1) Determining whether costs are IDCs.
    (i) Definition and scope of the IDA.
    (ii) Reasonably anticipated cost shared intangible.
    (iii) Costs included in IDCs.
    (iv) Examples.
    (2) Allocation of costs.
    (3) Stock-based compensation.
    (i) In general.
    (ii) Identification of stock-based compensation with the IDA.
    (iii) Measurement and timing of stock-based compensation IDC.
    (A) In general.
    (1) Transfers to which section 421 applies.
    (2) Deductions of foreign controlled participants.
    (3) Modification of stock option.
    (4) Expiration or termination of CSA.
    (B) Election with respect to options on publicly traded stock.
    (1) In general.
    (2) Publicly traded stock.
    (3) Generally accepted accounting principles.
    (4) Time and manner of making the election.
    (C) Consistency.
    (4) IDC share.
    (5) Examples.
    (e) Reasonably anticipated benefit shares.
    (1) Definition.
    (i) In general.
    (ii) Examples.
    (2) Measure of benefits.
    (i) In general.

[[Page 350]]

    (ii) Indirect bases for measuring anticipated benefits.
    (A) Units used, produced, or sold.
    (B) Sales.
    (C) Operating profit.
    (D) Other bases for measuring anticipated benefits.
    (E) Examples.
    (iii) Projections used to estimate benefits.
    (A) In general.
    (B) Examples.
    (f) Changes in participation under a CSA.
    (1) In general.
    (2) Controlled transfer of interests.
    (3) Capability variation.
    (4) Arm's length consideration for a change in participation.
    (5) Examples.
    (g) Supplemental guidance on methods applicable to PCTs.
    (1) In general.
    (2) Best method analysis applicable for evaluation of a PCT pusuant 
to a CSA.
    (i) In general.
    (ii) Consistency with upfront contractual terms and risk 
allocations--the investor model.
    (A) In general.
    (B) Examples.
    (iii) Consistency of evaluation with realistic alternatives.
    (A) In general.
    (B) Examples.
    (iv) Aggregation of transactions.
    (v) Discount rate.
    (A) In general.
    (B) Considerations in best method analysis of discount rates.
    (1) Discount rate variation between realistic alternatives.
    (2) Discount rate variation between forms of payment.
    (3) Post-tax rate.
    (C) Example.
    (vi) Financial projections.
    (vii) Accounting principles.
    (A) In general.
    (B) Examples.
    (viii) Valuations of subsequent PCTs.
    (A) Date of subsequent PCT.
    (B) Best method analysis for subsequent PCT.
    (ix) Arm's length range.
    (A) In general.
    (B) Methods based on two or more input parameters.
    (C) Variable input parameters.
    (D) Determination of arm's length PCT Payment.
    (1) No variable input parameters.
    (2) One variable input parameters.
    (3) More than one variable input parameter.
    (E) Adjustments.
    (x) Valuation undertaken on a pre-tax basis.
    (3) Comparable uncontrolled transaction method.
    (4) Income method.
    (i) In general.
    (A) Equating cost sharing and licensing alternatives.
    (B) Cost sharing alternative.
    (C) Licensing alternative.
    (D) Only one controlled participate with nonroutine platform 
contributions.
    (E) Income method payment forms.
    (F) Discount rates appropriate to cost sharing and licensing 
alternatives.
    (G) The effect of taxation on determining the arm's length amount.
    (ii) Evaluation of PCT Payor's cost sharing alternative.
    (iii) Evaluation of PCT Payor's licensing alternatives.
    (A) Evaluation based on CUT.
    (B) Evaluation based on CPM.
    (iv) Lump sum payment form.
    (v) Best method analysis considerations.
    (vi) Routine platform and operating contributions.
    (vii) Examples.
    (5) Acquisition Price Method.
    (i) In general.
    (ii) Determination of arm's length charge.
    (iii) Adjusted acquisition price.
    (iv) Best method analysis consideration.
    (v) Examples.
    (6) Market capitalization method.
    (i) In general.
    (ii) Determination of arm's length charge.
    (iii) Average market capitalization.
    (iv) Adjusted average market capitalization.
    (v) Best method analysis consideration.
    (vi) Examples.
    (7) Residual profit split method.
    (i) In general.
    (ii) Appropriate share of profits and losses.
    (iii) Profit split.
    (A) In general.
    (B) Determine nonroutine residual divisional profit or loss.
    (C) Allocate nonroutine residual divisional profit or loss.
    (1) In general.
    (2) Relative value determination.
    (3) Determination of PCT Payments.
    (4) Routine platform and operating contributions.
    (iv) Best method analysis considerations.
    (A) In general.
    (B) Comparability.
    (C) Data and assumptions.
    (D) Other factors affecting reliability.
    (v) Examples.
    (8) Unspecified methods.
    (h) Form of payment rules.
    (1) CST Payments.
    (2) PCT Payments.
    (i) In general.
    (ii) No PCT Payor stock.
    (iii) Specified form of payment.
    (A) In general.
    (B) Contingent payments.
    (C) Examples.
    (iv) Conversion from fixed to contingent form of payment.
    (3) Coordination of best method rule and form of payment.
    (i) Allocations by the Commissioner in connection with a CSA.
    (1) In general.
    (2) CST allocations.
    (i) In general.
    (ii) Adjustments to improve the reliability of projections used to 
estimate RAB shares.
    (A) Unreliable projects.
    (B) Foreign-to-foreign adjustments.
    (C) Correlative adjustments to PCTs.
    (D) Examples.
    (iii) Timing of CST allocations.
    (3) PCT allocations.
    (4) Allocations regarding changes in participation under CSA.
    (5) Allocations when CSTs are consistently and materially 
disproportionate to RAB shares.
    (6) Periodic adjustments.
    (i) In general.
    (ii) PRRR.
    (iii) AERR.
    (A) In general.
    (B) PVTP.
    (C) PVI.
    (iv) ADR.
    (A) In general.
    (B) Publicly traded companies.
    (C) Publicly traded.
    (D) PCT Payor WACC.
    (E) Generally accepted accounting principles.
    (v) Determination of periodic adjustments.
    (A) In general.
    (B) Adjusted RPSM as of Determination Date.
    (vi) Exceptions to periodic adjustments.
    (A) Controlled participants establish periodic adjustment not 
warranted.
    (1) Transactions involving the same platform contribution as in the 
Trigger PCT.
    (2) Results not reasonably anticipated.
    (3) Reduced AERR does not cause Periodic Trigger.
    (4) Increased AERR does not cause Periodic Trigger.
    (B) Circumstances in which Periodic Trigger deemed out to occur.
    (1) 10-year period.
    (2) 5-year period.
    (vii) Examples.
    (j) Definitions and special rules.
    (1) Definitions.

[[Page 351]]

    (i) In general.
    (ii) Examples.
    (2) Special rules.
    (i) Consolidated group.
    (ii) Trade or business.
    (iii) Partnership.
    (3) Character.
    (i) CST Payments.
    (ii) PCT Payments.
    (iii) Examples.
    (k) CSA administrative requirements.
    (1) CSA contractual requirements.
    (i) In general.
    (ii) Contractual provisions.
    (iii) Meaning of contemporaneous.
    (A) In general.
    (B) Example.
    (iv) Interpretation of contractual provisions.
    (A) In general.
    (B) Examples.
    (2) CSA documentation requirements.
    (i) In general.
    (ii) Additional CSA documentation requirements.
    (iii) Coordination rules and production of documents.
    (A) Coordination with penalty regulations.
    (B) Production of documentation.
    (3) CSA accounting requirements.
    (i) In general.
    (ii) Reliance on financial accounting.
    (4) CSA reporting requirements.
    (i) CSA Statement.
    (ii) Content of CSA Statement.
    (iii) Time for filing CSA Statement.
    (A) 90-day rule.
    (B) Annual return requirement.
    (1) In general.
    (2) Special filing rule for annual return requirement.
    (iv) Examples.
    (l) Effective/applicability date.
    (m) Transition rule.
    (1) In general.
    (2) Transitional modification of applicable provisions.
    (3) Special rule for certain periodic adjustments.
    (n) Expiration date.
* * * * *


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

* * * * *
    (m) * * *
    (3) Coordination with rules governing cost sharing arrangements. * 
* *
    (n) Effective/applicability dates.

0
Par. 6. Section 1.482-1 is amended by revising the last sentence of 
paragraph (c)(1) to read as follows:


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

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

0
Par. 7. Section 1.482-1T is amended by:
0
1. Revising paragraphs (b)(2)(i), (b)(2)(ii), (c), (d)(1), (d)(2), 
(d)(3)(i), (d)(3)(ii) and (j)(6)(iii).
0
2.Adding a new paragraph (b)(2)(iii).
0
3.Adding a new sentence to the end of paragraph (j)(6)(i).
    The additions and revisions read as follows:


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

* * * * *
    (b) * * *
    (2) Arm's length methods--(i) Methods. Sections 1.482-2 through 
1.482-6, 1.482-7T, and 1.482-9T provide specific methods to be used to 
evaluate whether transactions between or among members of the 
controlled group satisfy the arm's length standard, and if they do not, 
to determine the arm's length result. Section 1.482-1 and this section 
provide general principles applicable in determining arm's length 
results of such controlled transactions, but do not provide methods, 
for which reference must be made to those other sections in accordance 
with paragraphs (b)(2)(ii) and (iii) of this section. Section 1.482-7T 
provides the specific methods to be used to evaluate whether a cost 
sharing arrangement as defined in Sec.  1.482-7T produces results 
consistent with an arm's length result.
    (ii) [Reserved]. For further guidance, see Sec.  1.482-1(c) through 
(d)(3)(ii)(C) Example 1 and 2.
    (iii) Coordination of methods applicable to certain intangible 
development arrangements. Section 1.482-7T provides the specific 
methods to be used to determine arm's length results of controlled 
transactions in connection with a cost sharing arrangement as defined 
in Sec.  1.482-7T. Sections 1.482-4 and 1.482-9T, as appropriate, 
provide the specific methods to be used to determine arm's length 
results of arrangements, including partnerships, for sharing the costs 
and risks of developing intangibles, other than a cost sharing 
arrangement covered by Sec.  1.482-7T. See also Sec. Sec.  1.482-4T(g) 
(Coordination with rules governing cost sharing arrangements) and 
1.482-9T(m)(3) (Coordination with rules governing cost sharing 
arrangements).
    (c) through (d)(3)(ii)(C) Examples 1 and 2. [Reserved]. For further 
guidance, see Sec.  1.482-1(c) through (d)(3)(ii)(C) Example 1 and 2.
* * * * *
    (j) * * *
    (6) * * *
    (i) * * * The provision of paragraph (b)(2)(iii) of this section is 
generally applicable on January 5, 2009.
* * * * *
    (iii) Except as noted in the succeeding sentence, the applicability 
of Sec.  1.482-1T expires on or before July 31, 2009. The applicability 
of paragraph (b)(2)(iii) of this section expires on or before December 
30, 2011.

0
Par. 8. Section 1.482-2T is amended as follows:
0
1. Paragraph (e) is redesignated as paragraph (f) and newly-designated 
paragraph (f) is revised.
0
2. New paragraph (e) is added.
    The addition and revision reads as follows:


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

* * * * *
    (e) Cost sharing arrangement. For rules governing allocations under 
section 482 to reflect an arm's length consideration for controlled 
transactions involving a cost sharing arrangement, see Sec.  1.482-7T.
    (f) Effective/applicability date--(1) In general. The provision of 
paragraph (b) of this section is generally applicable for tax years 
beginning after December 31, 2006. The provision of paragraph (e) of 
this section is generally applicable on January 5, 2009.
    (2) Election to apply paragraph (b) to earlier taxable years. A 
person may elect to apply the provisions of paragraph (b) of this 
section to earlier taxable years in accordance with the rules set forth 
in Sec.  1.482-9T(n)(2).
    (3) Expiration date. The applicability of paragraph (b) of this 
section expires on or before July 31, 2009. The applicability of 
paragraph (e) of this section expires on or before December 30, 2011.

0
Par. 9. Section 1.482-4T is amended as follows
0
1. Paragraph (f)(3)(i)(B) is revised.
0
2. Paragraph (f)(7) is removed.
0
3. New paragraphs (g) and (h) are added.
    The additions and revision reads as follows:


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

* * * * *
    (f) * * *
    (3) * * *
    (i) * * *
    (B) Cost sharing arrangements. The rules in this paragraph (f)(3) 
regarding ownership with respect to cost shared intangibles and cost 
sharing

[[Page 352]]

arrangements will apply only as provided in Sec.  1.482-7T.
* * * * *
    (g) Coordination with rules governing cost sharing arrangements. 
Section 1.482-7T provides the specific methods to be used to determine 
arm's length results of controlled transactions in connection with a 
cost sharing arrangement. This section provides the specific methods to 
be used to determine arm's length results of a transfer of intangible 
property, including in an arrangement for sharing the costs and risks 
of developing intangibles other than a cost sharing arrangement covered 
by Sec.  1.482-7T. In the case of such an arrangement, consideration of 
the principles, methods, comparability, and reliability considerations 
set forth in Sec.  1.482-7T is relevant in determining the best method, 
including an unspecified method, under this section, as appropriately 
adjusted in light of the differences in the facts and circumstances 
between such arrangement and a cost sharing arrangement.
    (h) Effective/applicability date--(1) In general. Except as 
provided in the succeeding sentence, the provisions of paragraphs 
(f)(3) and (4) of this section are generally applicable for taxable 
years beginning after December 31, 2006. The provisions of paragraphs 
(f)(3)(i)(B) and (g) of this section are generally applicable on 
January 5, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraphs (f)(3) and (4) of this 
section to earlier taxable years in accordance with the rules set forth 
in Sec.  1.482-9T(n)(2).
    (3) Expiration date. The applicability of this section expires on 
or before December 30, 2011.

0
Par. 10. Section 1.482-5 is amended by revising the last sentence of 
paragraph (c)(2)(iv) to read as follows:


Sec.  1.482-5  Comparable profits method.

* * * * *
    (c) * * *
    (2) * * *
    (iv) * * * As another example, it may be appropriate to adjust the 
operating profit of a party to account for material differences in the 
utilization of or accounting for stock-based compensation (as defined 
by Sec.  1.482-7T(d)(3)(i)) among the tested party and comparable 
parties.
* * * * *

0
Par. 11. Section 1.482-7 is redesignated Sec.  1.482-7A, and an 
undesignated centerheading preceding Sec.  1.482-7A is added to read as 
follows:
    Regulations applicable on or before January 5, 2009.

0
Par. 12. Section 1.482-7T is added to read as follows:


Sec.  1.482-7T  Methods to determine taxable income in connection with 
a cost sharing arrangement (temporary).

    (a) In general. The arm's length amount charged in a controlled 
transaction reasonably anticipated to contribute to developing 
intangibles pursuant to a cost sharing arrangement (CSA), as described 
in paragraph (b) of this section, must be determined under a method 
described in this section. Each method must be applied in accordance 
with the provisions of Sec.  1.482-1, except as those provisions are 
modified in this section.
    (1) RAB share method for cost sharing transactions (CSTs). See 
paragraph (b)(1)(i) of this section regarding the requirement that 
controlled participants, as defined in section (j)(1)(i) of this 
section, share intangible development costs (IDCs) in proportion to 
their shares of reasonably anticipated benefits (RAB shares) by 
entering into cost sharing transactions (CSTs).
    (2) Methods for platform contribution transactions (PCTs). The 
arm's length amount charged in a platform contribution transaction 
(PCT) described in paragraph (b)(1)(ii) of this section must be 
determined under the method or methods applicable under the other 
section or sections of the section 482 regulations, as supplemented by 
paragraph (g) of this section. See Sec.  1.482-1(b)(2)(ii) (Selection 
of category of method applicable to transaction), Sec.  1.482-
1T(b)(2)(iii) (Coordination of methods applicable to certain intangible 
development arrangements), and paragraph (g) of this section 
(Supplemental guidance on methods applicable to PCTs).
    (3) Methods for other controlled transactions--(i) Contribution to 
a CSA by a controlled taxpayer that is not a controlled participant. If 
a controlled taxpayer that is not a controlled participant contributes 
to developing a cost shared intangible, as defined in section (j)(1)(i) 
of this section, it must receive consideration from the controlled 
participants under the rules of Sec.  1.482-4T(f)(4) (Contribution to 
the value of an intangible owned by another). Such consideration will 
be treated as an intangible development cost for purposes of paragraph 
(d) of this section.
    (ii) Transfer of interest in a cost shared intangible. If at any 
time (during the term, or upon or after the termination, of a CSA) a 
controlled participant transfers an interest in a cost shared 
intangible to another controlled taxpayer, the controlled participant 
must receive an arm's length amount of consideration from the 
transferee under the rules of Sec. Sec.  1.482-1 and 1.482-4 through 
1.482-6 as supplemented by paragraph (f)(4) of this section regarding 
arm's length consideration for a change in participation. For this 
purpose, a capability variation described in paragraph (f)(3) of this 
section is considered to be a controlled transfer of interests in cost 
shared intangibles.
    (iii) Other controlled transactions in connection with a CSA. 
Controlled transactions between controlled participants that are not 
PCTs or CSTs (for example, provision of a cross operating contribution, 
as defined in paragraph (j)(1)(i) of this section, or make-or-sell 
rights) require arm's length consideration from the latter controlled 
participant under the rules of Sec. Sec.  1.482-1, 1.482-4 through 
1.482-6, and 1.482-9T as supplemented by paragraph (g)(2)(iv) of this 
section.
    (iv) Controlled transactions in the absence of a CSA. If a 
controlled transaction is reasonably anticipated to contribute to 
developing intangibles pursuant to an arrangement that is not a CSA 
described in paragraph (b)(1) or (5) of this section, whether the 
results of any such controlled transaction are consistent with an arm's 
length result must be determined under the applicable rules of the 
other sections of the regulations under section 482. For example, an 
arrangement for developing intangibles in which one controlled 
taxpayer's costs of developing the intangibles significantly exceeds 
its share of reasonably anticipated benefits from exploiting the 
developed intangibles would not in substance be a CSA, as described in 
paragraphs (b)(1)(i) through (iii) of this section or paragraph 
(b)(5)(i) of this section. In such a case, unless the rules of this 
section are applicable by reason of paragraph (b)(5) of this section, 
the arrangement must be analyzed under other applicable sections of 
regulations under section 482 to determine whether it achieves arm's 
length results, and if not, to determine any allocations by the 
Commissioner that are consistent with such other regulations under 
section 482. See Sec. Sec.  1.482-1(b)(2)(ii) (Selection of category of 
method applicable to transaction) and 1.482-1T(b)(2)(iii) (Coordination 
of methods applicable to certain intangible development arrangements).
    (4) Coordination with the arm's length standard. A CSA produces 
results that are consistent with an arm's length result within the 
meaning of Sec.  1.482-

[[Page 353]]

1(b)(1) if, and only if, each controlled participant's IDC share (as 
determined under paragraph (d)(4) of this section) equals its RAB 
share, each controlled participant compensates its RAB share of the 
value of all platform contributions by other controlled participants, 
and all other requirements of this section are satisfied.
    (b) Cost sharing arrangement. A cost sharing arrangement is an 
arrangement by which controlled participants share the costs and risks 
of developing cost shared intangibles in proportion to their RAB 
shares. An arrangement is a CSA if and only if the requirements of 
paragraphs (b)(1) through (4) of this section are met.
    (1) Substantive requirements--(i) CSTs. All controlled participants 
must commit to, and in fact, engage in cost sharing transactions. In 
CSTs, the controlled participants make payments to each other (CST 
Payments) as appropriate, so that in each taxable year each controlled 
participant's IDC share is in proportion to its respective RAB share.
    (ii) PCTs. All controlled participants must commit to, and in fact, 
engage in platform contributions transactions to the extent that there 
are platform contributions pursuant to paragraph (c) of this section. 
In a PCT, each other controlled participant (PCT Payor) is obligated 
to, and must in fact, make arm's length payments (PCT Payments) to each 
controlled participant (PCT Payee) that provides a platform 
contribution. For guidance on determining such arm's length obligation, 
see paragraph (g) of this section.
    (iii) Divisional interests. Each controlled participant must 
receive a non-overlapping interest in the cost shared intangibles 
without further obligation to compensate another controlled participant 
for such interest.
    (iv) Examples. The following examples illustrate the principles of 
this paragraph (b)(1):

    Example 1. Company A and Company B, who are members of the same 
controlled group, execute an agreement to jointly develop vaccine X 
and own the exclusive rights to commercially exploit vaccine X in 
their respective territories, which together comprise the whole 
world. The agreement provides that they will share some, but not 
all, of the costs for developing Vaccine X in proportion to RAB 
share. Such agreement is not a CSA because Company A and Company B 
have not agreed to share all of the IDCs in proportion to their 
respective RAB shares.
    Example 2. Company A and Company B agree to share all the costs 
of developing Vaccine X. The agreement also provides for employing 
certain resources and capabilities of Company A in this program 
including a skilled research team and certain research facilities, 
and provides for Company B to make payments to Company A in this 
respect. However, the agreement expressly provides that the program 
will not employ, and so Company B is expressly relieved of the 
payments in regard to, certain software developed by Company A as a 
medical research tool to model certain cellular processes expected 
to be implicated in the operation of Vaccine X even though such 
software would reasonably be anticipated to be relevant to 
developing Vaccine X and, thus, would be a platform contribution. 
See paragraph (c) of this section. Such agreement is not a CSA 
because Company A and Company B have not engaged in a necessary PCT 
for purposes of developing Vaccine X.
    Example 3. Companies C and D, who are members of the same 
controlled group, enter into a CSA. In the first year of the CSA, C 
and D conduct the intangible development activity, as described in 
paragraph (d)(1) of this section. The total IDCs in regard to such 
activity are $3,000,000 of which C and D pay $2,000,000 and 
$1,000,000, respectively, directly to third parties. As between C 
and D, however, their CSA specifies that they will share all IDCs in 
accordance with their RAB shares (as described in paragraph (e)(1) 
of this section), which are 60% for C and 40% for D. It follows that 
C should bear $1,800,000 of the total IDCs (60% of total IDCs of 
$3,000,000) and D should bear $1,200,000 of the total IDCs (40% of 
total IDCs of $3,000,000). D makes a CST payment to C of $200,000, 
that is, the amount by which D's share of IDCs in accordance with 
its RAB share exceeds the amount of IDCs initially borne by D 
($1,200,000-$1,000,000), and which also equals the amount by which 
the total IDCs initially borne by C exceeds its share of IDCS in 
accordance with its RAB share ($2,000,000-$1,800,000). As a result 
of D's CST payment to C, the IDC shares of C and D are in proportion 
to their respective RAB shares.

    (2) Administrative requirements. The CSA must meet the requirements 
of paragraph (k) of this section.
    (3) Date of a PCT. The controlled participants must enter into a 
PCT as of the earliest date on or after the CSA is entered into on 
which a platform contribution is reasonably anticipated to contribute 
to developing cost shared intangibles.
    (4) Divisional interests--(i) In general. Pursuant to paragraph 
(b)(1)(iii) of this section, each controlled participant must receive a 
non-overlapping interest in the cost shared intangibles without further 
obligation to compensate another controlled participant for such 
interest. Each controlled participant must be entitled to the perpetual 
and exclusive right to the profits from transactions of any member of 
the controlled group that includes the controlled participant with 
uncontrolled taxpayers to the extent that such profits are attributable 
to such interest in the cost shared intangibles.
    (ii) Territorial based divisional interests. The CSA may divide all 
interests in cost shared intangibles on a territorial basis as follows. 
The entire world must be divided into two or more non-overlapping 
geographic territories. Each controlled participant must receive at 
least one such territory, and in the aggregate all the participants 
must receive all such territories. Each controlled participant will be 
assigned the perpetual and exclusive right to exploit the cost shared 
intangibles through the use, consumption, or disposition of property or 
services in its territories. Thus, compensation will be required if 
other members of the controlled group exploit the cost shared 
intangibles in such territory.
    (iii) Field of use based divisional interests. The CSA may divide 
all interests in cost shared intangibles on the basis of all uses 
(whether or not known at the time of the division) to which cost shared 
intangibles are to be put as follows. All anticipated uses of cost 
shared intangibles must be identified. Each controlled participant must 
be assigned at least one such anticipated use, and in the aggregate all 
the participants must be assigned all such anticipated uses. Each 
controlled participant will be assigned the perpetual and exclusive 
right to exploit the cost shared intangibles through the use or uses 
assigned to it and one controlled participant must be assigned the 
exclusive and perpetual right to exploit cost shared intangibles 
through any unanticipated uses.
    (iv) Other divisional bases. (A) In the event that the CSA does not 
divide interests in the cost shared intangibles on the basis of 
exclusive territories or fields of use as described in paragraphs 
(b)(4)(ii) and (iii) of this section, the CSA may adopt some other 
basis on which to divide all interests in the cost shared intangibles 
among the controlled participants, provided that each of the following 
criteria is met:
    (1) The basis clearly and unambiguously divides all interests in 
cost shared intangibles among the controlled participants.
    (2) The consistent use of such basis for the division of all 
interests in the cost shared intangibles can be dependably verified 
from the records maintained by the controlled participants.
    (3) The rights of the controlled participants to exploit cost 
shared intangibles are non-overlapping, exclusive, and perpetual.
    (4) The resulting benefits associated with each controlled 
participant's interest in cost shared intangibles are predictable with 
reasonable reliability.

[[Page 354]]

    (B) See paragraph (f)(3) of this section for rules regarding the 
requirement of arm's length consideration for changes in participation 
in CSAs involving divisions of interest described in this paragraph 
(b)(4)(iv).
    (v) Examples. The following examples illustrate the principles of 
this paragraph (b)(4):

    Example 1. Companies P and S, both members of the same 
controlled group, enter into a CSA to develop product Z. Under the 
CSA, P receives the interest in product Z in the United States and S 
receives the interest in product Z in the rest of the world, as 
described in paragraph (b)(4)(ii) of this section. Both P and S have 
plants for manufacturing product Z located in their respective 
geographic territories. However, for commercial reasons, product Z 
is nevertheless manufactured by P in the United States for sale to 
customers in certain locations just outside the United States in 
close proximity to P's U.S. manufacturing plant. Because S owns the 
territorial rights outside the United States, P must compensate S to 
ensure that S realizes all the cost shared intangible profits from 
P's sales of product Z in S's territory. The pricing of such 
compensation must also ensure that P realizes an appropriate return 
for its manufacturing efforts. Benefits projected with respect to 
such sales will be included for purposes of estimating S's, but not 
P's, RAB share.
    Example 2. The facts are the same as in Example 1 except that P 
and S agree to divide their interest in product Z based on site of 
manufacturing. P will have exclusive and perpetual rights in product 
Z manufactured in facilities owned by P. S will have exclusive and 
perpetual rights to product Z manufactured in facilities owned by S. 
P and S agree that neither will license manufacturing rights in 
product Z to any related or unrelated party. Both P and S maintain 
books and records that allow production at all sites to be verified. 
Both own facilities that will manufacture product Z and the relative 
capacities of these sites are known. All facilities are currently 
operating at near capacity and are expected to continue to operate 
at near capacity when product Z enters production so that it will 
not be feasible to shift production between P's and S's facilities. 
P and S have no plans to build new facilities and the lead time 
required to plan and build a manufacturing facility precludes the 
possibility that P or S will build a new facility during the period 
for which sales of Product Z are expected. Based on these facts, 
this basis for the division of interests in Product Z is a division 
described in paragraph (b)(4)(iv) of this section. The basis for the 
division of interest is unambiguous and clearly defined and its use 
can be dependably verified. P and S both have non-overlapping, 
exclusive and perpetual rights in Product Z. The division of 
interest results in the participant's relative benefits being 
predictable with reasonable reliability.
    Example 3. The facts are the same as in Example 2 except that 
P's and S's manufacturing facilities are not expected to operate at 
full capacity when product Z enters production. Production of 
Product Z can be shifted at any time between sites owned by P and 
sites owned by S, although neither P nor S intends to shift 
production as a result of the agreement. The division of interests 
in Product Z between P and S based on manufacturing site is not a 
division described in paragraph (b)(4)(iv) of this section because 
their relative shares of benefits are not predictable with 
reasonable reliability. The fact that neither P nor S intends to 
shift production is irrelevant.

    (5) Treatment of certain arrangements as CSAs--(i) Situation in 
which Commissioner must treat arrangement as a CSA. The Commissioner 
must apply the rules of this section to an arrangement among controlled 
taxpayers if the administrative requirements of paragraph (b)(2) of 
this section are met with respect to such arrangement and the 
controlled taxpayers reasonably concluded that such arrangement was a 
CSA meeting the requirements of paragraphs (b)(1), (3), and (4) of this 
section.
    (ii) Situation in which Commissioner may treat arrangement as a 
CSA. For arrangements among controlled taxpayers not described in 
paragraph (b)(5)(i) of this section, the Commissioner may apply the 
provisions of this section if the Commissioner concludes that the 
administrative requirements of paragraph (b)(2) of this section are 
met, and, notwithstanding technical failure to meet the substantive 
requirements of paragraph (b)(1), (3), or (4) of this section, the 
rules of this section will provide the most reliable measure of an 
arm's length result. See Sec.  1.482-1(c)(1) (the best method rule). 
For purposes of applying this paragraph (b)(5)(ii), any such 
arrangement shall be interpreted by reference to paragraph (k)(1)(iv) 
of this section.
    (iii) Examples. The following examples illustrate the principles of 
this paragraph (b)(5). In the examples, assume that Companies P and S 
are both members of the same controlled group.

    Example 1. (i) P owns the patent on a formula for a capsulated 
pain reliever, P-Cap. P reasonably anticipates, pending further 
research and experimentation, that the P-Cap formula could form the 
platform for a formula for P-Ves, an effervescent version of P-Cap. 
P also owns proprietary software that it reasonably anticipates to 
be critical to the research efforts. P and S execute a contract that 
purports to be a CSA by which they agree to proportionally share the 
costs and risks of developing a formula for P-Ves. The agreement 
reflects the various contractual requirements described in paragraph 
(k)(1) of this section and P and S comply with the documentation, 
accounting, and reporting requirements of paragraphs (k)(2) through 
(4) of this section. Both the patent rights for P-Cap and the 
software are reasonably anticipated to contribute to the development 
of P-Ves and therefore are platform contributions for which 
compensation is due from S as part of PCTs. Though P and S enter 
into and implement a PCT for the P-Cap patent rights that satisfies 
the arm's length standard, they fail to enter into a PCT for the 
software.
    (ii) In this case, P and S have substantially complied with the 
contractual requirements of paragraph (k)(1) of this section and the 
documentation, accounting, and reporting requirements of paragraphs 
(k)(2) through (4) of this section and therefore have met the 
administrative requirements of paragraph (b)(2) of this section. 
However, because they did not enter into a PCT, as required under 
paragraphs (b)(1)(ii) and (b)(3) of this section, for the software 
that was reasonably anticipated to contribute to the development of 
P-Ves (see paragraph (c) of this section), they cannot reasonably 
conclude that their arrangement was a CSA. Accordingly, the 
Commissioner is not required under paragraph (b)(5)(i) of this 
section to apply the rules of this section to their arrangement.
    (iii) Nevertheless, the arrangement between P and S closely 
resembles a CSA. If the Commissioner concludes that the rules of 
this section provide the most reliable measure of an arm's length 
result for such arrangement, then pursuant to paragraph (b)(5)(ii) 
of this section, the Commissioner may apply the rules of this 
section and treat P and S as entering into a PCT for the software in 
accordance with the requirements of paragraph (b)(1)(ii) of this 
section, and make any appropriate allocations under paragraph (i) of 
this section. Alternatively, the Commissioner may conclude that the 
rules of this section do not provide the most reliable measure of an 
arm's length result. In such case, the arrangement would be analyzed 
under the methods under other sections of the 482 regulations to 
determine whether the arrangement reaches an arm's length result.
    Example 2. The facts are the same as Example 1 except that P and 
S do enter into and implement a PCT for the software as required 
under this paragraph (b). The Commissioner determines that the PCT 
Payments for the software were not arm's length; nevertheless, under 
the facts and circumstances at the time they entered into the CSA 
and PCTs, P and S reasonably concluded their arrangement to be a 
CSA. Because P and S have met the requirements of paragraph (b)(2) 
of this section and reasonably concluded their arrangement is a CSA, 
pursuant to paragraph (b)(5)(i) of this section, the Commissioner 
must apply the rules of this section to their arrangement. 
Accordingly, the Commissioner treats the arrangement as a CSA and 
makes adjustments to the PCT Payments as appropriate under this 
section to achieve an arm's length result for the PCT for the 
software.
    Example 3. (i) The facts are the same as Example 1 except that P 
and S do enter into a PCT for the software as required under this 
paragraph (b). The agreement entered into by P and S provides for a 
fixed consideration of $50 million per year for four years, payable 
at the end of each year. This agreement

[[Page 355]]

satisfies the arm's length standard. However, S actually pays P 
consideration at the end of each year in the form of four annual 
royalties equal to two percent of sales. While such royalties at the 
time of the PCT were expected to be $50 million per year, actual 
sales during the first year were less than anticipated and the first 
royalty payment was only $25 million.
    (ii) In this case, P and S failed to implement the terms of 
their agreement. Under these circumstances, P and S could not 
reasonably conclude that their arrangement was a CSA, as described 
in paragraph (b)(1) of this section. Accordingly, the Commissioner 
is not required under paragraph (b)(5)(i) of this section to apply 
the rules of this section to their arrangement.
    (iii) Nevertheless, the arrangement between P and S closely 
resembles a CSA. If the Commissioner concludes that the rules of 
this section provide the most reliable measure of an arm's length 
result for such arrangement, then pursuant to paragraph (b)(5)(ii) 
of this section, the Commissioner may apply the rules of this 
section and make any appropriate allocations under paragraph (i) of 
this section. Alternatively, the Commissioner may conclude that the 
rules of this section do not provide the most reliable measure of an 
arm's length result. In such case, the arrangement would be analyzed 
under the methods under other sections of the 482 regulations to 
determine whether the arrangement reaches an arm's length result.
    Example 4. (i) The facts are the same as in Example 1 except 
that P does not own proprietary software and P and S use a different 
method for determining the arm's length amount of the PCT Payment 
for the P-Cap patent rights from the method used in Example 1.
    (ii) P and S determine that the arm's length amount of the PCT 
Payments for the P-Cap patent is $10 million. However, the IRS 
determines the best method for determining the arm's length amount 
of the PCT Payments for the P-Cap patent rights and under such 
method the arm's length amount is $100 million. To determine this 
$10 million present value, P and S assumed a useful life of eight 
years for the platform contribution, because the P-Cap patent rights 
will expire after eight years. However, use of the P-Cap patent 
rights in research is expected to lead to benefits attributable to 
exploitation of the cost shared intangibles extending many years 
beyond the expiration of the P-Cap patent, because use of the P-Cap 
patent rights will let P and S bring P-Ves to market before the 
competition, and because P and S expect to apply for additional 
patents covering P-Ves, which would bar competitors from selling 
that product for many future years. The assumption by P and S of a 
useful life for the platform contribution that is less than the 
anticipated period of exploitation of the cost shared intangibles is 
contrary to paragraph (g)(2)(ii) of this section, and reduces the 
reliability of the method used by P and S.
    (iii) The method used by P and S employs a declining royalty. 
The royalty starts at 8% of sales, based on an application of the 
CUT method in which the purported CUTs all involve licenses to 
manufacture and sell the current generation of P-Cap, and declines 
to 0% over eight years, declining by 1% each year. Such make-or-sell 
rights are fundamentally different from use of the P-Cap patent 
rights to generate a new product. This difference raises the issue 
of whether the make-or-sell rights are sufficiently comparable to 
the rights that are the subject of the PCT Payment. See Sec.  1.482-
4(c). While a royalty rate for make-or-sell rights can form the 
basis for a reliable determination of an arm's length PCT Payment in 
the CUT-based implementation of the income method described in 
paragraph (g)(4) of this section, under that method such royalty 
rate does not decline to zero. Therefore, the use of a declining 
royalty rate based on an initial rate for make-or-sell rights 
further reduces the reliability of the method used by P and S.
    (iv) Sales of the next-generation product are not anticipated 
until after seven years, at which point the royalty rate will have 
declined to 1%. The temporal mismatch between the period of the 
royalty rate decline and the period of exploitation raises further 
concerns about the method's reliability.
    (v) For the reasons given in paragraphs (ii) through (iv) of 
this Example 4, the method used by P and S is so unreliable and so 
contrary to provisions of this section that P and S could not 
reasonably conclude that they had contracted to make arm's length 
PCT Payments as required by paragraphs (b)(1)(ii) and (b)(3) of this 
section, and thus could not reasonably conclude that their 
arrangement was a CSA. Accordingly, the Commissioner is not required 
under paragraph (b)(5)(i) of this section to apply the rules of this 
section to their arrangement.
    (vi) Nevertheless, the arrangement between P and S closely 
resembles a CSA. If the Commissioner concludes that the rules of 
this section provide the most reliable measure of an arm's length 
result for such arrangement, then pursuant to paragraph (b)(5)(ii) 
of this section, the Commissioner may apply the rules of this 
section and make any appropriate allocations under paragraph (i) of 
this section. Alternatively, the Commissioner may conclude that the 
rules of this section do not provide the most reliable measure of an 
arm's length result. In such case, the arrangement would be analyzed 
under the methods under other section 482 regulations to determine 
whether the arrangement reaches an arm's length result.

    (6) Entity classification of CSAs. See Sec.  301.7701-1(c) of this 
chapter for the classification of CSAs for purposes of the Internal 
Revenue Code.
    (c) Platform contributions--(1) In general. A platform contribution 
is any resource, capability, or right that a controlled participant has 
developed, maintained, or acquired externally to the intangible 
development activity (whether prior to or during the course of the CSA) 
that is reasonably anticipated to contribute to developing cost shared 
intangibles. The determination whether a resource, capability, or right 
is reasonably anticipated to contribute to developing cost shared 
intangibles is ongoing and based on the best available information. 
Therefore, a resource, capability, or right reasonably determined not 
to be a platform contribution as of an earlier point in time, may be 
reasonably determined to be a platform contribution at a later point in 
time. The PCT obligation regarding a resource or capability or right 
once determined to be a platform contribution does not terminate merely 
because it may later be determined that such resource or capability or 
right has not contributed, and no longer is reasonably anticipated to 
contribute, to developing cost shared intangibles. Notwithstanding the 
other provisions of this paragraph (c), platform contributions do not 
include rights in land or depreciable tangible property, and do not 
include rights in other resources acquired by IDCs. See paragraph 
(d)(1) of this section.
    (2) Terms of platform contributions--(i) Presumed to be exclusive. 
For purposes of a PCT, the PCT Payee's provision of a platform 
contribution is presumed to be exclusive. Thus, it is presumed that the 
platform resource, capability, or right is not reasonably anticipated 
to be committed to any business activities other than the CSA Activity, 
as defined in paragraph (j)(1)(i) of this section, whether carried out 
by the controlled participants, other controlled taxpayers, or 
uncontrolled taxpayers.
    (ii) Rebuttal of exclusivity. The controlled participants may rebut 
the presumption set forth in paragraph (c)(2)(i) of this section to the 
satisfaction of the Commissioner. For example, if the platform resource 
is a research tool, then the controlled participants could rebut the 
presumption by establishing to the satisfaction of the Commissioner 
that, as of the date of the PCT, the tool is reasonably anticipated not 
only to contribute to the CSA Activity but also to be licensed to an 
uncontrolled taxpayer. In such case, the PCT Payments may need to be 
prorated as described in paragraph (c)(2)(iii) of this section.
    (iii) Proration of PCT Payments to the extent allocable to other 
business activities--(A) In general. Some transfer pricing methods 
employed to determine the arm's length amount of the PCT Payments do so 
by considering the overall value of the platform contributions as 
opposed to, for example, the value of the anticipated use of the 
platform contributions in the CSA Activity. Such a transfer pricing 
method is consistent with the presumption that the platform 
contribution is exclusive (that is, that the resources, capabilities or 
rights that are the subject of a platform contribution are reasonably 
anticipated

[[Page 356]]

to contribute only to the CSA Activity). See paragraph (c)(2)(i) of 
this section (Terms of platform contributions--Presumed to be 
exclusive). The PCT Payments determined under such transfer pricing 
method may have to be prorated if the controlled participants can rebut 
the presumption that the platform contribution is exclusive to the 
satisfaction of the Commissioner as provided in paragraph (c)(2)(ii) of 
this section. In the case of a platform contribution that also 
contributes to lines of business of a PCT Payor that are not reasonably 
anticipated to involve exploitation of the cost shared intangibles, the 
need for explicit proration may in some cases be avoided through 
aggregation of transactions. See paragraph (g)(2)(iv) of this section 
(Aggregation of transactions).
    (B) Determining the proration of PCT Payments. Proration will be 
done on a reasonable basis in proportion to the relative economic 
value, as of the date of the PCT, reasonably anticipated to be derived 
from the platform contribution by the CSA Activity as compared to the 
value reasonably anticipated to be derived from the platform 
contribution by other business activities. In the case of an aggregate 
valuation done under the principles of paragraph (g)(2)(iv) of this 
section that addresses payment for resources, capabilities, or rights 
used for business activities other than the CSA Activity (for example, 
the right to exploit an existing intangible without further 
development), the proration of the aggregate payments may have to 
reflect the economic value attributable to such resources, 
capabilities, or rights as well. For purposes of the best method rule 
under Sec.  1.482-1(c), the reliability of the analysis under a method 
that requires proration pursuant to this paragraph is reduced relative 
to the reliability of an analysis under a method that does not require 
proration.
    (3) Categorization of the PCT. For purposes of Sec.  1.482-
1(b)(1)(ii) and paragraph (a)(2) of this section, a PCT must be 
identified by the controlled participants as a particular type of 
transaction (for example, a license for royalty payments). See 
paragraph (k)(2)(ii)(I) of this section. Such designation must be 
consistent with the actual conduct of the controlled participants. If 
the conduct is consistent with different, economically equivalent types 
of transaction, then the controlled participants may designate the PCT 
as being any of such types of transaction. If the controlled 
participants fail to make such designation in their documentation, the 
Commissioner may make a designation consistent with the principles of 
paragraph (k)(1)(iv) of this section.
    (4) Certain make-or-sell rights excluded--(i) In general. Any right 
to exploit an existing intangible without further development, such as 
the right to make, replicate, license or sell existing products, does 
not constitute a platform contribution to a CSA, and the arm's length 
compensation for such rights (make-or-sell rights) does not satisfy the 
compensation obligation under a PCT.
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (c)(4):

    Example 1. P and S, which are members of the same controlled 
group, execute a CSA. Under the CSA, P and S will bear their RAB 
shares of IDCs for developing the second generation of ABC, a 
computer software program. Prior to that arrangement, P had incurred 
substantial costs and risks to develop ABC. Concurrent with entering 
into the arrangement, P (as the licensor) executes a license with S 
(as the licensee) by which S may make and sell copies of the 
existing ABC. Such make-or-sell rights do not constitute a platform 
contribution to the CSA. The rules of Sec. Sec.  1.482-1 and 1.482-4 
through 1.482-6 must be applied to determine the arm's length 
consideration in connection with the make-or-sell licensing 
arrangement. In certain circumstances, this determination of the 
arm's length consideration may be done on an aggregate basis with 
the evaluation of compensation obligations pursuant to the PCTs 
entered into by P and S in connection with the CSA. See paragraph 
(g)(2)(iv) of this section.
    Example 2. (i) P, a software company, has developed and 
currently exploits software program ABC. P and S enter into a CSA to 
develop future generations of ABC. The ABC source code is the 
platform on which future generations of ABC will be built and is 
therefore a platform contribution of P for which compensation is due 
from S pursuant to a PCT. Concurrent with entering into the CSA, P 
licenses to S the make-or-sell rights for the current version of 
ABC. P has entered into similar licenses with uncontrolled parties 
calling for sales-based royalty payments at a rate of 20%. The 
current version of ABC has an expected product life of three years. 
P and S enter into a contingent payment agreement to cover both the 
PCT Payments due from S for P's platform contribution and payments 
due from S for the make-or-sell license. Based on the uncontrolled 
make-or-sell licenses, P and S agree on a sales-based royalty rate 
of 20% in Year 1 that declines on a straight line basis to 0% over 
the 3 year product life of ABC.
    (ii) The make-or-sell rights for the current version of ABC are 
not platform contributions, though paragraph (g)(2)(iv) of this 
section provides for the possibility that the most reliable 
determination of an arm's length charge for the platform 
contribution and the make-or-sell license may be one that values the 
two transactions in the aggregate. A contingent payment schedule 
based on the uncontrolled make-or-sell licenses may provide an arm's 
length charge for the separate make-or-sell license between P and S, 
provided the royalty rates in the uncontrolled licenses similarly 
decline, but as a measure of the aggregate PCT and license payments 
it does not account for the arm's length value of P's platform 
contributions which include the rights in the source code and future 
development rights in ABC.

    (5) Examples. The following examples illustrate the principles of 
this paragraph (c). In each example, Companies P and S are members of 
the same controlled group, and execute a CSA providing that each will 
have the exclusive right to exploit cost shared intangibles in its own 
territory. See paragraph (b)(4)(ii) of this section (Territorial based 
divisional interests).

    Example 1. Company P has developed and currently markets version 
1.0 of a new software application XYZ. Company P and Company S 
execute a CSA under which they will share the IDCs for developing 
future versions of XYZ. Version 1.0 is reasonably anticipated to 
contribute to the development of future versions of XYZ and 
therefore Company P's rights in version 1.0 constitute a platform 
contribution from Company P that must be compensated by Company S 
pursuant to a PCT. Pursuant to paragraph (c)(3) of this section, the 
controlled participants designate the platform contribution as a 
transfer of intangibles that would otherwise be governed by Sec.  
1.482-4, if entered into by controlled parties. Accordingly, 
pursuant to paragraph (a)(2) of this section, the applicable method 
for determining the arm's length value of the compensation 
obligation under the PCT between Company P and Company S will be 
governed by Sec.  1.482-4 as supplemented by paragraph (g) of this 
section. Absent a showing to the contrary by P and S, the platform 
contribution in this case is presumed to be the exclusive provision 
of the benefit of all rights in version 1.0, other than the rights 
described in paragraph (c)(4) of this section (Certain make-or-sell 
rights excluded). This includes the right to use version 1.0 for 
purposes of research and the exclusive right in S's territory to 
exploit any future products that incorporated the technology of 
version 1.0, and would cover a term extending as long as the 
controlled participants were to exploit future versions of XYZ or 
any other product based on the version 1.0 platform. The 
compensation obligation of Company S pursuant to the PCT will 
reflect the full value of the platform contribution, as limited by 
Company S's RAB share.
    Example 2. Company P and Company S execute a CSA under which 
they will share the IDCs for developing Vaccine Z. Company P will 
commit to the project its research team that has successfully 
developed a number of other vaccines. The expertise and existing 
integration of the research team is a unique resource or capability 
of Company P which is reasonably anticipated to contribute to the 
development of Vaccine Z. Therefore, P's provision of the 
capabilities of the research team constitute a platform contribution 
for

[[Page 357]]

which compensation is due from Company S as part of a PCT. Pursuant 
to paragraph (c)(3) of this section, the controlled parties 
designate the platform contribution as a provision of services that 
would otherwise be governed by Sec.  1.482-9T(a) if entered into by 
controlled parties. Accordingly, pursuant to paragraph (a)(2) of 
this section, the applicable method for determining the arm's length 
value of the compensation obligation under the PCT between Company P 
and Company S will be governed by Sec.  1.482-9T(a) as supplemented 
by paragraph (g) of this section. Absent a showing to the contrary 
by P and S, the platform contribution in this case is presumed to be 
the exclusive provision of the benefits by Company P of its research 
team to the development of Vaccine Z. Because the IDCs include the 
ongoing compensation of the researchers, the compensation obligation 
under the PCT is only for the value of the commitment of the 
research team by Company P to the CSA's development efforts net of 
such researcher compensation. The value of the compensation 
obligation of Company S for the PCT will reflect the full value of 
the provision of services, as limited by Company S's RAB share.

    (d) Intangible development costs--(1) Determining whether costs are 
IDCs. Costs included in IDCs are determined by reference to the scope 
of the intangible development activity (IDA).
    (i) Definition and scope of the IDA. For purposes of this section, 
the IDA means the activity under the CSA of developing or attempting to 
develop reasonably anticipated cost shared intangibles. The scope of 
the IDA includes all of the controlled participants' activities that 
could reasonably be anticipated to contribute to developing the 
reasonably anticipated cost shared intangibles. The IDA cannot be 
described merely by a list of particular resources, capabilities, or 
rights that will be used in the CSA, because such a list would not 
identify reasonably anticipated cost shared intangibles. Also, the 
scope of the IDA may change as the nature or identity of the reasonably 
anticipated cost shared intangibles changes or the nature of the 
activities necessary for their development become clearer. For example, 
the relevance of certain ongoing work to developing reasonably 
anticipated cost shared intangibles or the need for additional work may 
only become clear over time.
    (ii) Reasonably anticipated cost shared intangible. For purposes of 
this section, reasonably anticipated cost shared intangible means any 
intangible, within the meaning of Sec.  1.482-4(b), that, at the 
applicable point in time, the controlled participants intend to develop 
under the CSA. Reasonably anticipated cost shared intangibles may 
change over the course of the CSA. The controlled participants may at 
any time change the reasonably anticipated cost shared intangibles but 
must document any such change pursuant to paragraph (k)(2)(ii)(A)(1) of 
this section. Removal of reasonably anticipated cost shared intangibles 
does not affect the controlled participants' interests in cost shared 
intangibles already developed under the CSA. In addition, the 
reasonably anticipated cost shared intangibles automatically expand to 
include the intended result of any further development of a cost shared 
intangible already developed under the CSA, or applications of such an 
intangible. However, the controlled participants may override this 
automatic expansion in a particular case if they separately remove 
specified further development of such intangible (or specified 
applications of such intangible) from the IDA, and document such 
separate removal pursuant to paragraph (k)(2)(ii)(A)(3) of this 
section.
    (iii) Costs included in IDCs. For purposes of this section, IDCs 
mean all costs, in cash or in kind (including stock-based compensation, 
as described in paragraph (d)(3) of this section), but excluding 
acquisition costs for land or depreciable property, in the ordinary 
course of business after the formation of a CSA that, based on analysis 
of the facts and circumstances, are directly identified with, or are 
reasonably allocable to, the IDA. Thus, IDCs include costs incurred in 
attempting to develop reasonably anticipated cost shared intangibles 
regardless of whether such costs ultimately lead to development of 
those intangibles, other intangibles developed unexpectedly, or no 
intangibles. IDCs shall also include the arm's length rental charge for 
the use of any land or depreciable tangible property (as determined 
under Sec.  1.482-2(c) (Use of tangible property)) directly identified 
with, or reasonably allocable to, the IDA. Reference to generally 
accepted accounting principles or Federal income tax accounting rules 
may provide a useful starting point but will not be conclusive 
regarding inclusion of costs in IDCs. IDCs do not include interest 
expense, foreign income taxes (as defined in Sec.  1.901-2(a)), or 
domestic income taxes.
    (iv) Examples. The following examples illustrate the principles of 
this paragraph (d)(1):

    Example 1. A contract that purports to be a CSA provides that 
the IDA to which the agreement applies consists of all research and 
development activity conducted at laboratories A, B, and C but not 
at other facilities maintained by the controlled participants. The 
contract does not describe the reasonably anticipated cost shared 
intangibles with respect to which research and development is to be 
undertaken. The contract fails to meet the requirements set forth in 
paragraph (k)(1)(ii)(B) of this section because it fails to 
adequately describe the scope of the IDA to be undertaken.
    Example 2. A contract that purports to be a CSA provides that 
the IDA to which the agreement applies consists of all research and 
development activity conducted by any of the controlled participants 
with the goal of developing a cure for a particular disease. Such a 
cure is thus a reasonably anticipated cost shared intangible. The 
contract also contains a provision that the IDA will exclude any 
activity that builds on the results of the controlled participants' 
prior research concerning Enzyme X even though such activity could 
reasonably be anticipated to contribute to developing such cure. The 
contract fails to meet the requirement set forth in paragraph 
(d)(1)(i) of this section that the scope of the IDA include all of 
the controlled participants' activities that could reasonably be 
anticipated to contribute to developing reasonably anticipated cost 
shared intangibles.

    (2) Allocation of costs. If a particular cost is directly 
identified with, or reasonably allocable to, a function the results of 
which will benefit both the IDA and other business activities, the cost 
must be allocated on a reasonable basis between the IDA and such other 
business activities in proportion to the relative economic value that 
the IDA and such other business activities are anticipated to derive 
from such results.
    (3) Stock-based compensation--(i) In general. As used in this 
section, the term stock-based compensation means any compensation 
provided by a controlled participant to an employee or independent 
contractor in the form of equity instruments, options to acquire stock 
(stock options), or rights with respect to (or determined by reference 
to) equity instruments or stock options, including but not limited to 
property to which section 83 applies and stock options to which section 
421 applies, regardless of whether ultimately settled in the form of 
cash, stock, or other property.
    (ii) Identification of stock-based compensation with the IDA. The 
determination of whether stock-based compensation is directly 
identified with, or reasonably allocable to, the IDA is made as of the 
date that the stock-based compensation is granted. Accordingly, all 
stock-based compensation that is granted during the term of the CSA 
and, at date of grant, is directly identified with, or reasonably 
allocable to, the IDA is included as an IDC under paragraph (d)(1) of 
this section. In the case of a repricing or other modification of a 
stock option, the determination of whether the repricing or other 
modification constitutes the

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grant of a new stock option for purposes of this paragraph (d)(3)(ii) 
will be made in accordance with the rules of section 424(h) and related 
regulations.
    (iii) Measurement and timing of stock-based compensation IDC--(A) 
In general. Except as otherwise provided in this paragraph (d)(3)(iii), 
the cost attributable to stock-based compensation is equal to the 
amount allowable to the controlled participant as a deduction for 
federal income tax purposes with respect to that stock-based 
compensation (for example, under section 83(h)) and is taken into 
account as an IDC under this section for the taxable year for which the 
deduction is allowable.
    (1) Transfers to which section 421 applies. Solely for purposes of 
this paragraph (d)(3)(iii)(A), section 421 does not apply to the 
transfer of stock pursuant to the exercise of an option that meets the 
requirements of section 422(a) or 423(a).
    (2) Deductions of foreign controlled participants. Solely for 
purposes of this paragraph (d)(3)(iii)(A), an amount is treated as an 
allowable deduction of a foreign controlled participant to the extent 
that a deduction would be allowable to a United States taxpayer.
    (3) Modification of stock option. Solely for purposes of this 
paragraph (d)(3)(iii)(A), if the repricing or other modification of a 
stock option is determined, under paragraph (d)(3)(ii) of this section, 
to constitute the grant of a new stock option not identified with, or 
reasonably allocable to, the IDA, the stock option that is repriced or 
otherwise modified will be treated as being exercised immediately 
before the modification, provided that the stock option is then 
exercisable and the fair market value of the underlying stock then 
exceeds the price at which the stock option is exercisable. 
Accordingly, the amount of the deduction that would be allowable (or 
treated as allowable under this paragraph (d)(3)(iii)(A)) to the 
controlled participant upon exercise of the stock option immediately 
before the modification must be taken into account as an IDC as of the 
date of the modification.
    (4) Expiration or termination of CSA. Solely for purposes of this 
paragraph (d)(3)(iii)(A), if an item of stock-based compensation 
identified with, or reasonably allocable to, the IDA is not exercised 
during the term of a CSA, that item of stock-based compensation will be 
treated as being exercised immediately before the expiration or 
termination of the CSA, provided that the stock-based compensation is 
then exercisable and the fair market value of the underlying stock then 
exceeds the price at which the stock-based compensation is exercisable. 
Accordingly, the amount of the deduction that would be allowable (or 
treated as allowable under this paragraph (d)(3)(iii)(A)) to the 
controlled participant upon exercise of the stock-based compensation 
must be taken into account as an IDC as of the date of the expiration 
or termination of the CSA.
    (B) Election with respect to options on publicly traded stock--(1) 
In general. With respect to stock-based compensation in the form of 
options on publicly traded stock, the controlled participants in a CSA 
may elect to take into account all IDCs attributable to those stock 
options in the same amount, and as of the same time, as the fair value 
of the stock options reflected as a charge against income in audited 
financial statements or disclosed in footnotes to such financial 
statements, provided that such statements are prepared in accordance 
with United States generally accepted accounting principles by or on 
behalf of the company issuing the publicly traded stock.
    (2) Publicly traded stock. As used in this paragraph 
(d)(3)(iii)(B), the term publicly traded stock means stock that is 
regularly traded on an established United States securities market and 
is issued by a company whose financial statements are prepared in 
accordance with United States generally accepted accounting principles 
for the taxable year.
    (3) Generally accepted accounting principles. For purposes of this 
paragraph (d)(3)(iii)(B), a financial statement prepared in accordance 
with a comprehensive body of generally accepted accounting principles 
other than United States generally accepted accounting principles is 
considered to be prepared in accordance with United States generally 
accepted accounting principles provided that either--
    (i) The fair value of the stock options under consideration is 
reflected in the reconciliation between such other accounting 
principles and United States generally accepted accounting principles 
required to be incorporated into the financial statement by the 
securities laws governing companies whose stock is regularly traded on 
United States securities markets; or
    (ii) In the absence of a reconciliation between such other 
accounting principles and United States generally accepted accounting 
principles that reflects the fair value of the stock options under 
consideration, such other accounting principles require that the fair 
value of the stock options under consideration be reflected as a charge 
against income in audited financial statements or disclosed in 
footnotes to such statements.
    (4) Time and manner of making the election. The election described 
in this paragraph (d)(3)(iii)(B) is made by an explicit reference to 
the election in the written contract required by paragraph (k)(1) of 
this section or in a written amendment to the CSA entered into with the 
consent of the Commissioner pursuant to paragraph (d)(3)(iii)(C) of 
this section. In the case of a CSA in existence on August 26, 2003, the 
election by written amendment to the CSA may be made without the 
consent of the Commissioner if such amendment is entered into not later 
than the latest due date (with regard to extensions) of a federal 
income tax return of any controlled participant for the first taxable 
year beginning after August 26, 2003.
    (C) Consistency. Generally, all controlled participants in a CSA 
taking options on publicly traded stock into account under paragraph 
(d)(3)(ii), (d)(3)(iii)(A), or (d)(3)(iii)(B) of this section must use 
that same method of identification, measurement and timing for all 
options on publicly traded stock with respect to that CSA. Controlled 
participants may change their method only with the consent of the 
Commissioner and only with respect to stock options granted during 
taxable years subsequent to the taxable year in which the 
Commissioner's consent is obtained. All controlled participants in the 
CSA must join in requests for the Commissioner's consent under this 
paragraph (d)(3)(iii)(C). Thus, for example, if the controlled 
participants make the election described in paragraph (d)(3)(iii)(B) of 
this section upon the formation of the CSA, the election may be revoked 
only with the consent of the Commissioner, and the consent will apply 
only to stock options granted in taxable years subsequent to the 
taxable year in which consent is obtained. Similarly, if controlled 
participants already have granted stock options that have been or will 
be taken into account under the general rule of paragraph 
(d)(3)(iii)(A) of this section, then except in cases specified in the 
last sentence of paragraph (d)(3)(iii)(B)(4) of this section, the 
controlled participants may make the election described in paragraph 
(d)(3)(iii)(B) of this section only with the consent of the 
Commissioner, and the consent will apply only to stock options granted 
in taxable years subsequent to the taxable year in which consent is 
obtained.
    (4) IDC share. A controlled participant's IDC share for a taxable 
year is equal to the controlled participant's

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cost contribution for the taxable year, divided by the sum of all IDCs 
for the taxable year. A controlled participant's cost contribution for 
a taxable year means all of the IDCs initially borne by the controlled 
participant, plus all of the CST Payments that the participant makes to 
other controlled participants, minus all of the CST Payments that the 
participant receives from other controlled participants.
    (5) Examples. The following examples illustrate this paragraph (d):

    Example 1. Foreign parent (FP) and its U.S. subsidiary (USS) 
enter into a CSA to develop a better mousetrap. USS and FP share the 
costs of FP's R&D facility that will be exclusively dedicated to 
this research, the salaries of the researchers at the facility, and 
overhead costs attributable to the project. They also share the cost 
of a conference facility that is at the disposal of the senior 
executive management of each company. Based on the facts and 
circumstances, the cost of the conference facility cannot be 
directly identified with, and is not reasonably allocable to, the 
IDA. In this case, the cost of the conference facility must be 
excluded from the amount of IDCs.
    Example 2. U.S. parent (USP) and its foreign subsidiary (FS) 
enter into a CSA to develop intangibles for producing a new device. 
USP and FS share the costs of an R&D facility, the salaries of the 
facility's researchers, and overhead costs attributable to the 
project. Although USP also incurs costs related to field testing of 
the device, USP does not include those costs in the IDCs that USP 
and FS will share under the CSA. The Commissioner may determine, 
based on the facts and circumstances, that the costs of field 
testing are IDCs that the controlled participants must share.
    Example 3. U.S. parent (USP) and its foreign subsidiary (FS) 
enter into a CSA to develop a new process patent. USP assigns 
certain employees to perform solely R&D to develop a new 
mathematical algorithm to perform certain calculations. That 
algorithm will be used both to develop the new process patent and to 
develop a new design patent the development of which is outside the 
scope of the CSA. During years covered by the CSA, USP compensates 
such employees with cash salaries, stock-based compensation, or a 
combination of both. USP and FS anticipate that the economic value 
attributable to the R&D will be derived from the process patent and 
the design patent in a relative proportion of 75% and 25%, 
respectively. Applying the principles of paragraph (d)(2) of this 
section, 75% of the compensation of such employees must be allocated 
to the development of the new process patent and, thus, treated as 
IDCs. With respect to the cash salary compensation, the IDC is 75% 
of the face value of the cash. With respect to the stock-based 
compensation, the IDC is 75% of the value of the stock-based 
compensation as determined under paragraph (d)(3)(iii) of this 
section.
    Example 4. Foreign parent (FP) and its U.S. subsidiary (USS) 
enter into a CSA to develop a new computer source code. FP has an 
executive officer who oversees a research facility and employees 
dedicated solely to the IDA. The executive officer also oversees 
other research facilities and employees unrelated to the IDA, and 
performs certain corporate overhead functions. The full amount of 
the costs of the research facility and employees dedicated solely to 
the IDA can be directly identified with the IDA and, therefore, are 
IDCs. In addition, based on the executive officer's records of time 
worked on various matters, the controlled participants reasonably 
allocate 20% of the executive officer's compensation to supervision 
of the facility and employees dedicated to the IDA, 50% of the 
executive officer's compensation to supervision of the facilities 
and employees unrelated to the IDA, and 30% of the executive 
officer's compensation to corporate overhead functions. The 
controlled participants also reasonably determine that the results 
of the executive officer's corporate overhead functions yield equal 
economic benefit to the IDA and the other business activities of FP. 
Applying the principles of paragraph (d)(1) of this section, the 
executive officer's compensation allocated to supervising the 
facility and employees dedicated to the IDA (amounting to 20% of the 
executive officer's total compensation) must be treated as IDCs. 
Applying the principles of paragraph (d)(2) of this section, half of 
the executive officer's compensation allocated to corporate overhead 
functions (that is, half of 30% of the executive officer's total 
compensation), must be treated as IDCs. Therefore, a total of 35% 
(20% plus 15%) of the executive officer's total compensation must be 
treated as IDCs.

    (e) Reasonably anticipated benefits share--(1) Definition--(i) In 
general. A controlled participant's share of reasonably anticipated 
benefits is equal to its reasonably anticipated benefits divided by the 
sum of the reasonably anticipated benefits, as defined in paragraph 
(j)(1)(i) of this section, of all the controlled participants. RAB 
shares must be updated to account for changes in economic conditions, 
the business operations and practices of the participants, and the 
ongoing development of intangibles under the CSA. For purposes of 
determining RAB shares at any given time, reasonably anticipated 
benefits must be estimated over the entire period, past and future, of 
exploitation of the cost shared intangibles, and must reflect 
appropriate updates to take into account the most reliable data 
regarding past and projected future results available at such time. A 
controlled participant's RAB share must be determined by using the most 
reliable estimate. In determining which of two or more available 
estimates is most reliable, the quality of the data and assumptions 
used in the analysis must be taken into account, consistent with Sec.  
1.482-1(c)(2)(ii) (Data and assumptions). Thus, the reliability of an 
estimate will depend largely on the completeness and accuracy of the 
data, the soundness of the assumptions, and the relative effects of 
particular deficiencies in data or assumptions on different estimates. 
If two estimates are equally reliable, no adjustment should be made 
based on differences between the estimates. The following factors will 
be particularly relevant in determining the reliability of an estimate 
of RAB shares:
    (A) The basis used for measuring benefits, as described in 
paragraph (e)(2)(ii) of this section.
    (B) The projections used to estimate benefits, as described in 
paragraph (e)(2)(iii) of this section.
    (ii) Example. The following example illustrates the principles of 
this paragraph (e)(1):

    Example. (i) USP and FS plan to conduct research to develop 
Product Lines A and B. USP and FS reasonably anticipate respective 
benefits from Product Line A of 100X and 200X and respective 
benefits from Product Line B, respectively, of 300X and 400X. USP 
and FS thus reasonably anticipate combined benefits from Product 
Lines A and B of 400X and 600X, respectively.
    (ii) USP and FS could enter into a separate CSA to develop 
Product Line A with respective RAB shares of 33\1/3\ percent and 
66\2/3\ percent (reflecting a ratio of 100X to 200X), and into a 
separate CSA to develop Product Line B with respective RAB shares of 
42\6/7\ percent and 57\1/7\ percent (reflecting a ratio of 300X to 
400X). Alternatively, USP and FS could enter into a single CSA to 
develop both Product Lines A and B with respective RAB shares of 40 
percent and 60 percent (in the ratio of 400X to 600X). If the 
separate CSAs are chosen, then any costs for activities that 
contribute to developing both Product Line A and Product Line B will 
constitute IDCs of the respective CSAs as required by paragraphs 
(d)(1) and (d)(2) of this section.

    (2) Measure of benefits--(i) In general. In order to estimate a 
controlled participant's RAB share, the amount of each controlled 
participant's reasonably anticipated benefits must be measured on a 
basis that is consistent for all such participants. See paragraph 
(e)(2)(ii)(E) Example 9 of this section. If a controlled participant 
transfers a cost shared intangible to another controlled taxpayer, 
other than by way of a transfer described in paragraph (f) of this 
section, that controlled participant's benefits from the transferred 
intangible must be measured by reference to the transferee's benefits, 
disregarding any consideration paid by the transferee to the controlled 
participant (such as a royalty pursuant to a license agreement). 
Reasonably anticipated benefits are measured either on a direct basis, 
by reference to estimated benefits to be generated by the use of cost 
shared

[[Page 360]]

intangibles (generally based on additional revenues plus cost savings 
less any additional costs incurred), or on an indirect basis, by 
reference to certain measurements that reasonably can be assumed to 
relate to benefits to be generated. Such indirect bases of measurement 
of anticipated benefits are described in paragraph (e)(2)(ii) of this 
section. A controlled participant's reasonably anticipated benefits 
must be measured on the basis, whether direct or indirect, that most 
reliably determines RAB shares. In determining which of two bases of 
measurement is most reliable, the factors set forth in Sec.  1.482-
1(c)(2)(ii) (Data and assumptions) must be taken into account. It 
normally will be expected that the basis that provided the most 
reliable estimate for a particular year will continue to provide the 
most reliable estimate in subsequent years, absent a material change in 
the factors that affect the reliability of the estimate. Regardless of 
whether a direct or indirect basis of measurement is used, adjustments 
may be required to account for material differences in the activities 
that controlled participants undertake to exploit their interests in 
cost shared intangibles. See Examples 4 and 7 of paragraph 
(e)(2)(ii)(E) of this section.
    (ii) Indirect bases for measuring anticipated benefits. Indirect 
bases for measuring anticipated benefits from participation in a CSA 
include the following:
    (A) Units used, produced, or sold. Units of items used, produced, 
or sold by each controlled participant in the business activities in 
which cost shared intangibles are exploited may be used as an indirect 
basis for measuring its anticipated benefits. This basis of measurement 
will more reliably determine RAB shares to the extent that each 
controlled participant is expected to have a similar increase in net 
profit or decrease in net loss attributable to the cost shared 
intangibles per unit of the item or items used, produced, or sold. This 
circumstance is most likely to arise when the cost shared intangibles 
are exploited by the controlled participants in the use, production, or 
sale of substantially uniform items under similar economic conditions.
    (B) Sales. Sales by each controlled participant in the business 
activities in which cost shared intangibles are exploited may be used 
as an indirect basis for measuring its anticipated benefits. This basis 
of measurement will more reliably determine RAB shares to the extent 
that each controlled participant is expected to have a similar increase 
in net profit or decrease in net loss attributable to cost shared 
intangibles per dollar of sales. This circumstance is most likely to 
arise if the costs of exploiting cost shared intangibles are not 
substantial relative to the revenues generated, or if the principal 
effect of using cost shared intangibles is to increase the controlled 
participants' revenues (for example, through a price premium on the 
products they sell) without affecting their costs substantially. Sales 
by each controlled participant are unlikely to provide a reliable basis 
for measuring RAB shares unless each controlled participant operates at 
the same market level (for example, manufacturing, distribution, etc.).
    (C) Operating profit. Operating profit of each controlled 
participant from the activities in which cost shared intangibles are 
exploited, as determined before any expense (including amortization) on 
account of IDCs, may be used as an indirect basis for measuring 
anticipated benefits. This basis of measurement will more reliably 
determine RAB shares to the extent that such profit is largely 
attributable to the use of cost shared intangibles, or if the share of 
profits attributable to the use of cost shared intangibles is expected 
to be similar for each controlled participant. This circumstance is 
most likely to arise when cost shared intangibles are closely 
associated with the activity that generates the profit and the activity 
could not be carried on or would generate little profit without use of 
those intangibles.
    (D) Other bases for measuring anticipated benefits. Other bases for 
measuring anticipated benefits may in some circumstances be 
appropriate, but only to the extent that there is expected to be a 
reasonably identifiable relationship between the basis of measurement 
used and additional income generated or costs saved by the use of cost 
shared intangibles. For example, a division of costs based on employee 
compensation would be considered unreliable unless there were a 
relationship between the amount of compensation and the expected 
additional income generated or costs saved by the controlled 
participants from using the cost shared intangibles.
    (E) Examples. The following examples illustrate this paragraph 
(e)(2)(ii):

    Example 1. Controlled parties A and B enter into a CSA to 
develop product and process intangibles for already existing Product 
P. Without such intangibles, A and B would each reasonably 
anticipate revenue, in present value terms, of $100M from sales of 
Product P until it becomes obsolete. With the intangibles, A and B 
each reasonably anticipate selling the same number of units each 
year, but reasonably anticipate that the price will be higher. 
Because the particular product intangible is more highly regarded in 
A's market, A reasonably anticipates an increase of $20M in present 
value revenue from the product intangible, while B reasonably 
anticipates an increase of only $10M in present value from the 
product intangible. Further, A and B each reasonably anticipate 
spending an additional amount equal to $5M in present value in 
production costs to include the feature embodying the product 
intangible. Finally, A and B each reasonably anticipate saving an 
amount equal to $2M in present value in production costs by using 
the process intangible. A and B reasonably anticipate no other 
economic effects from exploiting the cost shared intangibles. A's 
reasonably anticipated benefits from exploiting the cost shared 
intangibles equal its reasonably anticipated increase in revenue 
($20M) plus its reasonably anticipated cost savings ($2M) less its 
reasonably anticipated increased costs ($5M), which equals $17M. 
Similarly, B's reasonably anticipated benefits from exploiting the 
cost shared intangibles equal its reasonably anticipated increase in 
revenue ($10M) plus its reasonably anticipated cost savings ($2M) 
less its reasonably anticipated increased costs ($5M), which equals 
$7M. Thus A's reasonably anticipated benefits are $17M and B's 
reasonably anticipated benefits are $7M.
    Example 2. Foreign Parent (FP) and U.S. Subsidiary (USS) both 
produce a feedstock for the manufacture of various high-performance 
plastic products. Producing the feedstock requires large amounts of 
electricity, which accounts for a significant portion of its 
production cost. FP and USS enter into a CSA to develop a new 
process that will reduce the amount of electricity required to 
produce a unit of the feedstock. FP and USS currently both incur an 
electricity cost of $2 per unit of feedstock produced and rates for 
each are expected to remain similar in the future. The new process, 
if it is successful, will reduce the amount of electricity required 
by each company to produce a unit of the feedstock by 50%. Switching 
to the new process would not require FP or USS to incur significant 
investment or other costs. Therefore, the cost savings each company 
is expected to achieve after implementing the new process are $1 per 
unit of feedstock produced. Under the CSA, FP and USS divide the 
costs of developing the new process based on the units of the 
feedstock each is anticipated to produce in the future. In this 
case, units produced is the most reliable basis for measuring RAB 
shares and dividing the IDCs because each controlled participant is 
expected to have a similar $1 (50% of current charge of $2) decrease 
in costs per unit of the feedstock produced.
    Example 3. The facts are the same as in Example 2, except that 
currently USS pays $3 per unit of feedstock produced for electricity 
while FP pays $6 per unit of feedstock produced. In this case, units 
produced is not the most reliable basis for measuring RAB shares and 
dividing the IDCs because the participants do not expect to have a 
similar decrease in costs per unit of the feedstock produced. The 
Commissioner

[[Page 361]]

determines that the most reliable measure of RAB shares may be based 
on units of the feedstock produced if FP's units are weighted 
relative to USS's units by a factor of 2. This reflects the fact 
that FP pays twice as much as USS for electricity and, therefore, 
FP's savings of $3 per unit of the feedstock (50% reduction of 
current charge of $6) would be twice USS's savings of $1.50 per unit 
of feedstock (50% reduction of current charge of $3) from any new 
process eventually developed.
    Example 4. The facts are the same as in Example 3, except that 
to supply the particular needs of the U.S. market USS manufactures 
the feedstock with somewhat different properties than FP's 
feedstock. This requires USS to employ a somewhat different 
production process than does FP. Because of this difference, USS 
would incur significant construction costs in order to adopt any new 
process that may be developed under the cost sharing agreement. In 
this case, units produced is not the most reliable basis for 
measuring RAB shares. In order to reliably determine RAB shares, the 
Commissioner measures the reasonably anticipated benefits of USS and 
FP on a direct basis. USS's reasonably anticipated benefits are its 
reasonably anticipated total savings in electricity costs, less its 
reasonably anticipated costs of adopting the new process. FS's 
reasonably anticipated benefits are its reasonably anticipated total 
savings in electricity costs.
    Example 5. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a CSA to develop new anesthetic drugs. USP obtains the right to 
market any resulting drugs in the United States and FS obtains the 
right to market any resulting drugs in the rest of the world. USP 
and FS determine RAB shares on the basis of their respective total 
anticipated operating profit from all drugs under development. USP 
anticipates that it will receive a much higher profit than FS per 
unit sold because the price of the drugs is not regulated in the 
United States, whereas the price of the drugs is regulated in many 
non-U.S. jurisdictions. In both controlled participants' 
territories, the anticipated operating profits are almost entirely 
attributable to the use of the cost shared intangibles. In this 
case, the controlled participants' basis for measuring RAB shares is 
the most reliable.
    Example 6. (i) Foreign Parent (FP) and U.S. Subsidiary (USS) 
manufacture and sell fertilizers. They enter into a CSA to develop a 
new pellet form of a common agricultural fertilizer that is 
currently available only in powder form. Under the CSA, USS obtains 
the rights to produce and sell the new form of fertilizer for the 
U.S. market while FP obtains the rights to produce and sell the new 
form of fertilizer in the rest of the world. The costs of developing 
the new form of fertilizer are divided on the basis of the 
anticipated sales of fertilizer in the controlled participants' 
respective markets.
    (ii) If the research and development is successful, the pellet 
form will deliver the fertilizer more efficiently to crops and less 
fertilizer will be required to achieve the same effect on crop 
growth. The pellet form of fertilizer can be expected to sell at a 
price premium over the powder form of fertilizer based on the 
savings in the amount of fertilizer that needs to be used. This 
price premium will be a similar premium per dollar of sales in each 
territory. If the research and development is successful, the costs 
of producing pellet fertilizer are expected to be approximately the 
same as the costs of producing powder fertilizer and the same for 
both FP and USS. Both FP and USS operate at approximately the same 
market levels, selling their fertilizers largely to independent 
distributors.
    (iii) In this case, the controlled participants' basis for 
measuring RAB shares is the most reliable.
    Example 7. The facts are the same as in Example 6, except that 
FP distributes its fertilizers directly while USS sells to 
independent distributors. In this case, sales of USS and FP are not 
the most reliable basis for measuring RAB shares unless adjustments 
are made to account for the difference in market levels at which the 
sales occur.
    Example 8. Foreign Parent (FP) and U.S. Subsidiary (USS) enter 
into a CSA to develop materials that will be used to train all new 
entry-level employees. FP and USS determine that the new materials 
will save approximately ten hours of training time per employee. 
Because their entry-level employees are paid on differing wage 
scales, FP and USS decide that they should not measure benefits 
based on the number of entry-level employees hired by each. Rather, 
they measure benefits based on compensation paid to the entry-level 
employees hired by each. In this case, the basis used for measuring 
RAB shares is the most reliable because there is a direct 
relationship between compensation paid to new entry-level employees 
and costs saved by FP and USS from the use of the new training 
materials.
    Example 9. U.S. Parent (USP), Foreign Subsidiary 1 (FS1), and 
Foreign Subsidiary 2 (FS2) enter into a CSA to develop computer 
software that each will market and install on customers' computer 
systems. The controlled participants measure benefits on the basis 
of projected sales by USP, FS1, and FS2 of the software in their 
respective geographic areas. However, FS1 plans not only to sell but 
also to license the software to unrelated customers, and FS1's 
licensing income (which is a percentage of the licensees' sales) is 
not counted in the projected benefits. In this case, the basis used 
for measuring the benefits of each controlled participant is not the 
most reliable because all of the benefits received by controlled 
participants are not taken into account. In order to reliably 
determine RAB shares, FS1's projected benefits from licensing must 
be included in the measurement on a basis that is the same as that 
used to measure its own and the other controlled participants' 
projected benefits from sales (for example, all controlled 
participants might measure their benefits on the basis of operating 
profit).

    (iii) Projections used to estimate benefits--(A) In general. The 
reliability of an estimate of RAB shares also depends upon the 
reliability of projections used in making the estimate. Projections 
required for this purpose generally include a determination of the time 
period between the inception of the research and development activities 
under the CSA and the receipt of benefits, a projection of the time 
over which benefits will be received, and a projection of the benefits 
anticipated for each year in which it is anticipated that the cost 
shared intangible will generate benefits. A projection of the relevant 
basis for measuring anticipated benefits may require a projection of 
the factors that underlie it. For example, a projection of operating 
profits may require a projection of sales, cost of sales, operating 
expenses, and other factors that affect operating profits. If it is 
anticipated that there will be significant variation among controlled 
participants in the timing of their receipt of benefits, and 
consequently benefit shares are expected to vary significantly over the 
years in which benefits will be received, it normally will be necessary 
to use the present value of the projected benefits to reliably 
determine RAB shares. See paragraph (g)(2)(v) of this section for best 
method considerations regarding discount rates used for this purpose. 
If it is not anticipated that benefit shares will significantly change 
over time, current annual benefit shares may provide a reliable 
projection of RAB shares. This circumstance is most likely to occur 
when the CSA is a long-term arrangement, the arrangement covers a wide 
variety of intangibles, the composition of the cost shared intangibles 
is unlikely to change, the cost shared intangibles are unlikely to 
generate unusual profits, and each controlled participant's share of 
the market is stable.
    (B) Examples. The following examples illustrate the principles of 
this paragraph (e)(2)(iii):

    Example 1. (i) Foreign Parent (FP) and U.S. Subsidiary (USS) 
enter into a CSA to develop a new car model. The controlled 
participants plan to spend four years developing the new model and 
four years producing and selling the new model. USS and FP project 
total sales of $4 billion and $2 billion, respectively, over the 
planned four years of exploitation of the new model. The controlled 
participants determine RAB shares for each year of 66\2/3\% for USS 
and 33\1/3\% for FP, based on projected total sales.
    (ii) USS typically begins producing and selling new car models a 
year after FP begins producing and selling new car models. In order 
to reflect USS's one-year lag in introducing new car models, a more 
reliable projection of each participant's RAB share would be based 
on a projection of all four years of sales for each participant, 
discounted to present value.
    Example 2. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a CSA to develop new and improved household cleaning

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products. Both controlled participants have sold household cleaning 
products for many years and have stable worldwide market shares. The 
products under development are unlikely to produce unusual profits 
for either controlled participant. The controlled participants 
determine RAB shares on the basis of each controlled participant's 
current sales of household cleaning products. In this case, the 
controlled participants' RAB shares are reliably projected by 
current sales of cleaning products.
    Example 3. The facts are the same as in Example 2, except that 
FS's market share is rapidly expanding because of the business 
failure of a competitor in its geographic area. The controlled 
participants' RAB shares are not reliably projected by current sales 
of cleaning products. FS's benefit projections should take into 
account its growth in market share.
    Example 4. Foreign Parent (FP) and U.S. Subsidiary (USS) enter 
into a CSA to develop synthetic fertilizers and insecticides. FP and 
USS share costs on the basis of each controlled participant's 
current sales of fertilizers and insecticides. The market shares of 
the controlled participants have been stable for fertilizers, but 
FP's market share for insecticides has been expanding. The 
controlled participants' projections of RAB shares are reliable with 
regard to fertilizers, but not reliable with regard to insecticides; 
a more reliable projection of RAB shares would take into account the 
expanding market share for insecticides.

    (f) Changes in participation under a CSA--(1) In general. A change 
in participation under a CSA occurs when there is either a controlled 
transfer of interests or a capability variation. A change in 
participation requires arm's length consideration under paragraph 
(a)(3)(ii) of this section, and as more fully described in this 
paragraph (f).
    (2) Controlled transfer of interests. A controlled transfer of 
interests occurs when a participant in a CSA transfers all or part of 
its interests in cost shared intangibles under the CSA in a controlled 
transaction, and the transferee assumes the associated obligations 
under the CSA. After the controlled transfer of interests occurs, the 
CSA will still exist if at least two controlled participants still have 
interests in the cost shared intangibles. In such a case, the 
transferee will be treated as succeeding to the transferor's prior 
history under the CSA as pertains to the transferred interests, 
including the transferor's cost contributions, benefits derived, and 
PCT Payments attributable to such rights or obligations. A transfer 
that would otherwise constitute a controlled transfer of interests for 
purposes of this paragraph (f)(2) shall not constitute a controlled 
transfer of interests if it also constitutes a capability variation for 
purposes of paragraph (f)(3) of this section.
    (3) Capability variation. A capability variation occurs when, in a 
CSA in which interests in cost shared intangibles are divided as 
described in paragraph (b)(4)(iv) of this section, the controlled 
participants' division of interests or their relative capabilities or 
capacities to benefit from the cost shared intangibles are materially 
altered. For purposes of paragraph (a)(3)(ii) of this section, a 
capability variation is considered to be a controlled transfer of 
interests in cost shared intangibles, in which any controlled 
participant whose RAB share decreases as a result of the capability 
variation is a transferor, and any controlled participant whose RAB 
share thus increases is the transferee of the interests in cost shared 
intangibles.
    (4) Arm's length consideration for a change in participation. In 
the event of a change in participation, the arm's length amount of 
consideration from the transferee, under the rules of Sec. Sec.  1.482-
1 and 1.482-4 through 1.482-6 and paragraph (a)(3)(ii) of this section, 
will be determined consistent with the reasonably anticipated 
incremental change in the returns to the transferee and transferor 
resulting from such change in participation. Such changes in returns 
will themselves depend on the reasonably anticipated incremental 
changes in the benefits from exploiting the cost shared intangibles, 
IDCs borne, and PCT Payments (if any). However, any arm's length 
consideration required under this paragraph (f)(4) with respect to a 
capability variation shall be reduced as necessary to prevent 
duplication of an adjustment already performed under paragraph 
(i)(2)(ii)(A) of this section that resulted from the same capability 
variation. If an adjustment has been performed already under this 
paragraph (f)(4) with respect to a capability variation, then for 
purposes of any adjustment to be performed under paragraph 
(i)(2)(ii)(A) of this section, the controlled participants' projected 
benefit shares referred to in paragraph (i)(2)(ii)(A) of this section 
shall be considered to be the controlled participants' respective RAB 
shares after the capability variation occurred.
    (5) Examples. The following examples illustrate the principles of 
this paragraph (f):

    Example 1. X, Y, and Z are the only controlled participants in a 
CSA. The CSA divides interests in cost shared intangibles on a 
territorial basis as described in paragraph (b)(4)(ii) of this 
section. X is assigned the territories of the Americas, Y is 
assigned the territory of the UK and Australia, and Z is assigned 
the rest of the world. When the CSA is formed, X has a platform 
contribution T. Under the PCTs for T, Y, and Z are each obligated to 
pay X royalties equal to five percent of their respective sales. 
Aside from T, there are no platform contributions. Two years after 
the formation of the CSA, Y transfers to Z its interest in cost 
shared intangibles relating to the UK territory, and the associated 
obligations, in a controlled transfer of interests described in 
paragraph (f)(2) of this section. At that time the reasonably 
anticipated benefits from exploiting cost shared intangibles in the 
UK have a present value of $11M, the reasonably anticipated IDCs to 
be borne relating to the UK territory have a present value of $3M, 
and the reasonably anticipated PCT Payments to be made to X relating 
to sales in the UK territory have a present value of $2M. As arm's 
length consideration for the change in participation due to the 
controlled transfer of interests, Z must pay Y compensation with an 
anticipated present value of $11M, less $3M, less $2M, which equals 
$6M.
    Example 2. As in Example 2 of paragraph (b)(4)(v) of this 
section, companies P and S, both members of the same controlled 
group, enter into a CSA to develop product Z. P and S agree to 
divide their interest in product Z based on site of manufacturing. P 
will have exclusive and perpetual rights in product Z manufactured 
in facilities owned by P. S will have exclusive and perpetual rights 
to product Z manufactured in facilities owned by S. P and S agree 
that neither will license manufacturing rights in product Z to any 
related or unrelated party. Both P and S maintain books and records 
that allow production at all sites to be verified. Both own 
facilities that will manufacture product Z and the relative 
capacities of these sites are known. All facilities are currently 
operating at near capacity and are expected to continue to operate 
at near capacity when product Z enters production so that it will 
not be feasible to shift production between P's and S's facilities. 
P and S have no plans to build new facilities and the lead time 
required to plan and build a manufacturing facility precludes the 
possibility that P or S will build a new facility during the period 
for which sales of Product Z are expected. When the CSA is formed, P 
has a platform contribution T. Under the PCT for T, S is obligated 
to pay P sales-based royalties according to a certain formula. Aside 
from T, there are no other platform contributions. Two years after 
the formation of the CSA, owing to a change in plans not reasonably 
foreseeable at the time the CSA was entered into, S acquires 
additional facilities F for the manufacture of Product Z. Such 
acquisition constitutes a capability variation described in 
paragraph (f)(3) of this section. Under this capability variation, 
S's RAB share increases from 50% to 60%. Accordingly, there is a 
compensable change in participation under paragraph (f)(3) of this 
section.
    (g) Supplemental guidance on methods applicable to PCTs--(1) In 
general. This paragraph (g) provides supplemental guidance on applying 
the methods listed in this paragraph (g)(1) for purposes of evaluating 
the arm's length amount charged in a PCT. Each method will yield a 
value for the

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compensation obligation of each PCT Payor consistent with the product 
of the combined pre-tax value to all controlled participants of the 
platform contribution that is the subject of the PCT and the PCT 
Payor's RAB share. The methods are--
    (i) The comparable uncontrolled transaction method described in 
Sec.  1.482-4(c), or the comparable uncontrolled services price method 
described in Sec.  1.482-9T(c), as further described in paragraph 
(g)(3) of this section;
    (ii) The income method, described in paragraph (g)(4) of this 
section;
    (iii) The acquisition price method, described in paragraph (g)(5) 
of this section;
    (iv) The market capitalization method, described in paragraph 
(g)(6) of this section;
    (v) The residual profit split method, described in paragraph (g)(7) 
of this section; and
    (vi) Unspecified methods, described in paragraph (g)(8) of this 
section.
    (2) Best method analysis applicable for evaluation of a PCT 
pursuant to a CSA--(i) In general. 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 paragraph (g).
    (ii) Consistency with upfront contractual terms and risk 
allocation--the investor model--(A) In general. Although all of the 
factors entering into a best method analysis described in Sec.  1.482-
1(c) and (d) must be considered, specific factors may be particularly 
relevant in the context of a CSA. In particular, the relative 
reliability of an application of any method depends on the degree of 
consistency of the analysis with the applicable contractual terms and 
allocation of risk under the CSA and this section among the controlled 
participants as of the date of the PCT, unless a change in such terms 
or allocation has been made in return for arm's length consideration. 
In this regard, a CSA involves an upfront division of the risks as to 
both reasonably anticipated obligations and reasonably anticipated 
benefits over the reasonably anticipated term of the CSA Activity. 
Accordingly, the relative reliability of an application of a method 
also depends on the degree of consistency of the analysis with the 
assumption that, as of the date of the PCT, each controlled 
participant's aggregate net investment in the CSA Activity 
(attributable to platform contributions, operating contributions, as 
such term is defined in paragraph (j)(1)(i) of this section, operating 
cost contributions, as such term is defined in paragraph (j)(1)(i) of 
this section, and cost contributions) is reasonably anticipated to earn 
a rate of return equal to the appropriate discount rate for the 
controlled participant's CSA Activity over the entire period of such 
CSA Activity. If the cost shared intangibles themselves are reasonably 
anticipated to contribute to developing other intangibles, then the 
period described in the preceding sentence includes the period, 
reasonably anticipated as of the date of the PCT, of developing and 
exploiting such indirectly benefited intangibles.
    (B) Example. The following example illustrates the principles of 
this paragraph (g)(2)(ii):

    Example. (i) P, a U.S. corporation, has developed a software 
program, DEF, which applies certain algorithms to reconstruct 
complete DNA sequences from partially-observed DNA sequences. S is a 
wholly-owned foreign subsidiary of P. On the first day of Year 1, P 
and S enter into a CSA to develop a new generation of genetic tests, 
GHI, based in part on the use of DEF. DEF is therefore a platform 
contribution of P for which compensation is due from S pursuant to a 
PCT. S makes no platform contributions to the CSA. Sales of GHI are 
projected to commence two years after the inception of the CSA and 
then to continue for eight more years. Based on industry experience, 
P and S are confident that GHI will be replaced by a new type of 
genetic testing based on technology unrelated to DEF or GHI and 
that, at that point, GHI will have no further value. P and S project 
that that replacement will occur at the end of Year 10.
    (ii) For purposes of valuing the PCT for P's platform 
contribution of DEF to the CSA, P and S apply a type of residual 
profit split method that is not described in paragraph (g)(7) of 
this section and which, accordingly, constitutes an unspecified 
method. See paragraph (g)(7)(i) (last sentence) of this section. The 
principles of this paragraph (g)(2) apply to any method for valuing 
a PCT, including the unspecified method used by P and S.
    (iii) Under the method employed by P and S, in each year, a 
portion of the income from sales of GHI in S's territory is 
allocated to certain routine contributions made by S. The residual 
of the profit or loss from GHI sales in S's territory after the 
routine allocation step is divided between P and S pro rata to their 
capital stocks allocable to S's territory. Each controlled 
participant's capital stock is computed by capitalizing, applying a 
capital growth factor to, and amortizing its historical expenditures 
regarding DEF allocable to S's territory (in the case of P), or its 
ongoing cost contributions towards developing GHI (in the case of 
S). The amortization of the capital stocks is effected on a 
straight-line basis over an assumed four-year life for the relevant 
expenditures. The capital stocks are grown using an assumed growth 
factor that P and S consider to be appropriate.
    (iv) The assumption that all expenditures amortize on a 
straight-line basis over four years does not appropriately reflect 
the principle that as of the date of the PCT regarding DEF, every 
contribution to the development of GHI, including DEF, is reasonably 
anticipated to have value throughout the entire period of 
exploitation of GHI which is projected to continue through Year 10. 
Under this method as applied by P and S, the share of the residual 
profit in S's territory that is allocated to P as a PCT Payment from 
S will decrease every year. After Year 4, P's capital stock in DEF 
will necessarily be $0, so that P will receive none of the residual 
profit or loss from GHI sales in S's territory after Year 4 as a PCT 
Payment.
    (v) As a result of this limitation of the PCT Payments to be 
made by S, the anticipated return to S's aggregate investment in the 
CSA, over the whole period of S's CSA Activity, is at a rate that is 
significantly higher than the appropriate discount rate for S's CSA 
Activity (as determined by a reliable method). This discrepancy is 
not consistent with the investor model principle that S should 
anticipate a rate of return to its aggregate investment in the CSA, 
over the whole period of its CSA Activity, equal to the appropriate 
discount rate for its CSA Activity. The inconsistency of the method 
with the investor model materially lessens its reliability for 
purposes of a best method analysis. See Sec.  1.482-1(c)(2)(ii)(B).

    (iii) Consistency of evaluation with realistic alternatives--(A) In 
general. The relative reliability of an application of a method also 
depends on the degree of consistency of the analysis with the 
assumption that uncontrolled taxpayers dealing at arm's length would 
have evaluated the terms of the transaction, and only entered into such 
transaction, if no alternative is preferable. This condition is not 
met, therefore, where for any controlled participant the total 
anticipated present value of its income attributable to its entering 
into the CSA, as of the date of the PCT, is less than the total 
anticipated present value of its income that could be achieved through 
an alternative arrangement realistically available to that controlled 
participant. In principle, this comparison is made on a post-tax basis 
but, in many cases, a comparison made on a pre-tax basis will yield 
equivalent results. See also paragraph (g)(2)(v)(B)(1) of this section 
(Discount rate variation between realistic alternatives).
    (B) Examples. The following examples illustrate the principles of 
this paragraph (g)(2)(iii):

    Example 1. (i) P, a corporation, and S, a wholly owned 
subsidiary of P, enter into a CSA to develop a personal 
transportation device (the product). Under the arrangement, P will 
undertake all of the R&D, and manufacture and market the product in 
Country X. S will make CST Payments to P for its appropriate share 
of P's R&D costs, and

[[Page 364]]

manufacture and market the product in the rest of the world. P owns 
existing patents and trade secrets that are reasonably anticipated 
to contribute to the development of the product. Therefore the 
rights in the patents and trade secrets are platform contributions 
for which compensation is due from S as part of a PCT.
    (ii) S's manufacturing and distribution activities under the CSA 
will be routine in nature, and identical to the activities it would 
undertake if it alternatively licensed the product from P.
    (iii) Reasonably reliable estimates indicate that P could 
develop the product without assistance from S and license the 
product outside of Country X for a royalty of 20% of sales. Based on 
reliable financial projections that include all future development 
costs and licensing revenue that are allocable to the non-Country X 
market, and using a discount rate appropriate for the riskiness of 
P's role as a licensor (see paragraph (g)(2)(v) of this section), 
the post-tax present value of this licensing alternative to P for 
the non-Country X market (measured as of the date of the PCT) would 
be $500 million. Thus, based on this realistic alternative, the 
anticipated post-tax present value under the CSA to P in the non-
Country X market (measured as of the date of the PCT), taking into 
account anticipated development costs allocable to the non-Country X 
market, and anticipated CST Payments and PCT Payments from S, and 
using a discount rate appropriate for the riskiness of P's role as a 
participant in the CSA, should not be less than $500 million.
    Example 2. (i) The facts are the same as in Example 1, except 
that there are no reliable estimates of the value to P from the 
licensing alternative to the CSA. Further, reasonably reliable 
estimates indicate that an arm's length return for S's routine 
manufacturing and distribution activities is a 10% mark-up on total 
costs of goods sold plus operating expenses related to those 
activities. Finally, the Commissioner determines that the respective 
activities undertaken by P and S (other than licensing payments, CST 
Payments, and PCT Payments) would be identical regardless of whether 
the arrangement was undertaken as a CSA (CSA Scenario) or as a long-
term licensing arrangement (Licensing Scenario). In particular, in 
both Scenarios, P would perform all research activities and S would 
undertake routine manufacturing and distribution activities 
associated with its territory.
    (ii) P undertakes an economic analysis that derives S's cost 
contributions under the CSA, based on reliable financial 
projections. Based on this and further economic analysis, P 
determines S's PCT Payment as a certain lump sum amount to be paid 
as of the date of the PCT (Date D).
    (iii) Based on reliable financial projections that include S's 
cost contributions and that incorporate S's PCT Payment, as computed 
by P, and using a discount rate appropriate for the riskiness of S's 
role as a CSA participant (see paragraph (g)(2)(v) of this section), 
the anticipated post-tax net present value to S in the CSA Scenario 
(measured as of Date D) is $800 million. Further, based on these 
same reliable projections (but incorporating S's licensing payments 
instead of S's cost contributions and PCT Payment), and using a 
discount rate appropriate for the riskiness of S's role as a long-
term licensee, the anticipated post-tax net present value to S in 
the Licensing Scenario (measured as of Date D) is $100 million. 
Thus, S's anticipated post-tax net present value is $700 million 
greater in the CSA Scenario than in the Licensing Scenario. This 
result suggests that P's anticipated post-tax present value must be 
significantly less under the CSA Scenario than under the Licensing 
Scenario. This means that the reliability of P's analysis as 
described in paragraph (ii) of this Example 2 is reduced, since P 
would not be expected to enter into a cost sharing arrangement if 
its alternative of being a long-term licensor is preferable.
    Example 3. (i) The facts are the same as in paragraphs (i) and 
(ii) of Example 2. In addition, based on reliable financial 
projections that include S's cost contributions and S's PCT Payment, 
and using a discount rate appropriate for the riskiness of S's role 
as a CSA participant, the anticipated post-tax net present value to 
S under the CSA (measured as of the date of the PCT) is $50 million. 
Also, instead of entering the CSA, S has the realistic alternative 
of manufacturing and distributing product Z unrelated to the 
personal transportation device, with the same anticipated 10% mark-
up on total costs that it would anticipate for its routine 
activities in Example 2. Under its realistic alternative, at a 
discount rate appropriate for the riskiness of S's role with respect 
to product Z, S anticipates a present value of $100 million.
    (ii) Because the lump sum PCT Payment made by S results in S 
having a considerably lower anticipated net present value than S 
could achieve through an alternative arrangement realistically 
available to it, the reliability of P's calculation of the lump sum 
PCT Payment is reduced.

    (iv) Aggregation of transactions. The combined effect of multiple 
contemporaneous transactions, consisting either of multiple PCTs, or of 
one or more PCT and one or more other transactions in connection with a 
CSA that are not governed by this section (such as transactions 
involving cross operating contributions or make-or-sell rights), may 
require evaluation in accordance with the principles of aggregation 
described in Sec.  1.482-1(f)(2)(i). In such cases, it may be that the 
multiple transactions are reasonably anticipated, as of the date of the 
PCT(s), to be so interrelated that the method that provides the most 
reliable measure of an arm's length charge is a method under this 
section applied on an aggregate basis for the PCT(s) and other 
transactions. A section 482 adjustment may be made by comparing the 
aggregate arm's length charge so determined to the aggregate payments 
actually made for the multiple transactions. In such a case, it 
generally will not be necessary to allocate separately the aggregate 
arm's length charge as between various PCTs or as between PCTs and such 
other transactions. However, such an allocation may be necessary for 
other purposes, such as applying paragraph (i)(6) (Periodic 
adjustments) of this section. An aggregate determination of the arm's 
length charge for multiple transactions will often yield a payment for 
a controlled participant that is equal to the aggregate value of the 
platform contributions and other resources, capabilities, and rights 
covered by the multiple transactions multiplied by that controlled 
participant's RAB share. Because RAB shares only include benefits from 
cost shared intangibles, the reliability of an aggregate determination 
of payments for multiple transactions may be reduced to the extent that 
it includes transactions covering resources, capabilities, and rights 
for which the controlled participants' expected benefit shares differ 
substantially from their RAB shares.
    (v) Discount rate--(A) In general. The best method analysis in 
connection with certain methods or forms of payment may depend on a 
rate or rates of return used to convert projected results of 
transactions to present value, or to otherwise convert monetary amounts 
at one or more points in time to equivalent amounts at a different 
point or points in time. For this purpose, a discount rate or rates 
should be used that most reliably reflect the market-correlated risks 
of activities or transactions and should be applied to the best 
estimates of the relevant projected results, based on all the 
information potentially available at the time for which the present 
value calculation is to be performed. Depending on the particular facts 
and circumstances, the market-correlated risk involved and thus, the 
discount rate, may differ among a company's various activities or 
transactions. Normally, discount rates are most reliably determined by 
reference to market information.
    (B) Considerations in best method analysis of discount rate--(1) 
Discount rate variation between realistic alternatives. Realistic 
alternatives may involve varying risk exposure and, thus, may be more 
reliably evaluated using different discount rates. In some 
circumstances, a party may have less risk as a licensee of intangibles 
needed in its operations, and so require a lower discount rate, than it 
would have by entering into a CSA to develop such intangibles, which 
may involve the party's assumption of additional risk in funding its 
cost contributions to the

[[Page 365]]

IDA. Similarly, self-development of intangibles and licensing out may 
be riskier for the licensor, and so require a higher discount rate, 
than entering into a CSA to develop such intangibles, which would 
relieve the licensor of the obligation to fund a portion of the IDCs of 
the IDA.
    (2) Discount rate variation between forms of payment. Certain forms 
of payment may involve different risks than others. For example, 
ordinarily a royalty computed on a profits base would be more volatile, 
and so require a higher discount rate to discount projected payments to 
present value, than a royalty computed on a sales base.
    (3) Post-tax rate. In general, discount rate estimates that may be 
inferred from the operations of the capital markets are post-tax 
discount rates. Therefore, an analysis would in principle apply post-
tax discount rates to income net of expense items including taxes 
(post-tax income). However, in certain circumstances the result of 
applying a post-tax discount rate to post-tax income is equivalent to 
the product of--
    (i) The result of applying a post-tax discount rate to income net 
of expense items other than taxes (pre-tax income); and
    (ii) The difference of one minus the tax rate.
    Therefore, in such circumstances, calculation of pre-tax income, 
rather than post-tax income, may be sufficient. See, for example, 
paragraph (g)(4)(i)(G) of this section.
    (C) Example. The following example illustrates the principles of 
this paragraph (g)(2)(v):

    Example. (i) P and S form a CSA to develop intangible X, which 
will be used in product Y. P will develop X, and S will make CST 
Payments as its cost contributions. At the start of the CSA, P has a 
platform contribution, for which S commits to make a PCT Payment of 
5% of its sales of product Y. As part of the evaluation of whether 
that PCT Payment is arm's length, the Commissioner considers whether 
P had a more favorable realistic alternative (see paragraph 
(g)(2)(iii) of this section). Specifically, the Commissioner 
compares P's anticipated post-tax discounted present value of the 
financial projections under the CSA (taking into account S's PCT 
Payment of 5% of its sales of product Y) with P's anticipated post-
tax discounted present value of the financial projections under a 
reasonably available alternative Licensing Arrangement that consists 
of developing intangible X on its own and then licensing X to S or 
to an uncontrolled party similar to S. In undertaking the analysis, 
the Commissioner determines that, because it would be funding the 
entire development of the intangible, P undertakes greater risks in 
the licensing scenario than in the cost sharing scenario (in the 
cost sharing scenario P would be funding only part of the 
development of the intangible).
    (ii) The Commissioner determines that, as between the two 
scenarios, all of the components of P's anticipated financial flows 
are identical, except for the CST and PCT Payments under the CSA, 
compared to the licensing payments under the Licensing Alternative. 
Accordingly, the Commissioner concludes that the differences in 
market-correlated risks between the two scenarios, and therefore the 
differences in discount rates between the two scenarios, relate to 
the differences in these components of the financial projections.

    (vi) Financial projections. The reliability of an estimate of the 
value of a platform or operating contribution in connection with a PCT 
will often depend upon the reliability of projections used in making 
the estimate. Such projections should reflect the best estimates of the 
items projected (normally reflecting a probability weighted average of 
possible outcomes). Projections necessary for this purpose may include 
a projection of sales, IDCs, costs of developing operating 
contributions, routine operating expenses, and costs of sales. Some 
method applications directly estimate projections of items attributable 
to separate development and exploitation by the controlled participants 
within their respective divisions. Other method applications indirectly 
estimate projections of items from the perspective of the controlled 
group as a whole, rather than from the perspective of a particular 
participant, and then apportion the items so estimated on some assumed 
basis. For example, in some applications, sales might be directly 
projected by division, but worldwide projections of other items such as 
operating expenses might be apportioned among divisions in the same 
ratio as the divisions' respective sales. Which approach is more 
reliable depends on which provides the most reliable measure of an 
arm's length result, considering the competing perspectives under the 
facts and circumstances in light of the completeness and accuracy of 
the underlying data, the reliability of the assumptions, and the 
sensitivity of the results to possible deficiencies in the data and 
assumptions. For these purposes, projections that have been prepared 
for non-tax purposes are generally more reliable than projections that 
have been prepared solely for purposes of meeting the requirements in 
this paragraph (g).
    (vii) Accounting principles--(A) In general. Allocations or other 
valuations done for accounting purposes may provide a useful starting 
point but will not be conclusive for purposes of the best method 
analysis in evaluating the arm's length charge in a PCT, particularly 
where the accounting treatment of an asset is inconsistent with its 
economic value.
    (B) Examples. The following examples illustrate the principles of 
this paragraph (g)(2)(vii):

    Example 1. (i) USP, a U.S. corporation and FSub, a wholly owned 
foreign subsidiary of USP, enter into a CSA in Year 1 to develop 
software programs with application in the medical field. Company X 
is an uncontrolled software company located in the United States 
that is engaged in developing software programs that could 
significantly enhance the programs being developed by USP and FSub. 
Company X is still in a startup phase, so it has no currently 
exploitable products or marketing intangibles and its workforce 
consists of a team of software developers. Company X has negligible 
liabilities and tangible property. In Year 2, USP purchases Company 
X as part of an uncontrolled transaction in order to acquire its in-
process technology and workforce for purposes of the development 
activities of the CSA. USP files a consolidated return that includes 
Company X. For accounting purposes, $50 million of the $100 million 
acquisition price is allocated to the in-process technology and 
workforce, and the residual $50 million is allocated to goodwill.
    (ii) The in-process technology and workforce of Company X 
acquired by USP are reasonably anticipated to contribute to 
developing cost shared intangibles and therefore the rights in the 
in-process technology and workforce of Company X are platform 
contributions for which FSub must compensate USP as part of a PCT. 
In determining whether to apply the acquisition price or another 
method for purposes of evaluating the arm's length charge in the 
PCT, relevant best method analysis considerations must be weighed in 
light of the general principles of paragraph (g)(2) of this section. 
The allocation for accounting purposes raises an issue as to the 
reliability of using the acquisition price method in this case 
because it suggests that a significant portion of the value of 
Company X's nonroutine contributions to USP's business activities is 
allocable to goodwill, which is often difficult to value reliably 
and which, depending on the facts and circumstances, might not be 
attributable to platform contributions that are to be compensated by 
PCTs. See paragraph (g)(5)(iv)(A) of this section.
    (iii) This paragraph (g)(2)(vii) provides that accounting 
treatment may be a starting point, but is not determinative for 
purposes of assessing or applying methods to evaluate the arm's 
length charge in a PCT. The facts here reveal that Company X has 
nothing of economic value aside from its in-process technology and 
assembled workforce. The $50 million of the acquisition price 
allocated to goodwill for accounting purposes, therefore, is 
economically attributable to either of, or both, the in-process 
technology and the workforce. That moots the potential issue under 
the acquisition price method of the reliability of valuation of 
assets not to be

[[Page 366]]

compensated by PCTs, since there are no such assets. Assuming the 
acquisition price method is otherwise the most reliable method, the 
aggregate value of Company X's in-process technology and workforce 
is the full acquisition price of $100 million (subject to possible 
adjustment for differences in tax liabilities of the type described 
in paragraph (g)(5)(ii) of this section). Accordingly, the aggregate 
value of the arm's length PCT Payments due from FSub to USP for the 
platform contributions consisting of the rights in Company X's in-
process technology and workforce will equal $100 million (subject to 
adjustment as per paragraph (g)(5)(ii) of this section) multiplied 
by FSub's RAB share.
    Example 2. (i) The facts are the same as in Example 1, except 
that Company X is a mature software business in the United States 
with a successful current generation of software that it markets 
under a recognized trademark, in addition to having the research 
team and new generation software in process that could significantly 
enhance the programs being developed under USP's and FSub's CSA. USP 
continues Company X's existing business and integrates the research 
team and the in-process technology into the efforts under its CSA 
with FSub. For accounting purposes, the $100 million price for 
acquiring Company X is allocated $50 million to existing software 
and trademark, $25 million to in-process technology and research 
workforce, and the residual $25 million to goodwill and going 
concern value.
    (ii) In this case an analysis of the facts indicates a 
likelihood that, consistent with the allocation under the accounting 
treatment (although not necessarily in the same amount), a 
significant amount of the nonroutine contributions to the USP's 
business activities consist of goodwill and going concern value 
economically attributable to the existing U.S. software business 
rather than to the platform contributions consisting of the rights 
in the in-process technology and research workforce. In addition, an 
analysis of the facts indicates that a significant amount of the 
nonroutine contributions to USP's business activities consist of the 
make-or-sell rights under the existing software and trademark, which 
are not platform contributions and might be difficult to value. 
Accordingly, further consideration must be given to the extent to 
which these circumstances reduce the relative reliability of the 
acquisition price method in comparison to other potentially 
applicable methods for evaluating the PCT Payment.

    Example 3. (i) USP, a U.S. corporation, and FSub, a wholly-owned 
foreign subsidiary of USP, enter into a CSA in Year 1 to develop 
Product A. Company Y is an uncontrolled corporation that owns 
Technology X, which is critical to the development of Product A. 
Company Y currently markets Product B, which is dependent on 
Technology X. USP is solely interested in acquiring Technology X, 
but is only able to do so through the acquisition of Company Y in 
its entirety for $200 million in an uncontrolled transaction in Year 
2. For accounting purposes, the acquisition price is allocated as 
follows: $120 million to Product B and the underlying Technology X, 
$30 million to trademark and other marketing intangibles, and the 
residual $50 million to goodwill and going concern value. After the 
acquisition of Company Y, Technology X is used to develop Product A. 
No other part of Company Y is used in any manner. Immediately after 
the acquisition, product B is discontinued, and, therefore, the 
accompanying marketing intangibles become worthless. None of the 
previous employees of Company Y is retained.
    (ii) The Technology X of Company Y acquired by USP is reasonably 
anticipated to contribute to developing cost shared intangibles and 
is therefore a platform contribution for which FSub must compensate 
USP as part of a PCT. Although for accounting purposes a significant 
portion of the acquisition price of Company Y was allocated to items 
other than Technology X, the facts demonstrate that USP had no 
intention of using and therefore placed no economic value on any 
part of Company Y other than Technology X. If USP was willing to pay 
$200 million for Company Y solely for purposes of acquiring 
Technology X, then assuming the acquisition price method is 
otherwise the most reliable method, the value of Technology X is the 
full $200 million acquisition price. Accordingly, the value of the 
arm's length PCT Payment due from FSub to USP for the platform 
contribution consisting of the rights in Technology X will equal the 
product of $200 million (subject to adjustment as described in 
paragraph (g)(5)(ii) of this section) and FSub's RAB share.

    (viii) Valuations of subsequent PCTs--(A) Date of subsequent PCT. 
The date of a PCT may occur subsequent to the inception of the CSA. For 
example, an intangible initially developed outside the IDA may only 
subsequently become a platform contribution because that later time is 
the earliest date on which it is reasonably anticipated to contribute 
to developing cost shared intangibles within the IDA. In such case, the 
date of the PCT, and the analysis of the arm's length amount charged in 
the subsequent PCT, is as of such later time.
    (B) Best method analysis for subsequent PCT. In cases where PCTs 
occur on different dates, the determination of the arm's length amount 
charged, respectively, in the prior and subsequent PCTs must be 
coordinated in a manner that provides the most reliable measure of an 
arm's length result. In some circumstances, a subsequent PCT may be 
reliably evaluated independently of other PCTs, as may be possible for 
example, under the acquisition price method. In other circumstances, 
the results of prior and subsequent PCTs may be interrelated and so a 
subsequent PCT may be most reliably evaluated under the residual profit 
split method of paragraph (g)(7) of this section. In those cases, for 
purposes of allocating the present value of nonroutine residual 
divisional profit or loss, and so determining the present value of the 
subsequent PCT Payments, in accordance with paragraph (g)(7)(iii)(C) of 
this section, the PCT Payor's interest in cost shared intangibles, both 
already developed and in process, are treated as additional PCT Payor 
operating contributions as of the date of the subsequent PCT.
    (ix) Arm's length range--(A) In general. The guidance in Sec.  
1.482-1(e) regarding determination of an arm's length range, as 
modified by this section, applies in evaluating the arm's length amount 
charged in a PCT under a transfer pricing method provided in this 
section (applicable method). Section 1.482-1(e)(2)(i) provides that the 
arm's length range is ordinarily determined by applying a single 
pricing method selected under the best method rule to two or more 
uncontrolled transactions of similar comparability and reliability 
although use of more than one method may be appropriate for the 
purposes described in Sec.  1.482-1(c)(2)(iii). The rules provided in 
Sec.  1.482-1(e) and this section for determining an arm's length range 
shall not override the rules provided in paragraph (i)(6) of this 
section for periodic adjustments by the Commissioner. The provisions in 
paragraphs (g)(2)(ix)(C) and (D) of this section apply only to 
applicable methods that are based on two or more input parameters as 
described in paragraph (g)(2)(ix)(B) of this section. For an example of 
how the rules of this section for determining an arm's length range of 
PCT Payments are applied, see paragraph (g)(4)(vii) of this section.
    (B) Methods based on two or more input parameters. An applicable 
method may determine PCT Payments based on calculations involving two 
or more parameters whose values depend on the facts and circumstances 
of the case (input parameters). For some input parameters (market-based 
input parameters), the value is most reliably determined by reference 
to data that derives from uncontrolled transactions (market data). For 
example, the value of the return to a controlled participant's routine 
contributions, as such term is defined in paragraph (j)(1)(i) of this 
section, to the CSA Activity (which value is used as an input parameter 
in the income method described in paragraph (g)(4) of this section) may 
in some cases be most reliably determined by reference to the profit 
level of a company with rights, resources, and capabilities comparable 
to those routine contributions. See Sec.  1.482-5. As another example, 
the value for the discount rate that reflects the riskiness of a 
controlled participant's role in the CSA (which

[[Page 367]]

value is used as an input parameter in the income method described in 
paragraph (g)(4) of this section) may in some cases be most reliably 
determined by reference to the stock beta of a company whose overall 
risk is comparable to the riskiness of the controlled participant's 
role in the CSA.
    (C) Variable input parameters. For some market-based input 
parameters (variable input parameters), the parameter's value is most 
reliably determined by considering two or more observations of market 
data that have, or with adjustment can be brought to, a similar 
reliability and comparability, as described in Sec.  1.482-1(e)(2)(ii) 
(for example, profit levels or stock betas of two or more companies). 
See paragraph (g)(2)(ix)(B) of this section.
    (D) Determination of arm's length PCT Payment. For purposes of 
applying this paragraph (g)(2)(ix), each input parameter is assigned a 
single most reliable value, unless it is a variable input parameter as 
described in paragraph (g)(2)(ix)(C) of this section. The determination 
of the arm's length payment depends on the number of variable input 
parameters.
    (1) No variable input parameters. If there are no variable input 
parameters, the arm's length PCT Payment is a single value determined 
by using the single most reliable value determined for each input 
parameter.
    (2) One variable input parameter. If there is exactly one variable 
input parameter, then under the applicable method, the arm's length 
range of PCT Payments is the interquartile range, as described in Sec.  
1.482-1(e)(2)(iii)(C), of the set of PCT Payment values calculated by 
selecting--
    (i) Iteratively, the value of the variable input parameter that is 
based on each observation as described in paragraph (g)(2)(ix)(C) of 
this section; and
    (ii) The single most reliable values for each other input 
parameter.
    (3) More than one variable input parameter. If there are two or 
more variable input parameters, then under the applicable method, the 
arm's length range of PCT Payments is the interquartile range, as 
described in Sec.  1.482-1(e)(2)(iii)(C), of the set of PCT Payment 
values calculated iteratively using every possible combination of 
permitted choices of values for the input parameters. For input 
parameters other than a variable input parameter, the only such 
permitted choice is the single most reliable value. For variable input 
parameters, such permitted choices include any value that is--
    (i) Based on one of the observations described in paragraph 
(g)(2)(ix)(C) of this section; and
    (ii) Within the interquartile range (as described in Sec.  1.482-
1(e)(2)(iii)(C)) of the set of all values so based.
    (E) Adjustments. Section 1.482-1(e)(3), applied as modified by this 
paragraph (g)(2)(ix), determines when the Commissioner may make an 
adjustment to a PCT Payment due to the taxpayer's results being outside 
the arm's length range. Adjustment will be to the median, as defined in 
Sec.  1.482-1(e)(3). Thus, the Commissioner is not required to 
establish an arm's length range prior to making an allocation under 
section 482.
    (x) Valuation undertaken on a pre-tax basis. PCT Payments in 
general may increase the PCT Payee's tax liability and decrease the PCT 
Payor's tax liability. The arm's length amount of a PCT Payment 
determined under the methods in this paragraph (g) is the value of the 
PCT Payment itself, without regard to such tax effects. Therefore, the 
methods under this section must be applied, with suitable adjustments 
if needed, to determine the PCT Payments on a pre-tax basis. See 
paragraphs (g)(2)(v)(B)(3), (g)(4)(i)(G), (g)(5)(ii), and (g)(6)(ii) of 
this section.
    (3) Comparable uncontrolled transaction method. The comparable 
uncontrolled transaction (CUT) method described in Sec.  1.482-4(c), 
and the comparable uncontrolled services price (CUSP) method described 
in Sec.  1.482-9T(c), may be applied to evaluate whether the amount 
charged in a PCT is arm's length by reference to the amount charged in 
a comparable uncontrolled transaction. Although all of the factors 
entering into a best method analysis described in Sec.  1.482-1(c) and 
(d) must be considered, comparability and reliability under this method 
are particularly dependent on similarity of contractual terms, degree 
to which allocation of risks is proportional to reasonably anticipated 
benefits from exploiting the results of intangible development, similar 
period of commitment as to the sharing of intangible development risks, 
and similar scope, uncertainty, and profit potential of the subject 
intangible development, including a similar allocation of the risks of 
any existing resources, capabilities, or rights, as well as of the 
risks of developing other resources, capabilities, or rights that would 
be reasonably anticipated to contribute to exploitation within the 
parties' divisions, that is consistent with the actual allocation of 
risks between the controlled participants as provided in the CSA in 
accordance with this section. When applied in the manner described in 
Sec.  1.482-4(c) or 1.482-9T(c), the CUT or CUSP method will typically 
yield an arm's length total value for the platform contribution that is 
the subject of the PCT. That value must then be multiplied by each PCT 
Payor's respective RAB share in order to determine the arm's length PCT 
Payment due from each PCT Payor. The reliability of a CUT or CUSP that 
yields a value for the platform contribution only in the PCT Payor's 
division will be reduced to the extent that value is not consistent 
with the total worldwide value of the platform contribution multiplied 
by the PCT Payor's RAB share.
    (4) Income method--(i) In general--(A) Equating cost sharing and 
licensing alternatives. The income method evaluates whether the amount 
charged in a PCT is arm's length by reference to a controlled 
participant's best realistic alternative to entering into a CSA. Under 
this method, the arm's length charge for a PCT Payment will be an 
amount such that a controlled participant's present value, as of the 
date of the PCT, of its cost sharing alternative of entering into a CSA 
equals the present value of its best realistic alternative. In general, 
the best realistic alternative of the PCT Payor to entering into the 
CSA would be to license intangibles to be developed by an uncontrolled 
licensor that undertakes the commitment to bear the entire risk of 
intangible development that would otherwise have been shared under the 
CSA. Similarly, the best realistic alternative of the PCT Payee to 
entering into the CSA would be to undertake the commitment to bear the 
entire risk of intangible development that would otherwise have been 
shared under the CSA and license the resulting intangibles to an 
uncontrolled licensee. Paragraphs (g)(4)(ii) through (iv) of this 
section describe specific applications of the income method, but do not 
exclude other possible applications of this method.
    (B) Cost sharing alternative. The PCT Payor's cost sharing 
alternative corresponds to the actual CSA in accordance with this 
section, with the PCT Payor's obligation to make the PCT Payments to be 
determined and its commitment for the duration of the IDA to bear cost 
contributions.
    (C) Licensing alternative. The licensing alternative is derived on 
the basis of a functional and risk analysis of the cost sharing 
alternative, but with a shift of the risk of cost contributions to the 
licensor. Accordingly, the PCT Payor's licensing alternative consists 
of entering into a license with an uncontrolled party, for a term 
extending for what would be the duration of the CSA Activity, to 
license the make-or-sell

[[Page 368]]

rights in to-be-developed resources, capabilities, or rights of the 
licensor. Under such license, the licensor would undertake the 
commitment to bear the entire risk of intangible development that would 
otherwise have been shared under the CSA. Apart from any difference in 
the allocation of the risks of the IDA, the licensing alternative 
should assume contractual provisions with regard to non-overlapping 
divisional intangible interests, and with regard to allocations of 
other risks, that are consistent with the actual CSA in accordance with 
this section. For example, the analysis under the licensing alternative 
should assume a similar allocation of the risks of any existing 
resources, capabilities, or rights, as well as of the risks of 
developing other resources, capabilities, or rights that would be 
reasonably anticipated to contribute to exploitation within the 
parties' divisions, that is consistent with the actual allocation of 
risks between the controlled participants as provided in the CSA in 
accordance with this section.
    (D) Only one controlled participant with nonroutine platform 
contributions. This method involves only one of the controlled 
participants providing nonroutine platform contributions as the PCT 
Payee. For a method under which more than one controlled participant 
may be a PCT Payee, see the application of the residual profit method 
pursuant to paragraph (g)(7) of this section.
    (E) Income method payment forms. The income method may be applied 
to determine PCT Payments in any form of payment (for example, lump 
sum, royalty on sales, or royalty on divisional profit). For converting 
to another form of payment, see generally Sec.  1.482-7(h) (Form of 
payment rules).
    (F) Discount rates appropriate to cost sharing and licensing 
alternatives.
    (1) The present value of the cost sharing and licensing 
alternatives, respectively, should be determined using the appropriate 
discount rates in accordance with paragraph (g)(2)(v) of this section. 
See, for example, Sec.  1.482-7(g)(2)(v)(B)(1) (Discount rate variation 
between realistic alternatives). In circumstances where the market-
correlated risks as between the cost sharing and licensing alternatives 
are not materially different, a reliable analysis may be possible by 
using the same discount rate with respect to both alternatives.
    (2) The discount rate for the cost sharing alternative will 
generally depend on the form of PCT Payments assumed (for example, lump 
sum, royalty on sales, royalty on divisional profit).
    (G) The effect of taxation on determining the arm's length amount. 
In principle, the present values of the cost sharing and licensing 
alternatives should be determined by applying post-tax discount rates 
to post-tax income (including the post-tax value to the controlled 
participant of the PCT Payments). If such approach is adopted, then the 
post-tax value of the PCT Payments must be appropriately adjusted in 
order to determine the arm's length amount of the PCT Payments on a 
pre-tax basis. See paragraph (g)(2)(x) of this section. In certain 
circumstances, post-tax income may be derived as the product of the 
result of applying a post-tax discount rate to pre-tax income, and a 
factor equal to one minus the tax rate. See paragraph (g)(2)(v)(B)(3) 
of this section. Moreover, to the extent that a controlled 
participant's tax rate is not materially affected by whether it enters 
into the cost sharing or licensing alternative (or reliable adjustments 
may be made for varying tax rates), the factor (that is, one minus the 
tax rate) may be cancelled from both sides of the equation of the cost 
sharing and licensing alternative present values. Accordingly, in such 
circumstance it is sufficient to apply post-tax discount rates to 
projections of pre-tax income for the purpose of equating the cost 
sharing and licensing alternatives. The specific applications of the 
income method described in paragraphs (g)(4)(ii) through (iv) of this 
section and the examples set forth in paragraph (g)(4)(vii) of this 
section assume that such circumstance applies.
    (ii) Evaluation of PCT Payor's cost sharing alternative. The 
present value of the PCT Payor's cost sharing alternative is the 
present value of the stream of the reasonably anticipated residuals 
over the duration of the CSA Activity of divisional profits or losses, 
minus operating cost contributions, minus cost contributions, minus PCT 
Payments.
    (iii) Evaluation of PCT Payor's licensing alternative--(A) 
Evaluation based on CUT. The present value of the PCT Payor's licensing 
alternative may be determined using the comparable uncontrolled 
transaction method, as described in Sec.  1.482-4(c)(1) and (2). In 
this case, the present value of the PCT Payor's licensing alternative 
is the present value of the stream, over what would be the duration of 
the CSA Activity under the cost sharing alternative, of the reasonably 
anticipated residuals of the divisional profits or losses that would be 
achieved under the cost sharing alternative, minus operating cost 
contributions that would be made under the cost sharing alternative, 
minus the licensing payments as determined under the comparable 
uncontrolled transaction method.
    (B) Evaluation based on CPM. The present value of the PCT Payor's 
licensing alternative may be determined using the comparable profits 
method, as described in Sec.  1.482-5. In this case, the present value 
of the licensing alternative is determined as in paragraph 
(g)(4)(iii)(A) of this section, except that the PCT Payor's licensing 
payments, as defined in paragraph (j)(1)(i) of this section, are 
determined to be a lump sum, as of the date of the PCT, equal to the 
present value (using the discount rate appropriate for the licensing 
alternative) of the stream, over what would be the duration of the CSA 
Activity under the cost sharing alternative, of the reasonably 
anticipated residuals of the divisional profits or losses that would be 
achieved under the cost sharing alternative, minus operating cost 
contributions that would be made under the cost sharing alternative, 
minus market returns for routine contributions, as defined in paragraph 
(j)(1)(i) of this section.
    (iv) Lump sum payment form. Where the form of PCT Payment is a lump 
sum as of the date of the PCT, then, based on paragraphs (g)(4)(i) 
through (iii) of this section, the PCT Payment equals the difference 
between--
    (A) The present value, using the discount rate appropriate for the 
cost sharing alternative, of the stream of the reasonably anticipated 
residuals over the duration of the CSA Activity of divisional profits 
or losses, minus cost contributions and operating cost contributions; 
and
    (B) The present value of the licensing alternative.
    (v) Best method analysis considerations. (A) Whether results 
derived from this method are the most reliable measure of an arm's 
length result is determined using the factors described under the best 
method rule in Sec.  1.482-1(c). Thus, comparability and the quality of 
data, the reliability of the assumptions, and the sensitivity of the 
results to possible deficiencies in the data and assumptions, must be 
considered in determining whether this method provides the most 
reliable measure of an arm's length result.
    (B) This method will be more reliable to the extent that the 
controlled participants' respective tax rates are not materially 
affected by whether they enter into the cost sharing or licensing 
alternative. Even if this assumption of invariant tax rates across 
alternatives does not hold, this method may still be

[[Page 369]]

reliable to the extent that reliable adjustments can be made to reflect 
the variation in tax rates.
    (C) If the licensing alternative is evaluated using the comparable 
uncontrolled transactions method, as described in paragraph 
(g)(4)(iii)(A) of this section, any additional comparability and 
reliability considerations stated in Sec.  1.482-4(c)(2) may apply.
    (D) If the licensing alternative is evaluated using the comparable 
profits method, as described in paragraph (g)(4)(iii)(B) of this 
section, any additional comparability and reliability considerations 
stated in Sec.  1.482-5(c) may apply.
    (E) This method may be used even if the PCT Payor furnishes 
significant operating contributions, or commits to assume the risk of 
significant operating cost contributions, to the PCT Payor's division. 
However, in such a case, any comparable uncontrolled transactions 
described in paragraph (g)(4)(iii)(A) of this section, and any 
comparable transactions used under Sec.  1.482-5(c) as described in 
paragraphs (g)(4)(iii)(B) of this section, should be consistent with 
such contributions (or reliable adjustments must be made for material 
differences).
    (vi) Routine platform and operating contributions. For purposes of 
this paragraph (g)(4), any routine contributions that are platform or 
operating contributions, the valuation and PCT Payments which are 
determined and made independently of the income method, are treated 
similarly to cost contributions and operating cost contributions, 
respectively. Accordingly, wherever used in this paragraph, the term 
``routine contributions'' shall not include routine platform or 
operating contributions, and wherever the terms ``cost contributions'' 
and ``operating cost contributions'' appear in this paragraph, they 
shall include net routine platform contributions and net routine 
operating contributions, respectively. Net routine platform 
contributions are the value of a controlled participant's total 
reasonably anticipated routine platform contributions, plus its 
reasonably anticipated PCT Payments to other controlled participants in 
respect of their routine platform contributions, minus the reasonably 
anticipated PCT Payments it is to receive from other controlled 
participants in respect of its routine platform contributions. Net 
routine operating contributions are the value of a controlled 
participant's total reasonably anticipated routine operating 
contributions, plus its reasonably anticipated arm's length 
compensation to other controlled participants in respect of their 
routine operating contributions, minus the reasonably anticipated arm's 
length compensation it is to receive from other controlled participants 
in respect of its routine operating contributions.
    (vii) Examples. The following examples illustrate the principles of 
this paragraph (g)(4):

    Example 1. (i) USP, a software company, has developed version 
1.0 of a new software application that it is currently marketing. In 
Year 1 USP enters into a CSA with its wholly-owned foreign 
subsidiary, FS, to develop future versions of the software 
application. Under the CSA, USP will have the rights to exploit the 
future versions in the United States, and FS will have the rights to 
exploit them in the rest of the world. The future rights in version 
1.0, and USP's development team, are reasonably anticipated to 
contribute to the development of future versions and therefore the 
rights in version 1.0 are platform contributions for which 
compensation is due from FS as part of a PCT. USP does not transfer 
the current exploitation rights in version 1.0 to FS. FS does not 
furnish any platform contributions nor does it control any operating 
intangibles at the inception of the CSA that would be relevant to 
the exploitation of version 1.0 or future versions of the software. 
FS agrees to make PCT payments in the form of a single lump sum 
payment as of the date of the PCT.
    (ii) In evaluating the CSA, the Commissioner concludes that the 
cost sharing alternative represents a riskier alternative for FS 
than the licensing alternative because, in cost sharing, FS will 
take on the additional risks associated with CST Payments and of 
making the PCT payments as a single lump sum. Consequently, the 
Commissioner concludes that the appropriate discount rate to apply 
in assessing the licensing alternative, based on discount rates of 
comparable uncontrolled companies undertaking comparable licensing 
transactions, would be 13% per year, whereas the appropriate 
discount rate to apply in assessing the cost sharing alternative 
would be 15% per year. FS undertakes financial projections and 
anticipates making no sales during the first two years of the CSA in 
its territory with sales in Years 3 through Year 8 rapidly 
increasing to $200 million, $400 million, $600 million, $650 
million, $700 million and $750 million, respectively. After year 8, 
sales in the rest of the world are expected to remain at $750 
million per annum for the foreseeable future. Costs including 
routine costs and operating cost contributions are anticipated to 
equal 60% of gross sales from Year 3, onwards. FS anticipates its 
cost contributions will equal $50 million per year for the first 
four years of the CSA and equal 10% of gross sales in each year, 
thereafter. The Commissioner accepts the financial projections 
undertaken by FS. The Commissioner determines that the arm's length 
rate USP would have charged an uncontrolled licensee for a license 
of future versions of the software had USP further developed version 
1.0 on its own is 35% of the sales price, as determined under the 
comparable uncontrolled transaction method in Sec.  1.482-4(c). FS 
also determines that the tax rate applicable to it will be the same 
in the licensing alternative as in the CSA.
    (iii) Based on these projections and applying the appropriate 
discount rate, the Commissioner determines that under the cost 
sharing alternative, the present value of its divisional profits 
(after subtracting the present value of the anticipated operating 
cost contributions and cost contributions) would be $867 million 
(for simplicity of calculation in this example, all financial flows 
are assumed to occur at the beginning of each period). Under the 
licensing alternative, the present value of the divisional profits 
and losses minus the operating cost contributions would be $1.592 
billion, and the present value of the licensing payments would be 
$1.393 billion. Therefore, the total value of the licensing 
alternative would be $199 million. In order for the present value of 
the cost sharing alternative to equal the present value of the 
licensing alternative, the present value of the PCT payments must 
equal $668 million; the arm's length lump sum PCT payment therefore 
equals $668 million.
    Example 2. Arm's length range. (i) The facts are the same as in 
Example 1. The licensing discount rate (13%) and the CUT licensing 
rate (35%) used by the Commissioner as input parameters in applying 
the income method are the median values of comparable uncontrolled 
discount rates and license rates, respectively. The observations 
that are in the interquartile range of the respective input 
parameters are as follows:

------------------------------------------------------------------------
                                                            Comparable
                                                           uncontrolled
    Observations that are within interquartile range       discount rate
                                                             (percent)
------------------------------------------------------------------------
1.......................................................              11
2.......................................................              12
3 (Median)..............................................              13
4.......................................................              15
5.......................................................              17
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                            Comparable
                                                           uncontrolled
    Observations that are within interquartile range      licensing rate
                                                             (percent)
------------------------------------------------------------------------
1.......................................................              30
2.......................................................              32
3 (Median)..............................................              35
4.......................................................              37
5.......................................................              40
------------------------------------------------------------------------

    (ii) The Commissioner concludes that these estimates of the 
appropriate arm's length discount rates and licensing rates are 
independent of each other. Accordingly, the Commissioner undertakes 
25 different applications of the income method, using each 
combination of the discount rate and licensing rate parameters. In 
undertaking this analysis, the Commissioner assumes that the ratio 
of the median discount rate for the cost sharing alternative to the 
median discount rate for the licensing alternative (that is, 15% to 
13%) is maintained. The results of the 25 applications of the income 
method, sorted in

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ascending order of calculated PCT payment, are as follows:

----------------------------------------------------------------------------------------------------------------
                                 Comparable
                                uncontrolled      Comparable      Comparable      Calculated      Interquartile
  Income method application       licensing      uncontrolled    uncontrolled    lump sum PCT     range of PCT
             no.:               discount rate    CSA discount   licensing rate      payment         payments
                                  (percent)     rate (percent)     (percent)
----------------------------------------------------------------------------------------------------------------
1............................              17             19.6              30             291
2............................              17             19.6              32             347
3............................              15             17.3              30             367
4............................              17             19.6              35             431
5............................              15             17.3              32             433
6............................              13             15                30             469
7............................              17             19.6              37             487  LQ = 487
8............................              15             17.3              35             532
9............................              12             13.8              30             535
10...........................              13             15                32             549
11...........................              17             19.6              40             571
12...........................              15             17.3              37             598
13...........................              11             12.7              30             614  Median = 614
14...........................              12             13.8              32             623
15...........................              13             15                35             668
16...........................              15             17.3              40             697
17...........................              11             12.7              32             712
18...........................              13             15                37             748
19...........................              12             13.8              35             755  UQ = 755
20...........................              12             13.8              37             844
21...........................              11             12.7              35             860
22...........................              13             15                40             867
23...........................              11             12.7              37             959
24...........................              12             13.8              40             976
25...........................              11             12.7              40           1,107
----------------------------------------------------------------------------------------------------------------

    (iii) Accordingly, the Commissioner determines that a taxpayer 
will not be subject to adjustment if its initial (ex ante) 
determination of the PCT payment is between $487 million and $755 
million. In the event that the taxpayer's determination of the 
appropriate PCT payment falls outside this range, the adjustment 
made by the Commissioner will ordinarily be to $614.
    Example 3. (i) USP, a U.S. software company, has developed 
version 1.0 of a new software application, employed to store and 
retrieve complex data sets in certain types of storage media. 
Version 1.0 is currently being marketed. In Year 1, USP enters into 
a CSA with its wholly owned foreign subsidiary, FS, to develop 
future versions of the software application. Under the CSA, USP will 
have the exclusive rights to exploit the future versions in the 
U.S., and FS will have the exclusive rights to exploit them in the 
rest of the world. USP's rights in version 1.0, and its development 
team, are reasonably anticipated to contribute to the development of 
future versions of the software application and, therefore, the 
rights in version 1.0 are platform contributions for which 
compensation is due from FS as part of a PCT. USP also transfers the 
current exploitation rights in version 1.0 to FS and the arm's 
length amount of the compensation for such transfer is determined in 
the aggregate with the arm's length PCT Payments in this Example 3. 
FS does not furnish any platform contributions to the CSA nor does 
it control any operating intangibles at the inception of the CSA 
that would be relevant to the exploitation of version 1.0 or future 
versions of the software. It is reasonably anticipated that FS will 
have gross sales of $1000X in its territory for 5 years attributable 
to its exploitation of version 1.0 and the cost shared intangibles, 
after which time the software application will be rendered obsolete 
and unmarketable by the obsolescence of the storage medium 
technology to which it relates. FS's costs reasonably attributable 
to the CSA, other than cost contributions and operating cost 
contributions, are anticipated to be $250X per year. Certain 
operating cost contributions that will be borne by FS are reasonably 
anticipated to equal $200X per annum for 5 years. In addition, FS is 
reasonably anticipated to pay cost contributions of $200X per year 
as a controlled participant in the CSA.
    (ii) FS concludes that its realistic alternative would be to 
license software from an uncontrolled licensor that would undertake 
the commitment to bear the entire risk of software development. 
Applying CPM using the profit levels experienced by uncontrolled 
licensees with contractual provisions and allocations of risk that 
are comparable to those of FS's licensing alternative, FS determines 
that it could, as a licensee, reasonably expect a (pre-tax) routine 
return equal to 14% of gross sales or $140X per year for 5 years. 
The remaining net revenue would be paid to the uncontrolled licensor 
as a license fee of $410X per year. FS determines that the discount 
rate that would be applied to determine the present value of income 
and costs attributable to its participation in the licensing 
alternative would be 12.5% as compared to the 15% discount rate that 
would be applicable in determining the present valuable of the net 
income attributable to its participation in the CSA (reflecting the 
increased risk borne by FS in bearing a share of the R&D costs in 
the cost sharing alternative and the fact that FS intends to pay the 
PCT payment as a single lump sum). FS also determines that the tax 
rate applicable to it will be the same in the licensing alternative 
as in the CSA.
    (iii) On these facts, the present value to FS of entering into 
the cost sharing alternative equals the present value of the 
divisional profits ($1,000X minus $250X) minus operating cost 
contributions ($200X) minus cost contributions ($200X) minus PCT 
Payments, determined over 5 years by discounting at a discount rate 
of 15% (for simplicity of calculation in this example, all financial 
flows are assumed to occur at the beginning of each period). Thus, 
the present value of the residuals, prior to subtracting the value 
of the PCT Payments, is $1349X.
    (iv) On these facts, the present value to FS of entering into 
the licensing alternative would be $561X determined by discounting, 
over 5 years, divisional profits ($1,000X minus $250X) minus 
operating cost contributions ($200X) and licensing payments ($410X) 
at a discount rate of 12.5% per annum. The present value of the cost 
sharing alternative must also equal $561X but equals $1349X prior to 
subtracting the present value of the PCT payments. Consequently, the 
PCT payments must have a present value of $788X. Thus, the arm's 
length lump sum PCT payment made at the time of the PCT will equal 
$788X.

    (5) Acquisition price method--(i) In general. The acquisition price 
method applies the comparable uncontrolled transaction method of Sec.  
1.482-4(c), or the comparable uncontrolled services price method 
described in Sec.  1.482-9T(c), to evaluate whether the amount charged 
in a PCT, or group of PCTs, is arm's length by reference to the amount 
charged (the acquisition price) for the stock or asset purchase of an 
entire organization or portion thereof (the target) in an uncontrolled 
transaction. The acquisition price method is

[[Page 371]]

ordinarily used where substantially all the target's nonroutine 
contributions, as such term is defined in paragraph (j)(1)(i) of this 
section, made to the PCT Payee's business activities are covered by a 
PCT or group of PCTs.
    (ii) Determination of arm's length charge. Under this method, the 
arm's length charge for a PCT or group of PCTs covering resources, 
capabilities, and rights of the target is equal to the adjusted 
acquisition price, as divided among the controlled participants 
according to their respective RAB shares. However, an additional 
adjustment may be necessary to reflect the fact that PCT Payee's tax 
liability attributable to the purchase from target may differ from the 
tax liability attributable to the PCT Payments. See paragraph (g)(2)(x) 
of this section.
    (iii) Adjusted acquisition price. The adjusted acquisition price is 
the acquisition price of the target increased by the value of the 
target's liabilities on the date of the acquisition, other than 
liabilities not assumed in the case of an asset purchase, and decreased 
by the value of the target's tangible property on that date and by the 
value on that date of any other resources, capabilities, and rights not 
covered by a PCT or group of PCTs.
    (iv) Best method analysis considerations. The comparability and 
reliability considerations stated in Sec.  1.482-4(c)(2) apply. 
Consistent with those considerations, the reliability of applying the 
acquisition price method as a measure of the arm's length charge for 
the PCT Payment normally is reduced if--
    (A) A substantial portion of the target's nonroutine contributions 
to the PCT Payee's business activities is not required to be covered by 
a PCT or group of PCTs, and that portion of the nonroutine 
contributions cannot reliably be valued;
    (B) A substantial portion of the target's assets consists of 
tangible property that cannot reliably be valued; or
    (C) The date on which the target is acquired and the date of the 
PCT are not contemporaneous.
    (v) Example. The following example illustrates the principles of 
this paragraph (g)(5):

    Example. USP, a U.S. corporation, and its newly incorporated, 
wholly-owned foreign subsidiary (FS) enter into a CSA at the start 
of Year 1 to develop Group Z products. Under the CSA, USP and FS 
will have the exclusive rights to exploit the Group Z products in 
the U.S. and the rest of the world, respectively. At the start of 
Year 2, USP acquires Company X for cash consideration worth $110 
million. At this time USP's RAB share is 60% and FS's RAB share is 
40%. Company X joins in the filing of a U.S. consolidated income tax 
return with USP. Under paragraph (j)(2)(i) of this section, Company 
X and USP are treated as one taxpayer for purposes of this section. 
Accordingly, the rights in any of Company X's resources and 
capabilities that are reasonably anticipated to contribute to the 
development activities of the CSA will be considered platform 
contributions furnished by USP. Company X's resources and 
capabilities consist of its workforce, certain technology 
intangibles, $15 million of tangible property and other assets and 
$5 million in liabilities. The technology intangibles, as well as 
Company X's workforce, are reasonably anticipated to contribute to 
the development of the Group Z products under the CSA and, 
therefore, the rights in the technology intangibles and the 
workforce are platform contributions for which FS must make a PCT 
Payment to USP. None of Company X's existing intangible assets or 
any of its workforce are anticipated to contribute to activities 
outside the CSA. For purposes of this example, it is assumed that no 
additional adjustment on account of tax liabilities (as described in 
paragraph (g)(5)(ii) of this section) is needed. Applying the 
acquisition price method, the value of USP's platform contributions 
is the adjusted acquisition price of $100 million ($110 million 
acquisition price plus $5 million liabilities less $15 million 
tangible property and other assets). FS must make a PCT Payment to 
USP for these platform contributions with a reasonably anticipated 
present value of $40 million, which is the product of $100 million 
(the value of the platform contributions) and 40% (FS's RAB share at 
the time of the PCT).

    (6) Market capitalization method--(i) In general. The market 
capitalization method applies the comparable uncontrolled transaction 
method of Sec.  1.482-4(c), or the comparable uncontrolled services 
price method described in Sec.  1.482-9T(c), to evaluate whether the 
amount charged in a PCT, or group of PCTs, is arm's length by reference 
to the average market capitalization of a controlled participant (PCT 
Payee) whose stock is regularly traded on an established securities 
market. The market capitalization method is ordinarily used where 
substantially all of the PCT Payee's nonroutine contributions to the 
PCT Payee's business are covered by a PCT or group of PCTs.
    (ii) Determination of arm's length charge. Under the market 
capitalization method, the arm's length charge for a PCT or group of 
PCTs covering resources, capabilities, and rights of the PCT Payee is 
equal to the adjusted average market capitalization, as divided among 
the controlled participants according to their respective RAB shares. 
An increase to reflect the fact that a PCT Payment may increase the PCT 
Payee's tax liability and decrease the PCT Payor's tax liability may be 
warranted. See paragraph (g)(2)(x) of this section.
    (iii) Average market capitalization. The average market 
capitalization is the average of the daily market capitalizations of 
the PCT Payee over a period of time beginning 60 days before the date 
of the PCT and ending on the date of the PCT. The daily market 
capitalization of the PCT Payee is calculated on each day its stock is 
actively traded as the total number of shares outstanding multiplied by 
the adjusted closing price of the stock on that day. The adjusted 
closing price is the daily closing price of the stock, after 
adjustments for stock-based transactions (dividends and stock splits) 
and other pending corporate (combination and spin-off) restructuring 
transactions for which reliable arm's length adjustments can be made.
    (iv) Adjusted average market capitalization. The adjusted average 
market capitalization is the average market capitalization of the PCT 
Payee increased by the value of the PCT Payee's liabilities on the date 
of the PCT and decreased by the value on such date of the PCT Payee's 
tangible property and of any other resources, capabilities, or rights 
of the PCT Payee not covered by a PCT or group of PCTs.
    (v) Best method analysis considerations. The comparability and 
reliability considerations stated in Sec.  1.482-4(c)(2) apply. 
Consistent with those considerations, the reliability of applying the 
comparable uncontrolled transaction method using the adjusted market 
capitalization of a company as a measure of the arm's length charge for 
the PCT Payment normally is reduced if--
    (A) A substantial portion of the PCT Payee's nonroutine 
contributions to its business activities is not required to be covered 
by a PCT or group of PCTs, and that portion of the nonroutine 
contributions cannot reliably be valued;
    (B) A substantial portion of the PCT Payee's assets consists of 
tangible property that cannot reliably be valued; or
    (C) Facts and circumstances demonstrate the likelihood of a 
material divergence between the average market capitalization of the 
PCT Payee and the value of its resources, capabilities, and rights for 
which reliable adjustments cannot be made.
    (vi) Examples. The following examples illustrate the principles of 
this paragraph (g)(6):

    Example 1. (i) USP, a publicly traded U.S. company, and its 
newly incorporated wholly-owned foreign subsidiary (FS) enter into a 
CSA on Date 1 to develop software. At that

[[Page 372]]

time USP has in-process software but has no software ready for the 
market. Under the CSA, USP and FS will have the exclusive rights to 
exploit the software developed under the CSA in the United States 
and the rest of the world, respectively. On Date 1, USP's RAB share 
is 70% and FS's RAB share is 30%. USP's assembled team of 
researchers and its in-process software are reasonably anticipated 
to contribute to the development of the software under the CSA. 
Therefore, the rights in the research team and in-process software 
are platform contributions for which compensation is due from FS. 
Further, these rights are not reasonably anticipated to contribute 
to any business activity other than the CSA Activity.
    (ii) On Date 1, USP had an average market capitalization of $205 
million, tangible property and other assets that can be reliably 
valued worth $5 million, and no liabilities. Aside from those 
assets, USP had no assets other than its research team and in-
process software. Applying the market capitalization method, the 
value of USP's platform contributions is $200 million ($205 million 
average market capitalization of USP less $5 million of tangible 
property and other assets). The arm's length value of the PCT 
Payments FS must make to USP for the platform contributions, before 
any adjustment on account of tax liability as described in paragraph 
(g)(2)(ii) of this section, is $60 million, which is the product of 
$200 million (the value of the platform contributions) and 30% (FS's 
RAB share on Date 1).
    Example 2. Aggregation with make-or-sell rights. (i) The facts 
are the same as in Example 1, except that on Date 1 USP also has 
existing software ready for the market. USP separately enters into a 
license agreement with FS for make-or-sell rights for all existing 
software outside the United States. No marketing has occurred, and 
USP has no marketing intangibles. This license of current make-or-
sell rights is a transaction governed by Sec.  1.482-4. However, 
after analysis, it is determined that the arm's length PCT Payments 
and the arm's length payments for the make-or-sell license may be 
most reliably determined in the aggregate using the market 
capitalization method, under principles described in paragraph 
(g)(2)(iv) of this section, and it is further determined that those 
principles are most reliably implemented by computing the aggregate 
arm's length charge as the product of the aggregate value of the 
existing and in-process software and FS's RAB share on Date 1.
    (ii) Applying the market capitalization method, the aggregate 
value of USP's platform contributions and the make-or-sell rights in 
its existing software is $250 million ($255 million average market 
capitalization of USP less $5 million of tangible property and other 
assets). The total arm's length value of the PCT Payments and 
license payments FS must make to USP for the platform contributions 
and current make-or-sell rights, before any adjustment on account of 
tax liability as described in paragraph (g)(2)(ii) of this section, 
is $75 million, which is the product of $250 million (the value of 
the platform contributions and the make-or-sell rights) and 30% 
(FS's RAB share on Date 1).
    Example 3. Reduced reliability. The facts are the same as in 
Example 1 except that USP also has significant nonroutine assets 
that will be used solely in a nascent business division that is 
unrelated to the subject of the CSA and that cannot themselves be 
reliably valued. Those nonroutine contributions are not platform 
contributions and accordingly are not required to be covered by a 
PCT. The reliability of using the market capitalization method to 
determine the value of USP's platform contributions to the CSA is 
significantly reduced in this case because that method would require 
adjusting USP's average market capitalization to account for the 
significant nonroutine contributions that are not required to be 
covered by a PCT.

    (7) Residual profit split method--(i) In general. The residual 
profit split method evaluates whether the allocation of combined 
operating profit or loss attributable to one or more platform 
contributions subject to a PCT is arm's length by reference to the 
relative value of each controlled participant's contribution to that 
combined operating profit or loss. The combined operating profit or 
loss must be derived from the most narrowly identifiable business 
activity (relevant business activity) of the controlled participants 
for which data are available that include the CSA Activity. The 
residual profit split method may not be used where only one controlled 
participant makes significant nonroutine contributions (including 
platform or operating contributions) to the CSA Activity. The 
provisions of Sec.  1.482-6 shall apply to CSAs only to the extent 
provided and as modified in this paragraph (g)(7). Any other 
application to a CSA of a residual profit method not described in 
paragraphs (g)(7)(ii) and (iii) will constitute an unspecified method 
for purposes of sections 482 and 6662(e) and the regulations under 
those sections.
    (ii) Appropriate share of profits and losses. The relative value of 
each controlled participant's contribution to the success of the 
relevant business activity must be determined in a manner that reflects 
the functions performed, risks assumed, and resources employed by each 
participant in the relevant business activity, consistent with the best 
method analysis described in Sec.  1.482-1(c) and (d). Such an 
allocation is intended to correspond to the division of profit or loss 
that would result from an arrangement between uncontrolled taxpayers, 
each performing functions similar to those of the various controlled 
participants engaged in the relevant business activity. The profit 
allocated to any particular controlled participant is not necessarily 
limited to the total operating profit of the group from the relevant 
business activity. For example, in a given year, one controlled 
participant may earn a profit while another controlled participant 
incurs a loss. In addition, it may not be assumed that the combined 
operating profit or loss from the relevant business activity should be 
shared equally, or in any other arbitrary proportion.
    (iii) Profit split--(A) In general. Under the residual profit split 
method, the present value of each controlled participant's residual 
divisional profit or loss attributable to nonroutine contributions 
(nonroutine residual divisional profit or loss) is allocated between 
the controlled participants that each furnish significant nonroutine 
contributions (including platform or operating contributions) to the 
relevant business activity in that division.
    (B) Determine nonroutine residual divisional profit or loss. The 
present value of each controlled participant's nonroutine residual 
divisional profit or loss must be determined to reflect the most 
reliable measure of an arm's length result. The present value of 
nonroutine residual divisional profit or loss equals the present value 
of the stream of the reasonably anticipated residuals over the duration 
of the CSA Activity of divisional profit or loss, minus market returns 
for routine contributions, minus operating cost contributions, minus 
cost contributions, using a discount rate appropriate to such residuals 
in accordance with paragraph (g)(2)(v) of this section.
    (C) Allocate nonroutine residual divisional profit or loss--(1) In 
general. The present value of nonroutine residual divisional profit or 
loss in each controlled participant's division must be allocated among 
all of the controlled participants based upon the relative values, 
determined as of the date of the PCTs, of the PCT Payor's as compared 
to the PCT Payee's nonroutine contributions to the PCT Payor's 
division. For this purpose, the PCT Payor's nonroutine contribution 
consists of the sum of the PCT Payor's nonroutine operating 
contributions and the PCT Payor's RAB share of the PCT Payor's 
nonroutine platform contributions. For this purpose, the PCT Payee's 
nonroutine contribution consists of the PCT Payor's RAB share of the 
PCT Payee's nonroutine platform contributions.
    (2) Relative value determination. The relative values of the 
controlled participants' nonroutine contributions must be determined so 
as to reflect the most reliable measure of an arm's length result. 
Relative values may be measured by external market benchmarks that 
reflect the fair market value of such nonroutine contributions. 
Alternatively, the relative value of nonroutine

[[Page 373]]

contributions may be estimated by the capitalized cost of developing 
the nonroutine contributions and updates, as appropriately grown or 
discounted so that all contributions may be valued on a comparable 
dollar basis as of the same date. If the nonroutine contributions by a 
controlled participant are also used in other business activities (such 
as the exploitation of make-or-sell rights described in paragraph 
(c)(4) of this section), an allocation of the value of the nonroutine 
contributions must be made on a reasonable basis among all the business 
activities in which they are used in proportion to the relative 
economic value that the relevant business activity and such other 
business activities are anticipated to derive over time as the result 
of such nonroutine contributions.
    (3) Determination of PCT Payments. Any amount of the present value 
of a controlled participant's nonroutine residual divisional profit or 
loss that is allocated to another controlled participant represents the 
present value of the PCT Payments due to that other controlled 
participant for its platform contributions to the relevant business 
activity in the relevant division. For purposes of paragraph (j)(3)(ii) 
of this section, the present value of a PCT Payor's PCT Payments under 
this paragraph shall be deemed reduced to the extent of the present 
value of any PCT Payments owed to it from other controlled participants 
under this paragraph (g)(7). The resulting remainder may be converted 
to a fixed or contingent form of payment in accordance with paragraph 
(h) (Form of payment rules) of this section.
    (4) Routine platform and operating contributions. For purposes of 
this paragraph (g)(7), any routine platform or operating contributions, 
the valuation and PCT Payments for which are determined and made 
independently of the residual profit split method, are treated 
similarly to cost contributions and operating cost contributions, 
respectively. Accordingly, wherever used in this paragraph (g)(7), the 
term ``routine contributions'' shall not include routine platform or 
operating contributions, and wherever the terms ``cost contributions'' 
and ``operating cost contributions'' appear in this paragraph (g)(7), 
they shall include net routine platform contributions and net routine 
operating contributions, respectively, as defined in paragraph 
(g)(4)(vi) of this section.
    (iv) Best method analysis considerations--(A) In general. Whether 
results derived from this method are the most reliable measure of the 
arm's length result is determined using the factors described under the 
best method rule in Sec.  1.482-1(c). Thus, comparability and quality 
of data, reliability of assumptions, and sensitivity of results to 
possible deficiencies in the data and assumptions, must be considered 
in determining whether this method provides the most reliable measure 
of an arm's length result. The application of these factors to the 
residual profit split in the context of the relevant business activity 
of developing and exploiting cost shared intangibles is discussed in 
paragraphs (g)(7)(iv)(B), (C) and (D) of this section.
    (B) Comparability. The derivation of the present value of 
nonroutine residual divisional profit or loss includes a carveout on 
account of market returns for routine contributions. Thus, the 
comparability considerations that are relevant for that purpose include 
those that are relevant for the methods that are used to determine 
market returns for the routine contributions.
    (C) Data and assumptions. The reliability of the results derived 
from the residual profit split is affected by the quality of the data 
and assumptions used to apply this method. In particular, the following 
factors must be considered:
    (1) The reliability of the allocation of costs, income, and assets 
between the relevant business activity and the controlled participants' 
other activities that will affect the reliability of the determination 
of the divisional profit or loss and its allocation among the 
controlled participants. See Sec.  1.482-6(c)(2)(ii)(C)(1).
    (2) The degree of consistency between the controlled participants 
and uncontrolled taxpayers in accounting practices that materially 
affect the items that determine the amount and allocation of operating 
profit or loss affects the reliability of the result. See Sec.  1.482-
6(c)(2)(ii)(C)(2).
    (3) The reliability of the data used and the assumptions made in 
estimating the relative value of the nonroutine contributions by the 
controlled participants. In particular, if capitalized costs of 
development are used to estimate the relative value of nonroutine 
contributions, the reliability of the results is reduced relative to 
the reliability of other methods that do not require such an estimate. 
This is because, in any given case, the costs of developing a 
nonroutine contribution may not be related to its market value and 
because the calculation of the capitalized costs of development may 
require the allocation of indirect costs between the relevant business 
activity and the controlled participant's other activities, which may 
affect the reliability of the analysis.
    (D) Other factors affecting reliability. Like the methods described 
in Sec. Sec.  1.482-3 through 1.482-5 and Sec.  1.482-9T(c), the 
carveout on account of market returns for routine contributions relies 
exclusively on external market benchmarks. As indicated in Sec.  1.482-
1(c)(2)(i), as the degree of comparability between the controlled 
participants and uncontrolled transactions increases, the relative 
weight accorded the analysis under this method will increase. In 
addition, to the extent the allocation of nonroutine residual 
divisional profit or loss 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 the controlled participants are evaluated under the 
residual profit split. However, the reliability of the results of an 
analysis based on information from all the controlled participants is 
affected by the reliability of the data and the assumptions pertaining 
to each controlled participant. Thus, if the data and assumptions are 
significantly more reliable with respect to one of the controlled 
participants than with respect to the others, a different method, 
focusing solely on the results of that party, may yield more reliable 
results.
    (v) Examples. The following examples illustrate the principles of 
this paragraph (g)(7):

    Example 1. (i) USP, a U.S. electronic data storage company, has 
partially developed technology for a type of extremely small compact 
storage devices (nanodisks) which are expected to provide a 
significant increase in data storage capacity in various types of 
portable devices such as cell phone, MP3 players, laptop computers 
and digital cameras. At the same time, USP's wholly-owned 
subsidiary, FS, has developed significant marketing intangibles 
outside the United States in the form of customer lists, ongoing 
relations with various OEMs, and trademarks that are well recognized 
by consumers due to a long history of marketing successful data 
storage devices and other hardware used in various types of consumer 
electronics. At the beginning of Year 1, USP enters into a CSA with 
FS to develop nanodisk technologies for eventual commercial 
exploitation. Under the CSA, USP will have the right to exploit 
nanodisks in the United States, while FS will have the right to 
exploit nanodisks in the rest of the world. The partially developed 
nanodisk technologies owned by USP are reasonably anticipated to 
contribute to the development of commercially exploitable nanodisks 
and therefore the rights in the nanodisk technologies constitute 
platform contributions of USP for which compensation is due under 
PCTs. FS does

[[Page 374]]

not own any intangible assets that constitute platform contributions 
for the CSA. Due to the fact that nanodisk technologies have yet to 
be incorporated into any commercially available product, neither USP 
nor FS transfers rights to make or sell current products in 
conjunction with the CSA.
    (ii) Because only in FS's territory do both controlled 
participants make significant nonroutine contributions, USP and FS 
determine that they need to determine the relative value of their 
respective contributions to operating profit or loss attributable to 
the CSA only in FS's territory (that is, to FS's divisional profit 
or loss). FS anticipates making no nanodisk sales during the first 
year of the CSA in its territory with revenues in Year 2 reaching 
$200 million. Revenues through Year 5 are reasonably anticipated to 
increase by 50% per year. The annual growth rate for revenues is 
then expected to decline to 30% per annum in Years 6 and 7, 20% per 
annum in Years 8 and 9 and 10% per annum in Year 10. Revenues are 
then expected to start to decline; declining 10% in Year 11 and 5% 
per annum, thereafter. The routine costs (costs other than cost 
contributions, operating cost contributions, routine platform and 
operating contributions, and nonroutine contributions) that are 
allocable to this revenue in calculating FS's divisional profit or 
loss, are anticipated to equal 45% of gross sales from Year 2, 
onwards. FS undertakes routine distribution activities in its 
markets that constitute routine contributions to the relevant 
business activity of exploiting NanoBuild. USP and FS estimate that 
the total market return on these routine contributions will amount 
to 6% of the routine costs. FS anticipates that its operating cost 
contributions will equal $40 million per annum for the first two 
years of the CSA and $65 and $70 million in Years 3 and 4. 
Thereafter, operating cost contributions are expected to equal 7% of 
revenue in each year. FS expects its cost contributions to be $60 
million in Year 1, rise to $100 million in Years 2 and 3, and then 
decline again to $60 million. Thereafter, FS's cost contributions 
are expected to equal 10% of revenues.
    (iii) USP and FS determine the present value of the stream of 
the reasonably anticipated residuals in FS's territory over the 
duration of the CSA Activity of the divisional profit or loss 
(revenues minus routine costs), minus the market returns for routine 
contributions, the operating cost contributions, and the cost 
contributions. USP and FS determine, based on the considerations 
discussed in paragraph (g)(2)(v) of this section, that the 
appropriate discount rate is 17.5% per annum (for simplicity of 
calculation in this example, all financial flows are assumed to 
occur at the beginning of each period). Therefore, the present value 
of the nonroutine residual divisional profit is $1.319 billion.
    (iv) After analysis, USP and FS determine that the relative 
value of the nanodisk technologies contributed by USP to CSA (giving 
effect only to its value in FS's territory) is roughly 150% of the 
value of FS's marketing intangibles (which only have value in FS's 
territory). Consequently, 60% of the nonroutine residual divisional 
profit is attributable to USP's platform contribution. Therefore, 
FS's PCT payments should have an expected present value equal to 
$792 million (.6 x $1.319 billion).
    Example 2. (i) USP is a U.S. automobile manufacturing company 
that has completed significant research on the development of 
diesel-electric hybrid engines that, if they could be successfully 
manufactured, would result in providing a significant increased fuel 
economy for a wide variety of motor vehicles. Successful 
commercialization of the diesel-electric hybrid engine will require 
the development of a new class of advanced battery that will be 
light, relatively cheap to manufacture and yet capable of holding a 
substantial electric charge. FS, a foreign subsidiary of USP, has 
completed significant research on developing lithium-ion batteries 
that appear likely to have the requisite characteristics. At the 
beginning of Year 1, USP enters into a CSA with FS to further 
develop diesel-electric hybrid engines and lithium-ion battery 
technologies for eventual commercial exploitation. Under the CSA, 
USP will have the right to exploit the diesel-electric hybrid engine 
and lithium-ion battery technologies in the United States, while FS 
will have the right to exploit such technologies in the rest of the 
world. The partially developed diesel-electric hybrid engine and 
lithium-ion battery technologies owned by USP and FS, respectively, 
are reasonably anticipated to contribute to the development of 
commercially exploitable automobile engines and therefore the rights 
in both these technologies constitute platform contributions of USP 
and of FS for which compensation is due under PCTs. At the time of 
inception of the CSA, USP owns operating intangibles in the form of 
self-developed marketing intangibles which have significant value in 
the United States, but not in the rest of the world, and that are 
relevant to exploiting the cost shared intangibles. Similarly, FS 
owns self-developed marketing intangibles which have significant 
value in the rest of the world, but not in the United States, and 
that are relevant to exploiting the cost shared intangibles. 
Although the new class of diesel-electric hybrid engine using 
lithium-ion batteries is not yet ready for commercial exploitation, 
components based on this technology are beginning to be incorporated 
in current-generation gasoline-electric hybrid engines and the 
rights to make and sell such products are transferred from USP to FS 
and vice-versa in conjunction with the inception of the CSA.
    (ii) USP's estimated RAB share is 66.7 percent. During Year 1, 
it is anticipated that sales in USP's territory will be $1000X in 
Year 1. Sales in FS's territory are anticipated to be $500X. 
Thereafter, as revenue from the use of components in gasoline-
electric hybrids is supplemented by revenues from the production of 
complete diesel-electric hybrid engines using lithium-ion battery 
technology, anticipated sales in both territories will increase 
rapidly at a rate of 50% per annum through Year 4. Anticipated sales 
are then anticipated to increase at a rate of 40% per annum for 
another 4 years. Sales are then anticipated to increase at a rate of 
30% per annum through Year 10. Thereafter, sales are anticipated to 
decrease at a rate of 5% per annum for the foreseeable future as new 
automotive drivetrain technologies displace diesel-electric hybrid 
engines and lithium-ion batteries. Total operating expenses 
attributable to product exploitation (including operating cost 
contributions) equal 40% of sales per year for both USP and FS. USP 
and FS estimate that the total market return on their routine 
contributions to the CSA will amount to 6% of the operating 
expenses. USP is expected to bear \2/3\s of the total cost 
contributions for the foreseeable future. Cost contributions are 
expected to total $375X in Year 1 (of which $250X are borne by USP) 
and increase at a rate of 25% per annum through Year 6. In Years 7 
through 10, cost contributions are expected to increase 10% a year. 
Thereafter, cost contributions are expected to decrease by 5% a year 
for the foreseeable future.
    (iii) USP and FS determine the present value of the stream of 
the reasonably anticipated divisional profit or loss (revenues minus 
operating costs), minus the market returns for routine 
contributions, minus cost contributions. USP and FS determine, based 
on the considerations discussed in paragraph (g)(2)(v) of this 
section, that the appropriate discount rate is 12% per year. 
Therefore, the present value of the nonroutine residual divisional 
profit in USP's territory is $41,115X and in CFC's territory is 
$20,557X (for simplicity of calculation in this example, all 
financial flows are assumed to occur at the beginning of each 
period).
    (iv) After analysis, USP and FS determine that, in the United 
States the relative value of the technologies contributed by USP and 
FS to the CSA and of the operating intangibles used by USP in the 
exploitation of the cost shared intangibles (reported as equaling 
100 in total), equals: USP's platform contribution (59.5); FS's 
platform contribution (25.5); and USP's operating intangibles (15). 
Consequently, the present value of the arm's length amount of the 
PCT payments that USP should pay to FS for FS's platform 
contribution is $10,484X (.255 x $41,115X). Similarly, USP and FS 
determine that, in the rest of the world, the relative value of the 
technologies contributed by USP and FS to the CSA and of the 
operating intangibles used by FS in the exploitation of the cost 
shared intangibles can be divided as follows: USP's platform 
contribution (63); FS's platform contribution (27); and FS's 
operating intangibles (10). Consequently, the present value of the 
arm's length amount of the PCT payments that FS should pay to USP 
for USP's platform contribution is $12,951X (.63 x $20,557X). 
Therefore, FS is required to make a net payment to USP with a 
present value of $2,467X ($12,951X-10,484X).

    (8) Unspecified methods. Methods not specified in paragraphs (g)(3) 
through (7) of this section may be used to evaluate whether the amount 
charged for a PCT is arm's length. Any method used under this paragraph 
(g)(8) must be applied in accordance with the provisions of Sec.  
1.482-1 and of paragraph (g)(2) of this section. Consistent with the 
specified methods, an unspecified method should take into account the

[[Page 375]]

general principle that uncontrolled taxpayers evaluate the terms of a 
transaction by considering the realistic alternatives to that 
transaction, and only enter into a particular transaction if none of 
the alternatives is preferable to it. Therefore, in establishing 
whether a PCT achieved an arm's length result, an unspecified method 
should provide information on the prices or profits that the controlled 
participant could have realized by choosing a realistic alternative to 
the CSA. See paragraph (k)(2)(ii)(J) of this section. 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) (Best method 
rule). 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 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.
    (h) Form of payment rules--(1) CST Payments. CST Payments may not 
be paid in shares of stock in the payor (or stock in any member of the 
controlled group that includes the controlled participants).
    (2) PCT Payments--(i) In general. The consideration under a PCT for 
a platform contribution may take one or a combination of both of the 
following forms:
    (A) Payments of a fixed amount (fixed payments), either paid in a 
lump sum payment or in installment payments spread over a specified 
period, with interest calculated in accordance with Sec.  1.482-2(a) 
(Loans or advances).
    (B) Payments contingent on the exploitation of cost shared 
intangibles by the PCT Payor (contingent payments).
    (ii) No PCT Payor Stock. PCT Payments may not be paid in shares of 
stock in the PCT Payor (or stock in any member of the controlled group 
that includes the controlled participants).
    (iii) Specified form of payment--(A) In general. The form of 
payment selected (subject to the rules of this paragraph (h)) for any 
PCT, including, in the case of contingent payments, the contingent base 
and structure of the payments as set forth in paragraph (h)(2)(iii)(B) 
of this section, must be specified no later than the due date of the 
applicable tax return (including extensions) for the later of the 
taxable year of the PCT Payor or PCT Payee that includes the date of 
that PCT.
    (B) Contingent payments. In accordance with paragraph (k)(1)(iv)(A) 
of this section, a provision of a written contract described in 
paragraph (k)(1) of this section, or of the additional documentation 
described in paragraph (k)(2) of this section, that provides for 
payments for a PCT (or group of PCTs) to be contingent on the 
exploitation of cost shared intangibles will be respected as consistent 
with economic substance only if the allocation between the controlled 
participants of the risks attendant on such form of payment is 
determinable before the outcomes of such allocation that would have 
materially affected the PCT pricing are known or reasonably knowable. A 
contingent payment provision must clearly and unambiguously specify the 
basis on which the contingent payment obligations are to be determined. 
In particular, the contingent payment provision must clearly and 
unambiguously specify the events that give rise to an obligation to 
make PCT Payments, the royalty base (such as sales or revenues), and 
the computation used to determine the PCT Payments. The royalty base 
specified must be one that permits verification of its proper use by 
reference to books and records maintained by the controlled 
participants in the normal course of business (for example, books and 
records maintained for financial accounting or business management 
purposes).
    (C) Examples. The following examples illustrate the principles of 
this paragraph (h)(2)(iii).

    Example 1. A CSA provides that PCT payments with respect to a 
particular platform contribution shall be contingent payments equal 
to 15% of the revenues from sales of products that incorporate cost 
shared intangibles. The terms further permit (but do not require) 
the controlled participants to adjust such contingent payments in 
accordance with a formula set forth in the arrangement so that the 
15% rate is subject to adjustment by the controlled participants at 
their discretion on an after-the-fact, uncompensated basis. The 
Commissioner may impute payment terms that are consistent with 
economic substance with respect to the platform contribution because 
the contingent payment provision does not specify the computation 
used to determine the PCT Payments.
    Example 2. Taxpayer, an automobile manufacturer, is a controlled 
participant in a CSA that involves research and development to 
perfect certain manufacturing techniques necessary to the actual 
manufacture of a state-of-the-art, hybrid fuel injection system 
known as DRL337. The arrangement involves the platform contribution 
of a design patent covering DRL337. Pursuant to paragraph 
(h)(2)(iii)(B) of this section, the CSA provides for PCT payments 
with respect to the platform contribution of the patent in the form 
of royalties contingent on sales of automobiles that contain the 
DRL337 system. However, Taxpayer's system of book- and record-
keeping does not enable Taxpayer to track which automobile sales 
involve automobiles that contain the DRL337 system. Because Taxpayer 
has not complied with paragraph (h)(2)(iii)(B) of this section, the 
Commissioner may impute payment terms that are consistent with 
economic substance and susceptible to verification by the 
Commissioner.

    (iv) Conversion from fixed to contingent form of payment. With 
regard to a conversion of a fixed present value to a contingent form of 
payment, see paragraphs (g)(2)(v) (Discount rate) and (g)(2)(vi) 
(Financial projections) of this section.
    (3) Coordination of best method rule and form of payment. A method 
described in paragraph (g)(1) of this section evaluates the arm's 
length amount charged in a PCT in terms of a form of payment (method 
payment form). For example, the method payment form for the acquisition 
price method described in paragraph (g)(5) of this section, and for the 
market capitalization method described in paragraph (g)(6) of this 
section, is fixed payment. Applications of the income method provide 
different method payment forms. See paragraphs (g)(4)(i)(E) and 
(g)(4)(iv) of this section. The method payment form may not necessarily 
correspond to the form of payment specified pursuant to paragraphs 
(h)(2)(iii) and (k)(2)(ii)(l) of this section (specified payment form). 
The determination under Sec.  1.482-1(c) of the method that provides 
the most reliable measure of an arm's length result is to be made 
without regard to whether the respective method payment forms under the 
competing methods correspond to the specified payment form. If the 
method payment form of the method determined under Sec.  1.482-1(c) to 
provide the most reliable measure of an arm's length result differs 
from the specified payment form, then the conversion from such method 
payment form to such specified payment form will be made to the 
satisfaction of the Commissioner.
    (i) Allocations by the Commissioner in connection with a CSA--(1) 
In general. The Commissioner may make allocations to adjust the results 
of a controlled transaction in connection with a CSA so that the 
results are consistent with an arm's length result, in accordance with 
the provisions of this paragraph (i).
    (2) CST allocations--(i) In general. The Commissioner may make 
allocations to adjust the results of a CST so that the results are 
consistent with an

[[Page 376]]

arm's length result, including any allocations to make each controlled 
participant's IDC share, as determined under paragraph (d)(4) of this 
section, equal to that participant's RAB share, as determined under 
paragraph (e)(1) of this section. Such allocations may result from, for 
purposes of CST determinations, adjustments to--
    (A) Redetermine IDCs by adding any costs (or cost categories) that 
are directly identified with, or are reasonably allocable to, the IDA, 
or by removing any costs (or cost categories) that are not IDCs;
    (B) Reallocate costs between the IDA and other business activities;
    (C) Improve the reliability of the selection or application of the 
basis used for measuring benefits for purposes of estimating a 
controlled participant's RAB share;
    (D) Improve the reliability of the projections used to estimate RAB 
shares, including adjustments described in paragraph (i)(2)(ii) of this 
section; and
    (E) Allocate among the controlled participants any unallocated 
interests in cost shared intangibles.
    (ii) Adjustments to improve the reliability of projections used to 
estimate RAB shares--(A) Unreliable projections. A significant 
divergence between projected benefit shares and benefit shares adjusted 
to take into account any available actual benefits to date (adjusted 
benefit shares) may indicate that the projections were not reliable for 
purposes of estimating RAB shares. In such a case, the Commissioner may 
use adjusted benefit shares as the most reliable measure of RAB shares 
and adjust IDC shares accordingly. The projected benefit shares will 
not be considered unreliable, as applied in a given taxable year, based 
on a divergence from adjusted benefit shares for every controlled 
participant that is less than or equal to 20% of the participant's 
projected benefits share. Further, the Commissioner will not make an 
allocation based on such divergence if the difference is due to an 
extraordinary event, beyond the control of the controlled participants, 
which could not reasonably have been anticipated at the time that costs 
were shared. The Commissioner generally may adjust projections of 
benefits used to calculate benefit shares in accordance with the 
provisions of Sec.  1.482-1. In particular, if benefits are projected 
over a period of years, and the projections for initial years of the 
period prove to be unreliable, this may indicate that the projections 
for the remaining years of the period are also unreliable and thus 
should be adjusted. For purposes of this paragraph (i)(2)(ii)(A), all 
controlled participants that are not U.S. persons are treated as a 
single controlled participant. Therefore, an adjustment based on an 
unreliable projection of RAB shares will be made to the IDC shares of 
foreign controlled participants only if there is a matching adjustment 
to the IDC shares of controlled participants that are U.S. persons. 
Nothing in this paragraph (i)(2)(ii)(A) prevents the Commissioner from 
making an allocation if a taxpayer did not use the most reliable basis 
for measuring anticipated benefits. For example, if the taxpayer 
measures its anticipated benefits based on units sold, and the 
Commissioner determines that another basis is more reliable for 
measuring anticipated benefits, then the fact that actual units sold 
were within 20% of the projected unit sales will not preclude an 
allocation under this section.
    (B) Foreign-to-foreign adjustments. Adjustments to IDC shares based 
on an unreliable projection also may be made among foreign controlled 
participants if the variation between actual and projected benefits has 
the effect of substantially reducing U.S. tax.
    (C) Correlative adjustments to PCTs. Correlative adjustments will 
be made to any PCT Payments of a fixed amount that were determined 
based on RAB shares that are subsequently adjusted on a finding that 
they were based on unreliable projections. No correlative adjustments 
will be made to contingent PCT Payments regardless of whether RAB 
shares were used as a parameter in the valuation of those payments.
    (D) Examples. The following examples illustrate the principles of 
this paragraph (i)(2)(ii):

    Example 1. U.S. Parent (USP) and Foreign Subsidiary (FS) enter 
into a CSA to develop new food products, dividing costs on the basis 
of projected sales two years in the future. In Year 1, USP and FS 
project that their sales in Year 3 will be equal, and they divide 
costs accordingly. In Year 3, the Commissioner examines the 
controlled participants' method for dividing costs. USP and FS 
actually accounted for 42% and 58% of total sales, respectively. The 
Commissioner agrees that sales two years in the future provide a 
reliable basis for estimating benefit shares. Because the 
differences between USP's and FS's adjusted and projected benefit 
shares are less than 20% of their projected benefit shares, the 
projection of future benefits for Year 3 is reliable.
    Example 2. The facts are the same as in Example 1, except that 
in Year 3 USP and FS actually accounted for 35% and 65% of total 
sales, respectively. The divergence between USP's projected and 
adjusted benefit shares is greater than 20% of USP's projected 
benefit share and is not due to an extraordinary event beyond the 
control of the controlled participants. The Commissioner concludes 
that the projected benefit shares were unreliable, and uses adjusted 
benefit shares as the basis for an adjustment to the cost shares 
borne by USP and FS.
    Example 3. U.S. Parent (USP), a U.S. corporation, and its 
foreign subsidiary (FS) enter into a CSA in Year 1. They project 
that they will begin to receive benefits from cost shared 
intangibles in Years 4 through 6, and that USP will receive 60% of 
total benefits and FS 40% of total benefits. In Years 4 through 6, 
USP and FS actually receive 50% each of the total benefits. In 
evaluating the reliability of the controlled participants' 
projections, the Commissioner compares the adjusted benefit shares 
to the projected benefit shares. Although USP's adjusted benefit 
share (50%) is within 20% of its projected benefit share (60%), FS's 
adjusted benefit share (50%) is not within 20% of its projected 
benefit share (40%). Based on this discrepancy, the Commissioner may 
conclude that the controlled participants' projections were 
unreliable and may use adjusted benefit shares as the basis for an 
adjustment to the cost shares borne by USP and FS.
    Example 4. Three controlled taxpayers, USP, FS1, and FS2 enter 
into a CSA. FS1 and FS2 are foreign. USP is a domestic corporation 
that controls all the stock of FS1 and FS2. The controlled 
participants project that they will share the total benefits of the 
cost shared intangibles in the following percentages: USP 50%; FS1 
30%; and FS2 20%. Adjusted benefit shares are as follows: USP 45%; 
FS1 25%; and FS2 30%. In evaluating the reliability of the 
controlled participants' projections, the Commissioner compares 
these adjusted benefit shares to the projected benefit shares. For 
this purpose, FS1 and FS2 are treated as a single controlled 
participant. The adjusted benefit share received by USP (45%) is 
within 20% of its projected benefit share (50%). In addition, the 
non-U.S. controlled participant's adjusted benefit share (55%) is 
also within 20% of their projected benefit share (50%). Therefore, 
the Commissioner concludes that the controlled participant's 
projections of future benefits were reliable, despite the fact that 
FS2's adjusted benefit share (30%) is not within 20% of its 
projected benefit share (20%).
    Example 5. The facts are the same as in Example 4. In addition, 
the Commissioner determines that FS2 has significant operating 
losses and has no earnings and profits, and that FS1 is profitable 
and has earnings and profits. Based on all the evidence, the 
Commissioner concludes that the controlled participants arranged 
that FS1 would bear a larger cost share than appropriate in order to 
reduce FS1's earnings and profits and thereby reduce inclusions USP 
otherwise would be deemed to have on account of FS1 under subpart F. 
Pursuant to paragraph (i)(2)(ii)(B) of this section, the 
Commissioner may make an adjustment solely to the cost shares borne 
by FS1 and FS2 because FS2's projection of future benefits was 
unreliable and the variation between adjusted and projected benefits 
had the effect of substantially reducing USP's U.S. income tax 
liability (on account of FS1 subpart F income).

[[Page 377]]

    Example 6. (i)(A) Foreign Parent (FP) and U.S. Subsidiary (USS) 
enter into a CSA in 1996 to develop a new treatment for baldness. 
USS's interest in any treatment developed is the right to produce 
and sell the treatment in the U.S. market while FP retains rights to 
produce and sell the treatment in the rest of the world. USS and FP 
measure their anticipated benefits from the CSA based on their 
respective projected future sales of the baldness treatment. The 
following sales projections are used:

                                  Sales
                        [In millions of dollars]
------------------------------------------------------------------------
                           Year                              USS     FP
------------------------------------------------------------------------
1.........................................................      5     10
2.........................................................     20     20
3.........................................................     30     30
4.........................................................     40     40
5.........................................................     40     40
6.........................................................     40     40
7.........................................................     40     40
8.........................................................     20     20
9.........................................................     10     10
10........................................................      5      5
------------------------------------------------------------------------

    (B) In Year 1, the first year of sales, USS is projected to have 
lower sales than FP due to lags in U.S. regulatory approval for the 
baldness treatment. In each subsequent year, USS and FP are 
projected to have equal sales. Sales are projected to build over the 
first three years of the period, level off for several years, and 
then decline over the final years of the period as new and improved 
baldness treatments reach the market.
    (ii) To account for USS's lag in sales in the Year 1, the 
present discounted value of sales over the period is used as the 
basis for measuring benefits. Based on the risk associated with this 
venture, a discount rate of 10 percent is selected. The present 
discounted value of projected sales is determined to be 
approximately $154.4 million for USS and $158.9 million for FP. On 
this basis USS and FP are projected to obtain approximately 49.3% 
and 50.7% of the benefit, respectively, and the costs of developing 
the baldness treatment are shared accordingly.
    (iii)(A) In Year 6, the Commissioner examines the CSA. USS and 
FP have obtained the following sales results through Year 5:

                                  Sales
                        [In millions of dollars]
------------------------------------------------------------------------
                           Year                              USS     FP
------------------------------------------------------------------------
1.........................................................      0     17
2.........................................................     17     35
3.........................................................     25     41
4.........................................................     38     41
5.........................................................     39     41
------------------------------------------------------------------------

    (B) USS's sales initially grew more slowly than projected while 
FP's sales grew more quickly. In each of the first three years of 
the period, the share of total sales of at least one of the parties 
diverged by over 20% from its projected share of sales. However, by 
Year 5 both parties' sales had leveled off at approximately their 
projected values. Taking into account this leveling off of sales and 
all the facts and circumstances, the Commissioner determines that it 
is appropriate to use the original projections for the remaining 
years of sales. Combining the actual results through Year 5 with the 
projections for subsequent years, and using a discount rate of 10%, 
the present discounted value of sales is approximately $141.6 
million for USS and $187.3 million for FP. This result implies that 
USS and FP obtain approximately 43.1% and 56.9%, respectively, of 
the anticipated benefits from the baldness treatment. Because these 
adjusted benefit shares are within 20% of the benefit shares 
calculated based on the original sales projections, the Commissioner 
determines that, based on the difference between adjusted and 
projected benefit shares, the original projections were not 
unreliable. No adjustment is made based on the difference between 
adjusted and projected benefit shares.
    Example 7. (i) The facts are the same as in Example 6, except 
that the actual sales results through Year 5 are as follows:

                                  Sales
                        [In millions of dollars]
------------------------------------------------------------------------
                           Year                              USS     FP
------------------------------------------------------------------------
1.........................................................      0     17
2.........................................................     17     35
3.........................................................     25     44
4.........................................................     34     54
5.........................................................     36     55
------------------------------------------------------------------------

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

                                  Sales
                        [In millions of dollars]
------------------------------------------------------------------------
                           Year                              USS     FP
------------------------------------------------------------------------
6.........................................................     36     55
7.........................................................     36     55
8.........................................................     18     28
9.........................................................      9     14
10........................................................    4.5      7
------------------------------------------------------------------------

    (iii) Combining the actual results through Year 5 with the 
projections for subsequent years, and using a discount rate of 10%, 
the present discounted value of sales is approximately $131.2 
million for USS and $229.4 million for FP. This result implies that 
USS and FP obtain approximately 35.4% and 63.6%, respectively, of 
the anticipated benefits from the baldness treatment. These adjusted 
benefit shares diverge by greater than 20% from the benefit shares 
calculated based on the original sales projections, and the 
Commissioner determines that, based on the difference between 
adjusted and projected benefit shares, the original projections were 
unreliable. The Commissioner adjusts cost shares for each of the 
taxable years under examination to conform them to the recalculated 
shares of anticipated benefits.

    (iii) Timing of CST allocations. If the Commissioner makes an 
allocation to adjust the results of a CST, the allocation must be 
reflected for tax purposes in the year in which the IDCs were incurred. 
When a CST payment is owed by one controlled participant to another 
controlled participant, the Commissioner may make appropriate 
allocations to reflect an arm's length rate of interest for the time 
value of money, consistent with the provisions of Sec.  1.482-2(a) 
(Loans or advances).
    (3) PCT allocations. The Commissioner may make allocations to 
adjust the results of a PCT so that the results are consistent with an 
arm's length result in accordance with the provisions of the applicable 
sections of the regulations under section 482, as determined pursuant 
to paragraph (a)(2) of this section.
    (4) Allocations regarding changes in participation under a CSA. The 
Commissioner may make allocations to adjust the results of any 
controlled transaction described in paragraph (f) of this section if 
the controlled participants do not reflect arm's length results in 
relation to any such transaction.
    (5) Allocations when CSTs are consistently and materially 
disproportionate to RAB shares. If a controlled participant bears IDC 
shares that are consistently and materially greater or lesser than its 
RAB share, then the Commissioner may conclude that the economic 
substance of the arrangement between the controlled participants is 
inconsistent with the terms of the CSA. In such a case, the 
Commissioner may disregard such terms and impute an agreement that is 
consistent with the controlled participants' course of conduct, under 
which a controlled participant that bore a disproportionately greater 
IDC share received additional interests in the cost shared intangibles. 
See Sec.  1.482-1(d)(3)(ii)(B) (Identifying contractual terms) and 
Sec.  1.482-4(f)(3)(ii) (Identification of owner). Such additional 
interests will consist of partial undivided interests in the other 
controlled participant's interest in the cost shared intangible. 
Accordingly, that controlled participant must receive arm's length 
consideration from any controlled participant whose IDC share is less 
than its RAB share over time, under the provisions of Sec. Sec.  1.482-
1 and 1.482-4 through 1.482-6 to provide compensation for the latter 
controlled

[[Page 378]]

participants' use of such partial undivided interest.
    (6) Periodic adjustments--(i) In general. Subject to the exceptions 
in paragraph (i)(6)(vi) of this section, the Commissioner may make 
periodic adjustments for an open taxable year (the Adjustment Year) and 
for all subsequent taxable years for the duration of the CSA Activity 
with respect to all PCT Payments, if the Commissioner determines that, 
for a particular PCT (the Trigger PCT), a particular controlled 
participant that owes or owed a PCT Payment relating to that PCT (such 
controlled participant being referred to as the PCT Payor for purposes 
of this paragraph (i)(6)) has realized an Actually Experienced Return 
Ratio (AERR) that is outside the Periodic Return Ratio Range (PRRR). 
The satisfaction of the condition stated in the preceding sentence is 
referred to as a Periodic Trigger. See paragraphs (i)(6)(ii) through 
(vi) of this section regarding the PRRR, the AERR, and periodic 
adjustments. In determining whether to make such adjustments, the 
Commissioner may consider whether the outcome as adjusted more reliably 
reflects an arm's length result under all the relevant facts and 
circumstances, including any information known as of the Determination 
Date. The Determination Date is the date of the relevant determination 
by the Commissioner. The failure of the Commissioner to determine for 
an earlier taxable year that a PCT Payment was not arm's length will 
not preclude the Commissioner from making a periodic adjustment for a 
subsequent year. A periodic adjustment under this paragraph (i)(6) may 
be made without regard to whether the taxable year of the Trigger PCT 
or any other PCT remains open for statute of limitations purposes or 
whether a periodic adjustment has previously been made with respect to 
any PCT payment.
    (ii) PRRR. Except as provided in the next sentence, the PRRR will 
consist of return ratios that are not less than .667 nor more than 1.5. 
Alternatively, if the controlled participants have not substantially 
complied with the documentation requirements referenced in paragraph 
(k) of this section, as modified, if applicable, by paragraphs (m)(2) 
and (3) of this section, the PRRR will consist of return ratios that 
are not less than .8 nor more than 1.25.
    (iii) AERR--(A) In general. The AERR is the Present Value of Total 
Profits (PVTP) divided by the Present Value of Investment (PVI). In 
computing PVTP and PVI, present values are computed using the 
Applicable Discount Rate (ADR), and all information available as of the 
Determination Date is taken into account.
    (B) PVTP. The PVTP is the present value, as of the CSA Start Date, 
as defined in section (j)(1)(i) of this section, of the PCT Payor's 
actually experienced divisional profits or losses from the CSA Start 
Date through the end of the Adjustment Year.
    (C) PVI. The PVI is the present value, as of the CSA Start Date, of 
the PCT Payor's investment associated with the CSA Activity, defined as 
the sum of its cost contributions and its PCT Payments, from the CSA 
Start Date through the end of the Adjustment Year. For purposes of 
computing the PVI, PCT Payments means all PCT Payments due from a PCT 
Payor before netting against PCT Payments due from other controlled 
participants pursuant to paragraph (j)(3)(ii) of this section.
    (iv) ADR--(A) In general. Except as provided in paragraph 
(i)(6)(iv)(B) of this section, the ADR is the discount rate pursuant to 
paragraph (g)(2)(v) of this section, subject to such adjustments as the 
Commissioner determines appropriate.
    (B) Publicly traded companies. If the PCT Payor meets the 
conditions of paragraph (i)(6)(iv)(C) of this section, the ADR is the 
PCT Payor WACC as of the date of the Trigger PCT. However, if the 
Commissioner determines, or the controlled participants establish to 
the satisfaction of the Commissioner, that a discount rate other than 
the PCT Payor WACC better reflects the degree of risk of the CSA 
Activity as of such date, the ADR is such other discount rate.
    (C) Publicly traded. A PCT Payor meets the conditions of this 
paragraph (i)(6)(iv)(C) if--
    (1) Stock of the PCT Payor is publicly traded; or
    (2) Stock of the PCT Payor is not publicly traded, provided--
    (i) The PCT Payor is included in a group of companies for which 
consolidated financial statements are prepared; and
    (ii) A publicly traded company in such group owns, directly or 
indirectly, stock in PCT Payor. Stock of a company is publicly traded 
within the meaning of this paragraph (i)(6)(iv)(C) if such stock is 
regularly traded on an established United States securities market and 
the company issues financial statements prepared in accordance with 
United States generally accepted accounting principles for the taxable 
year.
    (D) PCT Payor WACC. The PCT Payor WACC is the WACC, as defined in 
paragraph (j)(1)(i) of this section, of the PCT Payor or the publicly 
traded company described in paragraph (i)(6)(iv)(C)(2)(ii) of this 
section, as the case may be.
    (E) Generally accepted accounting principles. For purposes of 
paragraph (i)(6)(iv)(C) of this section, a financial statement prepared 
in accordance with a comprehensive body of generally accepted 
accounting principles other than United States generally accepted 
accounting principles is considered to be prepared in accordance with 
United States generally accepted accounting principles provided that 
the amounts of debt, equity, and interest expense are reflected in any 
reconciliation between such other accounting principles and United 
States generally accepted accounting principles required to be 
incorporated into the financial statement by the securities laws 
governing companies whose stock is regularly traded on United States 
securities markets.
    (v) Determination of periodic adjustments. In the event of a 
Periodic Trigger, subject to paragraph (i)(6)(vi) of this section, the 
Commissioner may make periodic adjustments with respect to all PCT 
Payments between all PCT Payors and PCT Payees for the Adjustment Year 
and all subsequent years for the duration of the CSA Activity pursuant 
to the residual profit split method as provided in paragraph (g)(7) of 
this section, subject to the further modifications in this paragraph 
(i)(6)(v). A periodic adjustment may be made for a particular taxable 
year without regard to whether the taxable years of the Trigger PCT or 
other PCTs remain open for statute of limitation purposes.
    (A) In general. Periodic adjustments are determined by the 
following steps:
    (1) First, determine the present value, as of the date of the 
Trigger PCT, of the PCT Payments under paragraph (g)(7)(iii)(C)(3) of 
this section pursuant to the Adjusted RPSM as defined in paragraph 
(i)(6)(v)(B) of this section (first step result).
    (2) Second, convert the first step result into a stream of 
contingent payments on a base of reasonably anticipated divisional 
profits or losses over the entire duration of the CSA Activity, using a 
level royalty rate (second step rate). See paragraph (h)(2)(iv) of this 
section (Conversion from fixed to contingent form of payment). This 
conversion is made based on all information known as of the 
Determination Date.
    (3) Third, apply the second step rate to the actual divisional 
profit or loss for taxable years preceding and including the Adjustment 
Year to yield a stream of contingent payments for such years, and 
convert such stream to a present

[[Page 379]]

value as of the CSA Start Date under the principles of paragraph 
(g)(2)(v) of this section (third step result). For this purpose, the 
second step rate applied to a loss for a particular year will yield a 
negative contingent payment for that year.
    (4) Fourth, convert any actual PCT Payments up through the 
Adjustment Year to a present value as of the CSA Start Date under the 
principles of paragraph (g)(2)(v) of this section. Then subtract such 
amount from the third step result. Determine the nominal amount in the 
Adjustment Year that would have a present value as of the CSA Start 
Date equal to the present value determined in the previous sentence to 
determine the periodic adjustment in the Adjustment Year.
    (5) Fifth, apply the second step rate to the actual divisional 
profit or loss for each taxable year after the Adjustment Year up to 
and including the taxable year that includes the Determination Date to 
yield a stream of contingent payments for such years. For this purpose, 
the second step rate applied to a loss will yield a negative contingent 
payment for that year. Then subtract from each such payment any actual 
PCT Payment made for the same year to determine the periodic adjustment 
for such taxable year.
    (6) For each taxable year subsequent to the year that includes the 
Determination Date, the periodic adjustment for such taxable year 
(which is in lieu of any PCT Payment that would otherwise be payable 
for that year under the taxpayer's position) equals the second step 
rate applied to the actual divisional profit or loss for that year. For 
this purpose, the second step rate applied to a loss for a particular 
year will yield a negative contingent payment for that year.
    (7) If the periodic adjustment for any taxable year is a positive 
amount, then it is an additional PCT Payment owed from the PCT Payor to 
the PCT Payee for such year. If the periodic adjustment for any taxable 
year is a negative amount, then it is an additional PCT Payment owed by 
the PCT Payee to the PCT Payor for such year.
    (B) Adjusted RPSM as of Determination Date. The Adjusted RPSM is 
the residual profit split method pursuant to paragraph (g)(7) of this 
section applied to determine the present value, as of the date of the 
Trigger PCT, of the PCT Payments under paragraph (g)(7)(iii)(C)(3) of 
this section, with the following modifications.
    (1) Actual results up through the Determination Date shall be 
substituted for what otherwise were the projected results over such 
period, as reasonably anticipated as of the date of the Trigger PCT.
    (2) Projected results for the balance of the CSA Activity after the 
Determination Date, as reasonably anticipated as of the Determination 
Date, shall be substituted for what otherwise were the projected 
results over such period, as reasonably anticipated as of the date of 
the Trigger PCT.
    (3) The requirement in paragraph (g)(7)(i) of this section, that at 
least two controlled participants make significant nonroutine 
contributions, does not apply.
    (vi) Exceptions to periodic adjustments--(A) Controlled 
participants establish periodic adjustment not warranted. No periodic 
adjustment will be made under paragraphs (i)(6)(i) and (i)(6)(v) of 
this section if the controlled participants establish to the 
satisfaction of the Commissioner that all the conditions described in 
one of paragraphs (i)(6)(vi)(A)(1) through (4) of this section apply 
with respect to the Trigger PCT.
    (1) Transactions involving the same platform contribution as in the 
Trigger PCT.
    (i) The same platform contribution is furnished to an uncontrolled 
taxpayer under substantially the same circumstances as those of the 
relevant Trigger PCT and with a similar form of payment as the Trigger 
PCT;
    (ii) This transaction serves as the basis for the application of 
the comparable uncontrolled transaction method described in paragraph 
(g)(3) of this section, in the first year and all subsequent years in 
which substantial PCT Payments relating to the Trigger PCT were 
required to be paid; and
    (iii) The amount of those PCT Payments in that first year was arm's 
length.
    (2) Results not reasonably anticipated. The differential between 
the AERR and the nearest bound of the PRRR is due to extraordinary 
events beyond the control of the controlled participants that could not 
reasonably have been anticipated as of the date of the Trigger PCT.
    (3) Reduced AERR does not cause Periodic Trigger. The Periodic 
Trigger would not have occurred had the PCT Payor's divisional profits 
or losses used to calculate its PVTP excluded those profits or losses 
attributable to the PCT Payor's routine contributions to its 
exploitation of cost shared intangibles, attributable to its operating 
cost contributions, and attributable to its nonroutine contributions to 
the CSA Activity.
    (4) Increased AERR does not cause Periodic Trigger--(i) The 
Periodic Trigger would not have occurred had the divisional profits or 
losses of the PCT Payor used to calculate its PVTP included its 
reasonably anticipated divisional profits or losses after the 
Adjustment Year from the CSA Activity, including from its routine 
contributions, its operating cost contributions, and its nonroutine 
contributions to that activity, and had the cost contributions and PCT 
Payments of the PCT Payor used to calculate its PVI included its 
reasonably anticipated cost contributions and PCT Payments after the 
Adjustment Year. The reasonably anticipated amounts in the previous 
sentence are determined based on all information available as of the 
Determination Date.
    (ii) For purposes of this paragraph (i)(6)(vi)(A)(4), the 
controlled participants may, if they wish, assume that the average 
yearly divisional profits or losses for all taxable years prior to and 
including the Adjustment Year, in which there has been substantial 
exploitation of cost shared intangibles resulting from the CSA 
(exploitation years), will continue to be earned in each year over a 
period of years equal to 15 minus the number of exploitation years 
prior to and including the Determination Date.
    (B) Circumstances in which Periodic Trigger deemed not to occur. No 
Periodic Trigger will be deemed to have occurred at the times and in 
the circumstances described in paragraph (i)(6)(vi)(B)(1) or (2) of 
this section.
    (1) 10-year period. In any year subsequent to the 10-year period 
beginning with the first taxable year in which there is substantial 
exploitation of cost shared intangibles resulting from the CSA, if the 
AERR determined is within the PRRR for each year of such 10-year 
period.
    (2) 5-year period. In any year of the 5-year period beginning with 
the first taxable year in which there is substantial exploitation of 
cost shared intangibles resulting from the CSA, if the AERR falls below 
the lower bound of the PRRR.
    (vii) Examples. The following examples illustrate the rules of this 
paragraph (i)(6):

    Example 1. (i) At the beginning of Year 1, USP, a publicly 
traded U.S. company, and FS, its wholly-owned foreign subsidiary, 
enter into a CSA to develop new technology for cell phones. USP has 
a platform contribution, the rights for an in-process technology 
that when developed will improve the clarity of calls, for which 
compensation is due from FS. FS has no platform contributions to the 
CSA, no operating contributions, and no operating cost 
contributions. USP and FS agree to fixed

[[Page 380]]

PCT payments of $40 million in Year 1 and $10 million per year for 
Years 2 through 10. At the beginning of Year 1, the weighted average 
cost of capital of the controlled group that includes USP and FS is 
15%. In Year 9, the Commissioner audits Years 5 through 7 of the CSA 
and considers whether any periodic adjustments should be made. USP 
and FS have substantially complied with the documentation 
requirements of paragraph (k) of this section.
    (ii) FS experiences the results reported in the following table 
from its participation in the CSA through Year 7. In the table, all 
present values (PV) are reported as of the CSA Start Date, which is 
the same as the date of the PCT (and reflect a 15% discount rate as 
discussed in paragraph (iii) of this Example 1). Thus, in any year 
the present value of the cumulative investment is PVI and of the 
cumulative divisional profit or loss is PVTP. All amounts in this 
table and the tables that follow are reported in millions of dollars 
and cost contributions are referred to as ``CCs'' (for simplicity of 
calculation in this Example 1, all financial flows are assumed to 
occur at the beginning of the year).

----------------------------------------------------------------------------------------------------------------
                   a                        b        c       d         e            f            g          h
----------------------------------------------------------------------------------------------------------------
                                                                                                           AERR
                                                   Non-CC             PCT       Investment   Divisional   (PVTP/
                  Year                    Sales    costs    CCs     payments      (d+e)      profit or   PVI) (g/
                                                                                             loss (b-c)     f)
----------------------------------------------------------------------------------------------------------------
1......................................        0        0     15           40           55            0
2......................................        0        0     17           10           27            0
3......................................        0        0     18           10           28            0
4......................................      680      662     20           10           30           18
5......................................      836      718     22           10           32          118
6......................................    1,023      680     24           10           34          343
7......................................    1,079      747     27           10           37          332
PV through Year 5......................      925      846     69           69          138           79      .58
PV through Year 6......................    1,434    1,184     81           74          155          250     1.62
PV through Year 7......................    1,900    1,507     93           78          171          393     2.31
----------------------------------------------------------------------------------------------------------------

    (iii) Because USP is publicly traded in the United States and is 
a member of the controlled group to which FS (the PCT Payor) 
belongs, for purposes of calculating the AERR for FS, the present 
values of its PVTP and PVI are determined using an ADR of 15%, the 
weighted average cost of capital of the controlled group. (It is 
assumed that no other rate was determined or established, under 
paragraph (i)(6)(iv)(B) of this section, to better reflect the 
relevant degree of risk.) At a 15% discount rate, the PVTP, 
calculated as of Year 1, and based on actual profits realized by FS 
through Year 7 from exploiting the new cell phone technology 
developed by the CSA, is $393 million. The PVI, based on FS's cost 
contributions and its PCT Payments, is $171 million. The AERR for FS 
is equal to its PVTP divided by its PVI, $393 million/$171 million, 
or 2.31. There is a Periodic Trigger because FS's AERR of 2.31 falls 
outside the PRRR of .67 to 1.5, the applicable PRRR for controlled 
participants complying with the documentation requirements of this 
section.
    (iv) At the time of the Determination Date, it is determined 
that the first Adjustment Year in which a Periodic Trigger occurred 
was Year 6, when the AERR of FS was determined to be 1.62. It is 
also determined that for Year 6 none of the exceptions to periodic 
adjustments described in paragraph (i)(6)(vi) of this section 
applies. The Commissioner exercises its discretion under paragraph 
(i)(6)(i) of this section to make periodic adjustments using Year 6 
as the Adjustment Year. Therefore, the arm's length PCT Payments 
from FS to USP shall be determined for each taxable year using the 
adjusted residual profit split method described in paragraphs 
(g)(7)(v)(B) and (i)(6)(v)(B) of this section. Periodic adjustments 
will be made for each year to the extent the PCT Payments actually 
made by FS differ from the PCT Payment calculation under the 
adjusted residual profit split method.
    (v) It is determined, as of the Determination Date, that the 
cost shared intangibles will be exploited through Year 10. FS's 
return for routine functions (determined by the Commissioner, based 
on the return for comparable routine functions undertaken by 
comparable uncontrolled companies, to be 10% of non-CC costs), and 
its actual and projected results, are described in the following 
table.

----------------------------------------------------------------------------------------------------------------
                        a                            b        c          d         e         f            g
----------------------------------------------------------------------------------------------------------------
                                                                     Divisional                        Residual
                      Year                         Sales    Non-CC   profits or   CCs     Routine    profit (d-e-
                                                            costs    loss (b-c)            return         f)
----------------------------------------------------------------------------------------------------------------
1...............................................        0        0            0     15            0          -15
2...............................................        0        0            0     17            0          -17
3...............................................        0        0            0     18            0          -18
4...............................................      680      662           18     20           66          -68
5...............................................      836      718          118     22           72           24
6...............................................    1,023      680          343     24           68          251
7...............................................    1,079      747          332     27           75          230
8...............................................    1,138      822          316     29           82          205
9...............................................    1,200      894          306     32           89          185
10..............................................    1.265      974          291     35           97          159
Cumulative PV through Year 10 as of CSA Start       3,080    2,385          695    124          238          332
 Date...........................................
----------------------------------------------------------------------------------------------------------------

    (vi) The periodic adjustments are calculated in a series of 
steps set out in paragraph (i)(6)(v)(A) of this section. First, a 
lump sum for the PCT Payment is determined using the adjusted 
residual profit split method. Under the method, based on the 
considerations discussed in paragraph (g)(2)(v) of this section, the 
appropriate discount rate is 15% per year. The non-routine residual 
divisional profit or loss described in paragraph (g)(7)(iii)(B) of 
this section is $332 million. Further under paragraph (g)(7)(iii)(C) 
of this section, the entire nonroutine residual divisional profit 
constitutes the PCT Payment because only USP has nonroutine 
contributions.
    (vii) In step two, the first step result ($332 million) is 
converted into a level royalty rate

[[Page 381]]

based on the reasonably anticipated divisional profits or losses of 
the CSA Activity, the PV of which is reported in the table above 
(net PV of divisional profit or loss for Years 1 through 10 is $695 
million). Consequently, the step two result is a level royalty rate 
of 47.8% ($332/$694) of the divisional profit in Years 1 through 10.
    (viii) In step three, the Commissioner calculates the PCT 
Payments due through Year 6 by applying the step two royalty rate to 
the actual divisional profits for each year and then determines the 
aggregate PV of these PCT Payments as of the CSA Start Date ($120 
million as reported in the following table). In step four, the PCT 
Payments actually made through Year 6 are similarly converted to PV 
as of the CSA Start Date ($74 million) and subtracted from the 
amount determined in step three ($120 million - $74 million = $46 
million). That difference of $46 million, representing a net PV as 
of the CSA Start Date, is then converted to a nominal amount, as of 
the Adjustment Year, of equivalent present value (again using a 
discount rate of 15%). That nominal amount is $93 million (not shown 
in the table), and is the periodic adjustment in Year 6.

----------------------------------------------------------------------------------------------------------------
                              a                                    b            c            d            e
----------------------------------------------------------------------------------------------------------------
                                                                                          Nominal
                                                                                        royalty due    Nominal
                            Year                               Divisional    Royalty       under       payments
                                                                 profit        rate       adjusted       made
                                                                                         RPSM (b*c)
----------------------------------------------------------------------------------------------------------------
Year 1......................................................            0        47.8%           $0          $40
Year 2......................................................            0         47.8            0           10
Year 3......................................................            0         47.8            0           10
Year 4......................................................           18         47.8            9           10
Year 5......................................................          118         47.8           56           10
Year 6......................................................          343         47.8          164           10
Cumulative PV as of Year 1..................................  ...........  ...........          120           74
----------------------------------------------------------------------------------------------------------------

    (ix) Under step five, the royalties due from FS to USP for Year 
7 (the year after the Adjustment Year) through Year 9 (the year 
including the Determination Date) are determined. (These 
determinations are made for Years 8 and 9 after the divisional 
profit for those years becomes available.) For each year, the 
periodic adjustment is a PCT Payment due in addition to the $10 
million PCT Payment that must otherwise be paid under the CSA as 
described in paragraph (i) of this Example 1. That periodic 
adjustment is calculated as the product of the step two royalty rate 
and the divisional profit, minus the $10 million that was otherwise 
paid for that year. The calculations are shown in the following 
table:

----------------------------------------------------------------------------------------------------------------
                       a                              b            c            d            E            f
----------------------------------------------------------------------------------------------------------------
                                                                                            PCT
                                                  Divisional    Royalty    Royalty due    payments     Periodic
                      Year                          profit        rate         (b*c)     otherwise    adjustment
                                                                                            paid        (d-e)
----------------------------------------------------------------------------------------------------------------
7..............................................          332        47.8%         $159          $10         $149
8..............................................          316         47.8          151           10          141
9..............................................          306         47.8          146           10          136
----------------------------------------------------------------------------------------------------------------

    (x) Under step six, the periodic adjustment for Year 10 (the 
only exploitation year after the year containing the Determination 
Date) will be determined by applying the step two royalty rate to 
the divisional profit. This periodic adjustment is a PCT Payment 
payable from FS to USP, and is in lieu of the $10 payment otherwise 
due. The calculations are shown in the following table, based on a 
divisional profit of $291 million. USP and FS experienced the 
following results in Year 10.

----------------------------------------------------------------------------------------------------------------
                                                                             PCT payment called for
                Year                   Divisional    Royalty    Royalty due      under original        Periodic
                                         profit        rate                  agreement but not made   adjustment
----------------------------------------------------------------------------------------------------------------
10..................................          291        47.8%         $139  $10 (not paid)........         $139
----------------------------------------------------------------------------------------------------------------

    Example 2. The facts are the same as Example 1 (i) through 
(iii). At the time of the Determination Date, it is determined that 
the first Adjustment Year in which a Periodic Trigger occurred was 
Year 6, when the AERR of FS was determined to be 1.62. Upon further 
investigation as to what may have caused the high return in FS's 
market, the Commissioner learns that, in Years 4 through 6, USP's 
leading competitors experienced severe, unforeseen disruptions in 
their supply chains resulting in a significant increase in USP's and 
FS's market share for cell phones. Further analysis determines that 
without this unforeseen occurrence the Periodic Trigger would not 
have occurred. Based on paragraph (i)(6)(vi)(A)(2) of this section, 
the Commissioner determines to his satisfaction that no adjustments 
are warranted.

    (j) Definitions and special rules--(1) Definitions--(i) In general. 
For purposes of this section--

------------------------------------------------------------------------
                                                         Main cross
            Term                   Definition            references
------------------------------------------------------------------------
Acquisition price...........  ....................  Sec.   1.482-
                                                     7T(g)(5)(i).
Adjusted acquisition price..  ....................  Sec.   1.482-
                                                     7T(g)(5)(iii).
Adjusted average market       ....................  Sec.   1.482-
 capitalization.                                     7T(g)(6)(iv).
Adjusted benefit shares.....  ....................  Sec.   1.482-
                                                     7T(i)(2)(ii)(A).
Adjusted RPSM...............  ....................  Sec.   1.482-
                                                     7T(i)(6)(v)(B).

[[Page 382]]

 
Adjustment Year.............  ....................  Sec.   1.482-
                                                     7T(i)(6)(i).
ADR.........................  ....................  Sec.   1.482-
                                                     7T(i)(6)(iv).
AERR........................  ....................  Sec.   1.482-
                                                     7T(i)(6)(iii).
Applicable Method...........  ....................  Sec.   1.482-
                                                     7T(g)(2)(ix)(A).
Average market                ....................  Sec.   1.482-
 capitalization.                                     7T(g)(6)(iii).
Benefits....................  Benefits means the    Sec.   1.482-
                               sum of additional     7T(e)(1)(i).
                               revenue generated,
                               plus cost savings,
                               minus any cost
                               increases from
                               exploiting cost
                               shared intangibles.
Capability variation........  ....................  Sec.   1.482-
                                                     7T(f)(3).
Change in participation       ....................  Sec.   1.482-7T(f).
 under a CSA.
Consolidated group..........  ....................  Sec.   1.482-
                                                     7T(j)(2)(i).
Contingent payments.........  ....................  Sec.   1.482-
                                                     7T(h)(2)(i)(B).
Controlled participant......  Controlled            Sec.   1.482-
                               participant means a   7T(a)(1).
                               controlled
                               taxpayer, as
                               defined under Sec.
                                1.482-1(i)(5),
                               that is a party to
                               the contractual
                               agreement that
                               underlies the CSA,
                               and that reasonably
                               anticipates that it
                               will derive
                               benefits, as
                               defined in
                               paragraph (e)(1)(i)
                               of this section,
                               from exploiting one
                               or more cost shared
                               intangibles.
Controlled transfer of        ....................  Sec.   1.482-
 interests.                                          7T(f)(2).
Cost contribution...........  ....................  Sec.   1.482-
                                                     7T(d)(4).
Cost shared intangible......  Cost shared           Sec.   1.482-7T(b).
                               intangible means
                               any intangible,
                               within the meaning
                               of Sec.   1.482-
                               4(b), that is
                               developed by the
                               IDA, including any
                               portion of such
                               intangible that
                               reflects a platform
                               contribution.
                               Therefore, an
                               intangible
                               developed by the
                               IDA is a cost
                               shared intangible
                               even though the
                               intangible was not
                               always or was never
                               a reasonably
                               anticipated cost
                               shared intangible.
Cost sharing alternative....  ....................  Sec.   1.482-
                                                     7T(g)(4)(i)(B).
Cost sharing arrangement or   ....................  Sec.   1.482-7T(a),
 CSA.                                                (b).
Cost sharing transactions or  ....................  Sec.   1.482-
 CSTs.                                               7T(a)(1),
                                                     (b)(1)(i).
Cross operating               A cross operating     Sec.   1.482-
 contributions.                contribution is any   7T(a)(3)(iii),
                               resource or           (g)(2)(iv).
                               capability or
                               right, other than a
                               platform
                               contribution, that
                               a controlled
                               participant has
                               developed,
                               maintained, or
                               acquired prior to
                               the CSA Start Date
                               that is reasonably
                               anticipated to
                               contribute to the
                               CSA Activity within
                               another controlled
                               participant's
                               division.
CSA Activity................  CSA Activity is the   Sec.   1.482-
                               activity of           7T(c)(2)(i).
                               developing and
                               exploiting cost
                               shared intangibles.
CSA Start Date..............  The earliest date     Sec.   1.482-
                               that any IDC          7T(i)(6)(iii)(B).
                               described in
                               paragraph (d)(1) of
                               this section
                               occurred.
CST Payments................  ....................  Sec.   1.482-
                                                     7T(b)(1).
Date of PCT.................  ....................  Sec.   1.482-
                                                     7T(b)(3).
Determination Date..........  ....................  Sec.   1.482-
                                                     7T(i)(6)(i).
Division....................  Division means the    See definitions of
                               territory or other    divisional profit
                               division that         or loss, operating
                               serves as the basis   contribution, and
                               of the division of    operating cost
                               interests under the   contribution.
                               CSA in the cost
                               shared intangibles
                               pursuant to Sec.
                               1.482-7T(b)(4).
Divisional interest.........  ....................  Sec.   1.482-
                                                     7T(b)(1)(iii),
                                                     (b)(4).
Divisional profit or loss...  Divisional profit or  Sec.   1.482-
                               loss means the        7T(g)(4)(iii).
                               operating profit or
                               loss as separately
                               earned by each
                               controlled
                               participant in its
                               division from the
                               CSA Activity,
                               determined before
                               any expense
                               (including
                               amortization) on
                               account of cost
                               contributions,
                               operating cost
                               contributions,
                               routine platform
                               and operating
                               contributions,
                               nonroutine
                               contributions
                               (including platform
                               and operating
                               contributions), and
                               tax.
Fixed payments..............  ....................  Sec.   1.482-
                                                     7T(h)(2)(i)(A).
IDC share...................  ....................  Sec.   1.482-
                                                     7T(d)(4).
Input parameters............  ....................  Sec.   1.482-
                                                     7T(g)(2)(ix)(B).
Intangible development        ....................  Sec.   1.482-
 activity or IDA.                                    7T(d)(1).
Intangible development costs  ....................  Sec.   1.482-
 or IDCs.                                            7T(a)(1), (d)(1).
Licensing alternative.......  ....................  Sec.   1.482-
                                                     7T(g)(4)(i)(C).
Licensing payments..........  Licensing payments    Sec.   1.482-
                               means payments        7T(g)(4)(iii).
                               pursuant to the
                               licensing
                               obligations under
                               the licensing
                               alternative.

[[Page 383]]

 
Make-or-sell rights.........  ....................  Sec.   1.482-
                                                     7T(c)(4),
                                                     (g)(2)(iv).
Market-based input parameter  ....................  Sec.   1.482-
                                                     7T(g)(2)(ix)(B).
Market returns for routine    Market returns for    Sec.   1.482-
 contributions.                routine               7T(g)(4), (g)(7).
                               contributions means
                               returns determined
                               by reference to the
                               returns achieved by
                               uncontrolled
                               taxpayers engaged
                               in activities
                               similar to the
                               relevant business
                               activity in the
                               controlled
                               participant's
                               division,
                               consistent with the
                               methods described
                               in Sec.  Sec.
                               1.482-3, 1.482-4,
                               1.482-5, or Sec.
                               1.482-9T(c).
Method payment form.........  ....................  Sec.   1.482-
                                                     7T(h)(3).
Nonroutine contributions....  Nonroutine            Sec.   1.482-7T(g).
                               contributions means
                               a controlled
                               participant's
                               contributions to
                               the relevant
                               business activities
                               that are not
                               routine
                               contributions.
                               Nonroutine
                               contributions
                               ordinarily include
                               both nonroutine
                               platform
                               contributions and
                               nonroutine
                               operating
                               contributions used
                               by controlled
                               participants in the
                               commercial
                               exploitation of
                               their interests in
                               the cost shared
                               intangibles (for
                               example, marketing
                               intangibles used by
                               a controlled
                               participant in its
                               division to sell
                               products that are
                               based on the cost
                               shared intangible).
Nonroutine residual           ....................  Sec.   1.482-
 divisional profit or loss.                          7T(g)(7)(iii).
Operating contributions.....  An operating          Sec.   1.482-
                               contribution is any   7T(g)(2)(ii),
                               resource or           (g)(4)(v)(E),
                               capability or         (g)(7)(iii)(A) &
                               right, other than a   (C).
                               platform
                               contribution, that
                               a controlled
                               participant has
                               developed,
                               maintained, or
                               acquired prior to
                               the CSA Start Date
                               that is reasonably
                               anticipated to
                               contribute to the
                               CSA Activity within
                               the controlled
                               participant's
                               division.
Operating cost contributions  Operating cost        Sec.   1.482-
                               contributions means   7T(g)(2)(ii),
                               all costs in the      (g)(4)(iii),
                               ordinary course of    (g)(7)(iii)(B).
                               business on or
                               after the CSA Start
                               Date that, based on
                               analysis of the
                               facts and
                               circumstances, are
                               directly identified
                               with, or are
                               reasonably
                               allocable to,
                               developing
                               resources,
                               capabilities, or
                               rights (other than
                               reasonably
                               anticipated cost
                               shared intangibles)
                               that are reasonably
                               anticipated to
                               contribute to the
                               CSA Activity within
                               the controlled
                               participant's
                               division.
PCT Payee...................  ....................  Sec.   1.482-
                                                     7T(b)(1)(ii).
PCT Payment.................  ....................  Sec.   1.482-
                                                     7T(b)(1)(ii).
PCT Payor...................  ....................  Sec.   1.482-
                                                     7T(b)(1)(ii),
                                                     (i)(6)(i).
PCT Payor WACC..............  ....................  Sec.   1.482-
                                                     7T(i)(6)(iv)(D).
Periodic adjustments........  ....................  Sec.   1.482-
                                                     7T(i)(6)(i).
Periodic Trigger............  ....................  Sec.   1.482-
                                                     7T(i)(6)(i).
Platform contribution         ....................  Sec.   1.482-
 transaction or PCT.                                 7T(a)(2),
                                                     (b)(1)(ii).
Platform contributions......  ....................  Sec.   1.482-
                                                     7T(c)(1).
Post-tax income.............  ....................  Sec.   1.482-
                                                     7T(g)(2)(v)(B)(3),
                                                     (g)(4)(i)(G).
Pre-tax income..............  ....................  Sec.   1.482-
                                                     7T(g)(2)(v)(B)(3),
                                                     (g)(4)(i)(G).
Projected benefit shares....  ....................  Sec.   1.482-
                                                     7T(i)(2)(ii)(A).
PRRR........................  ....................  Sec.   1.482-
                                                     7T(i)(6)(ii).
PVI.........................  ....................  Sec.   1.482-
                                                     7T(i)(6)(iii)(C).
PVTP........................  ....................  Sec.   1.482-
                                                     7T(i)(6)(iii)(B).
Reasonably anticipated        A controlled          Sec.   1.482-
 benefits.                     participant's         7T(e)(1).
                               reasonably
                               anticipated
                               benefits means the
                               benefits that
                               reasonably may be
                               anticipated to be
                               derived from
                               exploiting cost
                               shared intangibles.
                               For purposes of
                               this definition,
                               benefits mean the
                               sum of additional
                               revenue generated,
                               plus cost savings,
                               minus any cost
                               increases from
                               exploiting cost
                               shared intangibles.
Reasonably anticipated        ....................  Sec.   1.482-
 benefits or RAB shares.                             7T(a)(1), (e)(1).
Reasonably anticipated cost   ....................  Sec.   1.482-
 shared intangible.                                  7T(d)(1)(ii).
Relevant business activity..  ....................  Sec.   1.482-
                                                     7T(g)(7)(i).

[[Page 384]]

 
Routine contributions.......  Routine               Sec.   1.482-
                               contributions means   7T(g)(4), (g)(7).
                               a controlled
                               participant's
                               contributions to
                               the relevant
                               business activities
                               that are of the
                               same or 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
                               participants.
Routine platform and          ....................  Sec.   1.482-
 operating contributions,                            7T(g)(4)(vi), 1.482-
 and net routine platform                            7(g)(7)(iii)(C)(4).
 and operating contributions.
Specified payment form......  ....................  Sec.   1.482-
                                                     7T(h)(3).
Stock-based compensation....  ....................  Sec.   1.482-
                                                     7T(d)(3).
Stock options...............  ....................  Sec.   1.482-
                                                     7T(d)(3)(i).
Subsequent PCT..............  ....................  Sec.   1.482-
                                                     7T(g)(2)(viii).
Target......................  ....................  Sec.   1.482-
                                                     7T(g)(5)(i).
Trigger PCT.................  ....................  Sec.   1.482-
                                                     7T(i)(6)(i).
Variable input parameter....  ....................  Sec.   1.482-
                                                     7T(g)(2)(ix)(C).
WACC........................  WACC means weighted   Sec.   1.482-
                               average cost of       7T(i)(6)(iv)(D).
                               capital.
------------------------------------------------------------------------

    (ii) Examples. The following examples illustrate certain 
definitions in paragraph (j)(1)(i) of this section:

    Example 1. Controlled participant. Foreign Parent (FP) is a 
foreign corporation engaged in the extraction of a natural resource. 
FP has a U.S. subsidiary (USS) to which FP sells supplies of this 
resource for sale in the United States. FP enters into a CSA with 
USS to develop a new machine to extract the natural resource. The 
machine uses a new extraction process that will be patented in the 
United States and in other countries. The CSA provides that USS will 
receive the rights to exploit the machine in the extraction of the 
natural resource in the United States, and FP will receive the 
rights in the rest of the world. This resource does not, however, 
exist in the United States. Despite the fact that USS has received 
the right to exploit this process in the United States, USS is not a 
controlled participant because it will not derive a benefit from 
exploiting the intangible developed under the CSA.
    Example 2. Controlled participants. (i) U.S. Parent (USP), one 
foreign subsidiary (FS), and a second foreign subsidiary 
constituting the group's research arm (R+D) enter into a CSA to 
develop manufacturing intangibles for a new product line A. USP and 
FS are assigned the exclusive rights to exploit the intangibles 
respectively in the United States and the rest of the world, where 
each presently manufactures and sells various existing product 
lines. R+D is not assigned any rights to exploit the intangibles. 
R+D's activity consists solely in carrying out research for the 
group. It is reliably projected that the RAB shares of USP and FS 
will be 66\2/3\% and 33\1/3\%, respectively, and the parties' 
agreement provides that USP and FS will reimburse 66\2/3\% and 33\1/
3\%, respectively, of the IDCs incurred by R+D with respect to the 
new intangible.
    (ii) R+D does not qualify as a controlled participant within the 
meaning of paragraph (j)(1)(i) of this section, because it will not 
derive any benefits from exploiting cost shared intangibles. 
Therefore, R+D is treated as a service provider for purposes of this 
section and must receive arm's length consideration for the 
assistance it is deemed to provide to USP and FS, under the rules of 
paragraph (a)(3) of this section and Sec. Sec.  1.482-4(f)(3)(iii), 
1.482-4T(f)(4), and 1.482-9T, as appropriate. Such consideration 
must be treated as IDCs incurred by USP and FS in proportion to 
their RAB shares (that is, 66\2/3\% and 33\1/3\%, respectively). R+D 
will not be considered to bear any share of the IDCs under the 
arrangement.
    Example 3. Cost shared intangible, reasonably anticipated cost 
shared intangible. U.S. Parent (USP) has developed and currently 
exploits an antihistamine, XY, which is manufactured in tablet form. 
USP enters into a CSA with its wholly-owned foreign subsidiary (FS) 
to develop XYZ, a new improved version of XY that will be 
manufactured as a nasal spray. Work under the CSA is fully devoted 
to developing XYZ, and XYZ is developed. During the development 
period, XYZ is a reasonably anticipated cost shared intangible under 
the CSA. Once developed, XYZ is a cost shared intangible under the 
CSA.
    Example 4. Cost shared intangible. The facts are the same as in 
Example 3, except that in the course of developing XYZ, the 
controlled participants by accident discover ABC, a cure for disease 
D. ABC is a cost shared intangible under the CSA.
    Example 5. Reasonably anticipated benefits. Controlled parties A 
and B enter into a cost sharing arrangement to develop product and 
process intangibles for an already existing Product P. Without such 
intangibles, A and B would each reasonably anticipate revenue, in 
present value terms, of $100M from sales of Product P until it 
became obsolete. With the intangibles, A and B each reasonably 
anticipate selling the same number of units each year, but 
reasonably anticipate that the price will be higher. Because the 
particular product intangible is more highly regarded in A's market, 
A reasonably anticipates an increase of $20M in present value 
revenue from the product intangible, while B reasonably anticipates 
only an increase of $10M. Further, A and B each reasonably 
anticipate spending an extra $5M present value in production costs 
to include the feature embodying the product intangible. Finally, A 
and B each reasonably anticipate saving $2M present value in 
production costs by using the process intangible. A and B reasonably 
anticipate no other economic effects from exploiting the cost shared 
intangibles. A's reasonably anticipated benefits from exploiting the 
cost shared intangibles equal its reasonably anticipated increase in 
revenue ($20M) plus its reasonably anticipated cost savings ($2M) 
minus its reasonably anticipated increased costs ($5M), which equals 
$17M. Similarly, B's reasonably anticipated benefits from exploiting 
the cost shared intangibles equal its reasonably anticipated 
increase in revenue ($10M) plus its reasonably anticipated cost 
savings ($2M) minus its reasonably anticipated increased costs 
($5M), which equals $7M. Thus A's reasonably anticipated benefits 
are $17M and B's reasonably anticipated benefits are $7M.

    (2) Special rules--(i) Consolidated group. For purposes of this 
section, all members of the same consolidated group shall be treated as 
one taxpayer. For these purposes, the term consolidated group means all 
members of a group of controlled entities created

[[Page 385]]

or organized within a single country and subjected to an income tax by 
such country on the basis of their combined income.
    (ii) Trade or business. A participant that is a foreign corporation 
or nonresident alien individual will not be treated as engaged in a 
trade or business within the United States solely by reason of its 
participation in a CSA. See generally Sec.  1.864-2(a).
    (iii) Partnership. A CSA, or an arrangement to which the 
Commissioner applies the rules of this section, will not be treated as 
a partnership to which the rules of subchapter K of the Internal 
Revenue Code apply. See Sec.  301.7701-1(c) of this chapter.
    (3) Character--(i) CST Payments. CST Payments generally will be 
considered the payor's costs of developing intangibles at the location 
where such development is conducted. For these purposes, IDCs borne 
directly by a controlled participant that are deductible are deemed to 
be reduced to the extent of any CST Payments owed to it by other 
controlled participants pursuant to the CSA. Each cost sharing payment 
received by a payee will be treated as coming pro rata from payments 
made by all payors and will be applied pro rata against the deductions 
for the taxable year that the payee is allowed in connection with the 
IDCs. Payments received in excess of such deductions will be treated as 
in consideration for use of the land and tangible property furnished 
for purposes of the CSA by the payee. For purposes of the research 
credit determined under section 41, CST Payments among controlled 
participants will be treated as provided for intra-group transactions 
in Sec.  1.41-6(i). Any payment made or received by a taxpayer pursuant 
to an arrangement that the Commissioner determines not to be a CSA will 
be subject to the provisions of Sec. Sec.  1.482-1, 1.482-4 through 
1.482-6 and 1.482-9T. Any payment that in substance constitutes a cost 
sharing payment will be treated as such for purposes of this section, 
regardless of its characterization under foreign law.
    (ii) PCT Payments. A PCT Payor's payment required under paragraph 
(b)(1)(ii) of this section is deemed to be reduced to the extent of any 
payments owed to it under such paragraph from other controlled 
participants. Each PCT Payment received by a PCT Payee will be treated 
as coming pro rata out of payments made by all PCT Payors. PCT Payments 
will be characterized consistently with the designation of the type of 
transaction pursuant to paragraphs (c)(3) and (k)(2)(ii)(H) of this 
section. Depending on such designation, such payments will be treated 
as either consideration for a transfer of an interest in intangible 
property or for services.
    (iii) Examples. The following examples illustrate this paragraph 
(j)(3):

    Example 1. U.S. Parent (USP) and its wholly owned Foreign 
Subsidiary (FS) form a CSA to develop a miniature widget, the Small 
R. Based on RAB shares, USP agrees to bear 40% and FS to bear 60% of 
the costs incurred during the term of the agreement. The principal 
IDCs are operating costs incurred by FS in Country Z of 100X 
annually, and costs incurred by USP in the United States also of 
100X annually. Of the total costs of 200X, USP's share is 80X and 
FS's share is 120X so that FS must make a payment to USP of 20X. The 
payment will be treated as a reimbursement of 20X of USP's costs in 
the United States. Accordingly, USP's Form 1120 will reflect an 80X 
deduction on account of activities performed in the United States 
for purposes of allocation and apportionment of the deduction to 
source. The Form 5471 ``Information Return of U.S. Persons With 
Respect to Certain Foreign Corporations'' for FS will reflect a 100X 
deduction on account of activities performed in Country Z and a 20X 
deduction on account of activities performed in the United States.
    Example 2. The facts are the same as in Example 1, except that 
the 100X of costs borne by USP consist of 5X of costs incurred by 
USP in the United States and 95X of arm's length rental charge, as 
described in paragraph (d)(1)(iii) of this section, for the use of a 
facility in the United States. The depreciation deduction 
attributable to the U.S. facility is 7X. The 20X net payment by FS 
to USP will first be applied in reduction pro rata of the 5X 
deduction for costs and the 7X depreciation deduction attributable 
to the U.S. facility. The 8X remainder will be treated as rent for 
the U.S. facility.
    Example 3. (i) Four members A, B, C, and D of a controlled group 
form a CSA to develop the next generation technology for their 
business. Based on RAB shares, the participants agree to bear shares 
of the costs incurred during the term of the agreement in the 
following percentages: A 40%; B 15%; C 25%; and D 20%. The arm's 
length values of the platform contributions they respectively own 
are in the following amounts for the taxable year: A 80X; B 40X; C 
30X; and D 30X. The provisional (before offsets) and final PCT 
Payments among A, B, C, and D are shown in the table as follows:

                       [All amounts stated in X's]
------------------------------------------------------------------------
                                         A        B        C        D
------------------------------------------------------------------------
Payments............................     <40>     <21>   <37.5>     <30>
Receipts............................       48       34     22.5       24
                                     -----------------------------------
    Final...........................        8       13     <15>      <6>
------------------------------------------------------------------------

    (ii) The first row/first column shows A's provisional PCT 
Payment equal to the product of 100X (sum of 40X, 30X, and 30X) and 
A's RAB share of 40%. The second row/first column shows A's 
provisional PCT receipts equal to the sum of the products of 80X and 
B's, C's, and D's RAB shares (15%, 25%, and 20%, respectively). The 
other entries in the first two rows of the table are similarly 
computed. The last row shows the final PCT receipts/payments after 
offsets. Thus, for the taxable year, A and B are treated as 
receiving the 8X and 13X, respectively, pro rata out of payments by 
C and D of 15X and 6X, respectively.

    (k) CSA administrative requirements. A controlled participant meets 
the requirements of this paragraph if it substantially complies, 
respectively, with the CSA contractual, documentation, accounting, and 
reporting requirements of paragraphs (k)(1), (k)(2), (k)(3), and (k)(4) 
of this section.
    (1) CSA contractual requirements--(i) In general. A CSA must be 
recorded in writing in a contract that is contemporaneous with the 
formation (and any revision) of the CSA and that includes the 
contractual provisions described in this paragraph (k)(1).
    (ii) Contractual provisions. The written contract described in this 
paragraph (k)(1) must include provisions that--
    (A) List the controlled participants and any other members of the 
controlled group that are reasonably anticipated to benefit from the 
use of the cost shared intangibles, including the address of each 
domestic entity and the country of organization of each foreign entity;
    (B) Describe the scope of the IDA to be undertaken and each 
reasonably anticipated cost shared intangible or class of reasonably 
anticipated cost shared intangibles;
    (C) Specify the functions and risks that each controlled 
participant will undertake in connection with the CSA;
    (D) Divide among the controlled participants all divisional 
interests in

[[Page 386]]

cost shared intangibles and specify each controlled participant's 
divisional interest in the cost shared intangibles, as described in 
paragraphs (b)(1)(iii) and (b)(4) of this section, that it will own and 
exploit without any further obligation to compensate any other 
controlled participant for such interest;
    (E) Provide a method to calculate the controlled participants' RAB 
shares, based on factors that can reasonably be expected to reflect the 
participants' shares of anticipated benefits, and require that such RAB 
shares must be updated, as described in paragraph (e)(1) of this 
section (see also paragraph (k)(2)(ii)(F) of this section);
    (F) Enumerate all categories of IDCs to be shared under the CSA;
    (G) Specify that the controlled participant must use a consistent 
method of accounting to determine IDCs and RAB shares, as described in 
paragraphs (d) and (e) of this section, respectively, and must 
translate foreign currencies on a consistent basis;
    (H) Require the controlled participant to enter into CSTs covering 
all IDCs, as described in paragraph (b)(1)(i) of this section, in 
connection with the CSA;
    (I) Require the controlled participants to enter into PCTs covering 
all platform contributions, as described in paragraph (b)(1)(ii) of 
this section, in connection with the CSA;
    (J) Specify the form of payment due under each PCT (or group of 
PCTs) in existence at the formation (and any revision) of the CSA, 
including information and explanation that reasonably supports an 
analysis of applicable provisions of paragraph (h) of this section; and
    (K) Specify the date on which the CSA is entered into and the 
duration of the CSA, the conditions under which the CSA may be modified 
or terminated, and the consequences of a modification or termination 
(including consequences described under the rules of paragraph (f) of 
this section).
    (iii) Meaning of contemporaneous--(A) In general. For purposes of 
this paragraph (k)(1), a written contractual agreement is 
contemporaneous with the formation (or revision) of a CSA if, and only 
if, the controlled participants record the CSA, in its entirety, in a 
document that they sign and date no later than 60 days after the first 
occurrence of any IDC described in paragraph (d) of this section to 
which such agreement (or revision) is to apply.
    (B) Example. The following example illustrates the principles of 
this paragraph (k)(1)(iii):

    Example. Companies A and B, both of which are members of the 
same controlled group, commence an IDA on March 1, Year 1. Company A 
pays the first IDCs in relation to the IDA, as cash salaries to A's 
research staff, for the staff's work during the first week of March, 
Year 1. A and B, however, do not sign and date any written 
contractual agreement until August 1, Year 1, whereupon they execute 
a ``Cost Sharing Agreement'' that purports to be ``effective as of'' 
March 1 of Year 1. The arrangement fails the requirement that the 
participants record their arrangement in a written contractual 
agreement that is contemporaneous with the formation of a CSA. The 
arrangement has failed to meet the requirements set forth in 
paragraph (b)(2) of this section and, pursuant to paragraph (b) of 
this section, cannot be a CSA.

    (iv) Interpretation of contractual provisions--(A) In general. The 
provisions of a written contract described in this paragraph (k)(1) and 
of the additional documentation described in paragraph (k)(2) of this 
section must be clear and unambiguous. The provisions will be 
interpreted by reference to the economic substance of the transaction 
and the actual conduct of the controlled participants. See Sec.  1.482-
1(d)(3)(ii)(B) (discussing interpretation of contractual terms in 
assessing the comparability of controlled and uncontrolled 
transactions). Accordingly, the Commissioner may impute contractual 
terms in a CSA consistent with the economic substance of the CSA and 
may disregard contractual terms that lack economic substance. An 
allocation of risk between controlled participants after the outcome of 
such risk is known or reasonably knowable lacks economic substance. See 
Sec.  1.482-1(d)(3)(iii)(B). A contractual term that is disregarded due 
to a lack of economic substance does not satisfy a contractual 
requirement set forth in this paragraph (k)(1) or documentation 
requirement set forth in paragraph (k)(2) of this section. See 
paragraph (b)(5) of this section for the treatment of an arrangement 
among controlled taxpayers that fails to comply with the requirements 
of this section.
    (B) Examples. The following examples illustrate the principles of 
this paragraph (k)(1)(iv). In each example, it is assumed that the 
Commissioner will exercise the discretion granted pursuant to paragraph 
(b)(5)(ii) of this section to apply the provisions of this section to 
the arrangement that purports to be a CSA.

    Example 1. The contractual provisions recorded upon formation of 
an arrangement that purports to be a CSA provide that PCT payments 
with respect to a particular external contribution will consist of 
payments contingent on sales. Contrary to the contractual 
provisions, the PCT payments actually made are contingent on 
profits. Because the controlled participants' actual conduct is 
different from the contractual terms, the Commissioner may 
determine, based on the facts and circumstances, that--
    (i) The actual payments have economic substance and, therefore, 
impute payment terms in the CSA consistent with the actual payments; 
or
    (ii) The contract terms reflect the economic substance of the 
arrangement and, therefore, the actual payments must be adjusted to 
conform to the terms.
    Example 2. An arrangement that purports to be a CSA provides 
that PCT payments with respect to a particular external contribution 
shall be contingent payments equal to 10% of sales of products that 
incorporate cost shared intangibles. The contract terms further 
provide that the controlled participants must adjust such contingent 
payments in accordance with a formula set forth in the terms. During 
the first three years of the arrangement, the controlled 
participants fail to make the adjustments required by the terms with 
respect to the PCT payments. The Commissioner may determine, based 
on the facts and circumstances, that--
    (i) The contingent payment terms with respect to the external 
contribution do not have economic substance because the controlled 
participants did not act in accordance with their upfront risk 
allocation; or
    (ii) The contract terms reflect the economic substance of the 
arrangement and, therefore, the actual payments must be adjusted to 
conform to the terms.

    (2) CSA documentation requirements--(i) In general. The controlled 
participants must timely update and maintain sufficient documentation 
to establish that the participants have met the CSA contractual 
requirements of paragraph (k)(1) of this section and the additional CSA 
documentation requirements of this paragraph (k)(2).
    (ii) Additional CSA documentation requirements. The controlled 
participants to a CSA must timely update and maintain documentation 
sufficient to--
    (A) Describe the current scope of the IDA and identify--
    (1) Any additions or subtractions from the list of reasonably 
anticipated cost shared intangibles reported pursuant to paragraph 
(k)(1)(ii)(B) of this section;
    (2) Any cost shared intangible, together with each controlled 
participant's interest therein; and
    (3) Any further development of intangibles already developed under 
the CSA or of specified applications of such intangibles which has been 
removed from the IDA (see paragraphs (d)(1)(ii) and (j)(1)(i) of this 
section (definitions of reasonably anticipated cost shared intangible, 
cost shared intangible)) and the steps (including any accounting 
classifications and allocations) taken to implement such removal.

[[Page 387]]

    (B) Establish that each controlled participant reasonably 
anticipates that it will derive benefits from exploiting cost shared 
intangibles;
    (C) Describe the functions and risks that each controlled 
participant has undertaken during the term of the CSA;
    (D) Provide an overview of each controlled participant's business 
segments, including an analysis of the economic and legal factors that 
affect CST and PCT pricing;
    (E) Establish the amount of each controlled participant's IDCs for 
each taxable year under the CSA, including all IDCs attributable to 
stock-based compensation, as described in paragraph (d)(3) of this 
section (including the method of measurement and timing used in 
determining such IDCs, and the data, as of the date of grant, used to 
identify stock-based compensation with the IDA);
    (F) Describe the method used to estimate each controlled 
participant's RAB share for each year during the course of the CSA, 
including--
    (1) All projections used to estimate benefits;
    (2) All updates of the RAB shares in accordance with paragraph 
(e)(1) of this section; and
    (3) An explanation of why that method was selected and why the 
method provides the most reliable measure for estimating RAB shares;
    (G) Describe all platform contributions;
    (H) Designate the type of transaction involved for each PCT or 
group of PCTs;
    (I) Specify, within the time period provided in paragraph 
(h)(2)(iii) of this section, the form of payment due under each PCT or 
group of PCTs, including information and explanation that reasonably 
supports an analysis of applicable provisions of paragraph (h) of this 
section;
    (J) Describe and explain the method selected to determine the arm's 
length payment due under each PCT, including--
    (1) An explanation of why the method selected constitutes the best 
method, as described in Sec.  1.482-1(c)(2), for measuring an arm's 
length result;
    (2) The economic analyses, data, and projections relied upon in 
developing and selecting the best method, including the source of the 
data and projections used;
    (3) Each alternative method that was considered, and the reason or 
reasons that the alternative method was not selected;
    (4) Any data that the controlled participant obtains, after the CSA 
takes effect, that would help determine if the controlled participant's 
method selected has been applied in a reasonable manner;
    (5) The discount rate or rates, where applicable, used for purposes 
of evaluating PCT Payments, including information and explanation that 
reasonably supports an analysis of applicable provisions of paragraph 
(g)(2)(v) of this section;
    (6) The estimated arm's length values of any platform contributions 
as of the dates of the relevant PCTs, in accordance with paragraph 
(g)(2)(ii) of this section;
    (7) A discussion, where applicable, of why transactions were or 
were not aggregated under the principles of paragraph (g)(2)(iv) of 
this section;
    (8) The method payment form and any conversion made from the method 
payment form to the specified payment form, as described in paragraph 
(h)(3) of this section; and
    (9) If applicable under paragraph (i)(6)(iv) of this section, the 
WACC of the parent of the controlled group that includes the controlled 
participants.
    (iii) Coordination rules and production of documents--(A) 
Coordination with penalty regulations. See Sec.  1.6662-6(d)(2)(iii)(D) 
regarding coordination of the rules of this paragraph (k) with the 
documentation requirements for purposes of the accuracy-related penalty 
under section 6662(e) and (h).
    (B) Production of documentation. Each controlled participant must 
provide to the Commissioner, within 30 days of a request, the items 
described in this paragraph (k)(2) and paragraph (k)(3) of this 
section. The time for compliance described in this paragraph 
(k)(2)(iii)(B) may be extended at the discretion of the Commissioner.
    (3) CSA accounting requirements--(i) In general. The controlled 
participants must maintain books and records (and related or underlying 
data and information) that are sufficient to--
    (A) Establish that the controlled participants have used (and are 
using) a consistent method of accounting to measure costs and benefits;
    (B) Permit verification that the amount of any contingent PCT 
Payments due have been (and are being) properly determined;
    (C) Translate foreign currencies on a consistent basis; and
    (D) To the extent that the method of accounting used materially 
differs from U.S. generally accepted accounting principles, explain any 
such material differences.
    (ii) Reliance on financial accounting. For purposes of this 
section, the controlled participants may not rely solely upon financial 
accounting to establish satisfaction of the accounting requirements of 
this paragraph (k)(4) of this section. Rather, the method of accounting 
must clearly reflect income. Thor Power Tools Co. v. Commissioner, 439 
U.S. 522 (1979).
    (4) CSA reporting requirements--(i) CSA Statement. Each controlled 
participant must file with the Internal Revenue Service, in the manner 
described in this paragraph (k)(4), a ``Statement of Controlled 
Participant to Sec.  1.482-7T Cost Sharing Arrangement'' (CSA 
Statement) that complies with the requirements of this paragraph 
(k)(5).
    (ii) Content of CSA Statement. The CSA Statement of each controlled 
participant must--
    (A) State that the participant is a controlled participant in a 
CSA;
    (B) Provide the controlled participant's taxpayer identification 
number;
    (C) List the other controlled participants in the CSA, the country 
of organization of each such participant, and the taxpayer 
identification number of each such participant;
    (D) Specify the earliest date that any IDC described in paragraph 
(d)(1) of this section occurred; and
    (E) Indicate the date on which the controlled participants formed 
(or revised) the CSA and, if different from such date, the date on 
which the controlled participants recorded the CSA (or any revision) 
contemporaneously in accordance with paragraphs (k)(1)(i) and (iii) of 
this section.
    (iii) Time for filing CSA Statement--(A) 90-day rule. Each 
controlled participant must file its original CSA Statement with the 
Internal Revenue Service Ogden Campus, no later than 90 days after the 
first occurrence of an IDC to which the newly-formed CSA applies, as 
described in paragraph (k)(1)(iii)(A) of this section, or, in the case 
of a taxpayer that became a controlled participant after the formation 
of the CSA, no later than 90 days after such taxpayer became a 
controlled participant. A CSA Statement filed in accordance with this 
paragraph (k)(4)(iii)(A) must be dated and signed, under penalties of 
perjury, by an officer of the controlled participant who is duly 
authorized (under local law) to sign the statement on behalf of the 
controlled participant.
    (B) Annual return requirement--(1) In general. Each controlled 
participant must attach to its U.S. income tax return, for each taxable 
year for the duration of the CSA, a copy of the original CSA Statement 
that the controlled participant filed in accordance with the 90-day 
rule of

[[Page 388]]

paragraph (k)(4)(iii)(A) of this section. In addition, the controlled 
participant must update the information reflected on the original CSA 
Statement annually by attaching a schedule that documents changes in 
such information over time.
    (2) Special filing rule for annual return requirement. If a 
controlled participant is not required to file a U.S. income tax 
return, the participant must ensure that the copy or copies of the CSA 
Statement and any updates are attached to Schedule M of any Form 5471, 
any Form 5472 ``Information Return of a Foreign Owned Corporation'', or 
any Form 8865 ``Return of U.S. Persons With Respect to Certain Foreign 
Partnerships'', filed with respect to that participant.
    (iv) Examples. The following examples illustrate this paragraph 
(k)(4). In each example, Companies A and B are members of the same 
controlled group.

    Example 1. A and B, both of which file U.S. tax returns, agree 
to share the costs of developing a new chemical formula in 
accordance with the provisions of this section. On March 30, Year 1, 
A and B record their agreement in a written contract styled, ``Cost 
Sharing Agreement.'' The contract applies by its terms to IDCs 
occurring after March 1, Year 1. The first IDCs to which the CSA 
applies occurred on March 15, Year 1. To comply with paragraph 
(k)(4)(iii)(A) of this section, A and B individually must file 
separate CSA Statements no later than 90 days after March 15, Year 1 
(June 13, Year 1). Further, to comply with paragraph (k)(4)(iii)(B) 
of this section, A and B must attach copies of their respective CSA 
Statements to their respective Year 1 U.S. income tax returns.
    Example 2. The facts are the same as in Example 1, except that a 
year has passed and C, which files a U.S. tax return, joined the CSA 
on May 9, Year 2. To comply with the annual filing requirement 
described in paragraph (k)(4)(iii)(B) of this section, A and B must 
each attach copies of their respective CSA Statements (as filed for 
Year 1) to their respective Year 2 income tax returns, along with a 
schedule updated appropriately to reflect the changes in information 
described in paragraph (k)(4)(ii) of this section resulting from the 
addition of C to the CSA. To comply with both the 90-day rule 
described in paragraph (k)(4)(iii)(A) of this section and the annual 
filing requirement described in paragraph (k)(4)(iii)(B) of this 
section, C must file a CSA Statement no later than 90 days after May 
9, Year 2 (August 7, Year 2), and must attach a copy of such CSA 
Statement to its Year 2 income tax return.

    (l) Effective/applicability date. This section applies on January 
5, 2009.
    (m) Transition rule--(1) In general. An arrangement in existence on 
January 5, 2009 will be considered a CSA, as described under paragraph 
(b) of this section, if, prior to such date, it was a qualified cost 
sharing arrangement under the provisions of Sec.  1.482-7 (as contained 
in the 26 CFR part 1 edition revised as of January 1, 1996, hereafter 
referred to as ``former Sec.  1.482-7''), but only if the written 
contract, as described in paragraph (k)(1) of this section, is amended, 
if necessary, to conform with, and only if the activities of the 
controlled participants substantially comply with, the provisions of 
this section, as modified by paragraphs (m)(2) and (m)(3) of this 
section, by July 6, 2009.
    (2) Transitional modification of applicable provisions. For 
purposes of this paragraph (m), conformity and substantial compliance 
with the provisions of this section shall be determined with the 
following modifications:
    (i) CSTs and PCTs occurring prior to January 5, 2009 shall be 
subject to the provisions of former Sec.  1.482-7 rather than this 
section.
    (ii) Except to the extent provided in paragraph (m)(3) of this 
section, PCTs that occur under a CSA that was a qualified cost sharing 
arrangement under the provisions of former Sec.  1.482-7 and remained 
in effect on January 5, 2009, shall be subject to the periodic 
adjustment rules of Sec.  1.482-4(f)(2) rather than the rules of 
paragraph (i)(6) of this section.
    (iii) Paragraphs (b)(1)(iii) and (b)(4) of this section shall not 
apply.
    (iv) Paragraph (k)(1)(ii)(D) of this section shall not apply.
    (v) Paragraphs (k)(1)(ii)(H) and (k)(1)(ii)(I) of this section 
shall be construed as applying only to transactions entered into on or 
after January 5, 2009.
    (vi) The deadline for recordation of the revised written 
contractual agreement pursuant to paragraph (k)(1)(iii) of this section 
shall be no later than July 6, 2009.
    (vii) Paragraphs (k)(2)(ii)(G) through (J) of this section shall be 
construed as applying only with reference to PCTs entered into on or 
after January 5, 2009.
    (viii) Paragraph (k)(4)(iii)(A) of this section shall be construed 
as requiring a CSA Statement with respect to the revised written 
contractual agreement described in paragraph (m)(3)(vi) of this section 
no later than September 2, 2009.
    (ix) Paragraph (k)(4)(iii)(B) of this section shall be construed as 
only applying for taxable years ending after the filing of the CSA 
Statement described in paragraph (m)(2)(viii) of this section.
    (3) Special rule for certain periodic adjustments. The periodic 
adjustment rules in paragraph (i)(6) of this section (rather than the 
rules of Sec.  1.482-4(f)(2)) shall apply to PCTs that occur on or 
after the date of a material change in the scope of the CSA from its 
scope as of January 5, 2009. A material change in scope would include a 
material expansion of the activities undertaken beyond the scope of the 
intangible development area, as described in former Sec.  1.482-
7(b)(4)(iv). For this purpose, a contraction of the scope of a CSA, 
absent a material expansion into one or more lines of research and 
development beyond the scope of the intangible development area, does 
not constitute a material change in scope of the CSA. Whether a 
material change in scope has occurred is determined on a cumulative 
basis. Therefore, a series of expansions, any one of which is not a 
material expansion by itself, may collectively constitute a material 
expansion.
    (n) Expiration date. The applicability of this section expires on 
or before December 30, 2011.

0
Par. 13. Section 1.482-8 is amended by revising paragraph (b) Examples 
10, 11, and 12 and adding Examples 13, 14, 15, 16, 17 and 18 at the end 
of paragraph (b) to read as follows:


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

* * * * *
    (b) * * *
    Examples 10 through 18. [Reserved]. For further guidance, see Sec.  
1.482-8T(b) Examples 10 through 18.

0
Par. 14. Section 1.482-8T is amended by:
0
1. Adding Examples 13, 14, 15, 16, 17 and 18 at the end of paragraph 
(b).
0
2. Revising paragraph (c).
    The additions and revision reads as follows:


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

* * * * *
    (b) * * *
    Example 13. Preference for acquisition price method. (i) USP 
develops, manufacturers, and distributes pharmaceutical products. 
USP and FS, USP's wholly-owned subsidiary, enter into a CSA to 
develop a new oncological drug, Oncol. Immediately prior to entering 
into the CSA, USP acquires Company X, an unrelated U.S. 
pharmaceutical company. Company X is solely engaged in oncological 
pharmaceutical research, and its only significant resources and 
capabilities are its workforce and its sole patent, which is 
associated with Compound X, a promising molecular compound derived 
from a rare plant, which USP reasonably anticipates will contribute 
to developing Oncol. All of Company X researchers will be engaged 
solely in research that is reasonably anticipated to contribute to 
developing Oncol as well. The rights in the Compound X and the 
commitment of Company X's researchers to the development of Oncol 
are platform

[[Page 389]]

contributions for which compensation is due from FS as part of a 
PCT.
    (ii) In this case, the acquisition price method, based on the 
lump sum price paid by USP for Company X, is likely to provide a 
more reliable measure of an arm's length PCT Payment due to USP than 
the application of any other method. See Sec. Sec.  1.482-4(c)(2) 
and 1.482-7T(g)(5)(iv)(A).
    Example 14. Preference for market capitalization method. (i) 
Company X is a publicly traded U.S. company solely engaged in 
oncological pharmaceutical research and its only significant 
resources and capabilities are its workforce and its sole patent, 
which is associated with Compound Y, a promising molecular compound 
derived from a rare plant. Company X has no marketable products. 
Company X enters into a CSA with FS, a newly-formed foreign 
subsidiary, to develop a new oncological drug, Oncol, derived from 
Compound Y. Compound Y is reasonably anticipated to contribute to 
developing Oncol. All of Company X researchers will be engaged 
solely in research that is reasonably anticipated to contribute to 
developing Oncol under the CSA. The rights in Compound Y and the 
commitment of Company X's researchers are platform contributions for 
which compensation is due from FS as part of a PCT.
    (ii) In this case, given that Company X's platform contributions 
covered by PCTs relate to its entire economic value, the application 
of the market capitalization method, based on the market 
capitalization of Company X, provides a reliable measure of an arm's 
length result for Company X's PCTs to the CSA. See Sec. Sec.  1.482-
4(c)(2) and 1.482-7T(g)(6)(v)(A).
    Example 15. Preference for market capitalization method. (i) 
MicroDent, Inc. (MDI) is a publicly traded company that developed a 
new dental surgical microscope ScopeX-1, which drastically shortens 
many surgical procedures. On January 1 of Year 1, MDI entered into a 
CSA with a wholly-owned foreign subsidiary (FS) to develop ScopeX-2, 
the next generation of ScopeX-1. In the CSA, divisional interests 
are divided on a territorial basis. The rights associated with 
ScopeX-1, as well as MDI's research capabilities are reasonably 
anticipated to contribute to the development of ScopeX-2 and are 
therefore platform contributions for which compensation is due from 
FS as part of a PCT. At the time of the PCT, MDI's only product was 
the ScopeX-1 microscope, although MDI was in the process of 
developing ScopeX-2. Concurrent with the CSA, MDI separately 
transfers exclusive and perpetual exploitation rights associated 
with ScopeX-1 to FS in the same territory as assigned to FS in the 
CSA.
    (ii) Although the transactions between MDI and FS under the CSA 
are distinct from the transactions between MDI and FS relating to 
the exploitation rights for ScopeX-1, it is likely to be more 
reliable to evaluate the combined effect of the transactions than to 
evaluate them in isolation. This is because the combined 
transactions between MDI and FS relate to all of the economic value 
of MDI (that is, the exploitation rights and research rights 
associated with ScopeX-1, as well as the research capabilities of 
MDI). In this case, application of the market capitalization method, 
based on the enterprise value of MDI on January 1 of Year 1, is 
likely to provides a reliable measure of an arm's length payment for 
the aggregated transactions. See Sec. Sec.  1.482-4(c)(2) and 1.482-
7T(g)(6)(v)(A).
    (iii) Notwithstanding that the market capitalization method 
provides the most reliable measure of the aggregated transactions 
between MDI and FS, see Sec.  1.482-7T(g)(2)(iv) for further 
considerations of when further analysis may be required to 
distinguish between the remuneration to MDI associated with PCTs 
under the CSA (for research rights and capabilities associated with 
ScopeX-1) and the remuneration to MDI for the exploitation rights 
associated with ScopeX-1.
    Example 16. Income method (applied using CPM) preferred to 
acquisition price method. The facts are the same as Example 13, 
except that the acquisition occurred significantly in advance of 
formation of the CSA, and reliable adjustments cannot be made for 
this time difference. In addition, Company X has other valuable 
molecular patents and associated research capabilities, apart from 
Compound X, that are not reasonably anticipated to contribute to the 
development of Oncol and that cannot be reliably valued. The CSA 
divides divisional interests on a territorial basis. Under the terms 
of the CSA, USP will undertake all R&D (consisting of laboratory 
research and clinical testing) and manufacturing associated with 
Oncol, as well as the distribution activities for its territory (the 
United States). FS will distribute Oncol in its territory (the rest 
of the world). FS's distribution activities are routine in nature, 
and the profitability from its activities may be reliably determined 
from third-party comparables. FS does not furnish any platform 
contributions. At the time of the PCT, reliable (ex ante) financial 
projections associated with the development of Oncol and its 
separate exploitation in each of USP's and FSub's assigned 
geographical territories are undertaken. In this case, application 
of the income method using CPM is likely to provide a more reliable 
measure of an arm's length result than application of the 
acquisition price method based on the price paid by USP for Company 
X. See Sec.  1.482-7T(g)(4)(v) and (g)(5)(iv)(C).
    Example 17. Evaluation of alternative methods. (i) The facts are 
the same as Example 13, except that the acquisition occurred 
sometime prior to the CSA, and Company X has some areas of promising 
research that are not reasonably anticipated to contribute to 
developing Oncol. For purposes of this example, the CSA is assumed 
to divide divisional interests on a territorial basis. In general, 
the Commissioner determines that the acquisition price data is 
useful in informing the arm's length price, but not necessarily 
determinative. Under the terms of the CSA, USP will undertake all 
R&D (consisting of laboratory research and clinical testing) and 
manufacturing associated with Oncol, as well as the distribution 
activities for its territory (the United States). FS will distribute 
Oncol in its territory (the rest of the world). FS's distribution 
activities are routine in nature, and the profitability from its 
activities may be reliably determined from third-party comparables. 
At the time of the PCT, financial projections associated with the 
development of Oncol and its separate exploitation in each of USP's 
and FSub's assigned geographical territories are undertaken.
    (ii) Under the facts, it is possible that the acquisition price 
method or the income method using CPM might reasonably be applied. 
Whether the acquisition price method or the income method provides 
the most reliable evidence of the arm's length price of USP's 
contributions depends on a number of factors, including the 
reliability of the financial projections, the reliability of the 
discount rate chosen, and the extent to which the acquisition price 
of Company X can be reliably adjusted to account for changes in 
value over the time period between the acquisition and the formation 
of the CSA and to account for the value of the in-process research 
done by Company X that does not constitute platform contributions to 
the CSA. See Sec.  1.482-7T(g)(4)(v) and (g)(5)(iv)(A) and (C).
    Example 18. Evaluation of alternative methods. (i) The facts are 
the same as Example 17, except that FS has a patent on Compound Y, 
which the parties reasonably anticipate will be useful in mitigating 
potential side effects associated with Compound X and thereby 
contribute to the development of Oncol. The rights in Compound Y 
constitute a platform contribution for which compensation is due 
from USP as part of a PCT. The value of FS's platform contribution 
cannot be reliably measured by market benchmarks.
    (ii) Under the facts, it is possible that either the acquisition 
price method and the income method together or the residual profit 
split method might reasonably be applied to determine the arm's 
length PCT Payments due between USP and FS. Under the first option 
the PCT Payment for the platform contributions related to Company 
X's workforce and Compound X would be determined using the 
acquisition price method referring to the lump sum price paid by USP 
for Company X. Because the value of these platform contributions can 
be determined by reference to a market benchmark, they are 
considered routine platform contributions. Accordingly, under this 
option, the platform contribution related to Compound Y would be the 
only nonroutine platform contribution and the relevant PCT Payment 
is determined using the income method. Under the second option, 
rather than looking to the acquisition price for Company X, all the 
platform contributions are considered nonroutine and the RPSM is 
applied to determine the PCT Payments for each platform 
contribution. Under either option, the PCT Payments will be netted 
against each other.
    (iii) Whether the acquisition price method together with the 
income method or the residual profit split method provides the most 
reliable evidence of the arm's length price of the platform 
contributions of USP and FS depends on a number of factors, 
including the reliability of the determination of the relative 
values of the platform

[[Page 390]]

contributions for purposes of the RPSM, and the extent to which the 
acquisition price of Company X can be reliably adjusted to account 
for changes in value over the time period between the acquisition 
and the formation of the CSA and to account for the value of the 
rights in the in-process research done by Company X that does not 
constitute platform contributions to the CSA. In these 
circumstances, it is also relevant to consider whether the results 
of each method are consistent with each other, or whether one or 
both methods are consistent with other potential methods that could 
be applied. See Sec.  1.482-7T(g)(4)(v), (g)(5)(iv), and (g)(7)(iv).

    (c) Effective/applicability date--(1) In general. Paragraphs (a) 
and (b) Examples 10 through 12 of this section are generally applicable 
for taxable years beginning after December 31, 2006. Paragraph (b) 
Examples 13 through 18 of this section are generally applicable on 
January 5, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraph (b) Examples 10 through 
12 of this section to earlier taxable years in accordance with rules 
set forth in Sec.  1.482-9T(n)(2).
    (3) Expiration date. The applicability of paragraphs (a) and (b) 
Examples 10 through 12 of this section expires on or before July 31, 
2009. The applicability of paragraph (b) Examples 13 through 18 of this 
section expires on or before December 30, 2011.

0
Par. 15. Section 1.482-9T is amended by revising paragraph (m)(3), the 
heading for paragraph (n) and paragraph (n)(3) to read as follows:


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

* * * * *
    (m) * * *
    (3) Coordination with rules governing cost sharing arrangements. 
Section 1.482-7T provides the specific methods to be used to determine 
arm's length results of controlled transactions in connection with a 
cost sharing arrangement. This section provides the specific methods to 
be used to determine arm's length results of a controlled service 
transaction, including in an arrangement for sharing the costs and 
risks of developing intangibles other than a cost sharing arrangement 
covered by Sec.  1.482-7T. In the case of such an arrangement, 
consideration of the principles, methods, comparability, and 
reliability considerations set forth in Sec.  1.482-7T is relevant in 
determining the best method, including an unspecified method, under 
this section, as appropriately adjusted in light of the differences in 
the facts and circumstances between such arrangement and a cost sharing 
arrangement.
* * * * *
    (n) Effective/applicability dates. * * *
    (3) Expiration dates. The applicability of this section expires on 
July 31, 2009, except paragraph (m)(3) of this section, which expires 
on December 30, 2011.

0
Par. 16. Section 1.861-17 is amended by revising paragraph (c)(3)(iv) 
to read as follows:


Sec.  1.861-17   Allocation and apportionment of research and 
experimental expenditures.

* * * * *
    (c) * * *
    (3) * * *
    (iv) Effect of cost sharing arrangements. If the corporation 
controlled by the taxpayer has entered into a cost sharing arrangement, 
in accordance with the provisions of Sec.  1.482-7T, with the taxpayer 
for the purpose of developing intangible property, then that 
corporation shall not reasonably be expected to benefit from the 
taxpayer's share of the research expense.
* * * * *

0
Par. 17. Section 1.6662-6 is amended by:
0
1. Removing the third and fourth sentences from paragraph (d)(2)(i).
0
2. Adding a new paragraph (d)(2)(iii)(D).
    The addition reads as follows:


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

* * * * *
    (d) * * *
    (2) * * *
    (iii) * * *
    (D) Satisfaction of the documentation requirements described in 
Sec.  1.482-7T(k)(2) for the purpose of complying with the rules for 
CSAs under Sec.  1.482-7T also satisfies all of the documentation 
requirements listed in paragraph (d)(2)(iii)(B) of this section, except 
the requirements listed in paragraphs (d)(2)(iii)(B)(2) and (10) of 
this section, with respect to CSTs and PCTs described in Sec.  1.482-
7T(b)(1)(i) and (ii), provided that the documentation also satisfies 
the requirements of paragraph (d)(2)(iii)(A) of this section.
* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 18. The authority citation for part 301 continues to read in part 
as follows:

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

0
Par. 19. Section 301.7701-1 is amended by revising paragraphs (c) and 
(f) to read as follows:


Sec.  301.7701-1   Classification of organizations for Federal tax 
purposes.

* * * * *
    (c) Cost sharing arrangements. A cost sharing arrangement that is 
described in Sec.  1.482-7T of this chapter, including any arrangement 
that the Commissioner treats as a CSA under Sec.  1.482-7T(b)(5) of 
this chapter, is not recognized as a separate entity for purposes of 
the Internal Revenue Code. See Sec.  1.482-7T of this chapter for the 
rules regarding CSAs.
* * * * *
    (f) Effective/applicability dates. Except as provided in the 
following sentence, the rules of this section are applicable as of 
January 1, 1997. The rules of paragraph (c) of this section are 
applicable on January 5, 2009.

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

0
Par. 20. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

0
Par. 21. In Sec.  602.101, paragraph (b) is amended by adding the 
following entry in numerical order to the table:


Sec.  602.101   OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
    CFR part or section where identified and        Current OMB control
                    described                               no.
------------------------------------------------------------------------
 
                              * * * * * * *
1.482-7T........................................  1545-1364
 
                              * * * * * * *
------------------------------------------------------------------------



[[Page 391]]

L.E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: December 18, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E8-30715 Filed 12-31-08; 11:15 am]
BILLING CODE 4830-01-P