[Federal Register Volume 74, Number 148 (Tuesday, August 4, 2009)]
[Rules and Regulations]
[Pages 38830-38876]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-18326]



[[Page 38829]]

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Part IV





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 31, and 602



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

  Federal Register / Vol. 74, No. 148 / Tuesday, August 4, 2009 / Rules 
and Regulations  

[[Page 38830]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 31, and 602

[TD 9456]
RIN 1545-BI78, 1545-BI79, 1545-BI80


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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

DATES: Effective Date: These regulations are effective on July 31, 
2009.
    Applicability Dates: These regulations apply to taxable years 
beginning after July 31, 2009.

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

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-2149. The collection of information 
in these final regulations is in Sec.  1.482-9. This information is 
required to enable the IRS to verify that a taxpayer is reporting the 
correct amount of taxable income. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a valid control number.
    Books and records relating to a collection of information must be 
retained as long as their contents might become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 482 of the Internal Revenue Code generally provides that 
the Secretary may allocate gross income, deductions, and credits 
between or among two or more organizations, trades or businesses owned 
or controlled by the same interests in order to prevent evasion of 
taxes or clearly to reflect income of a controlled taxpayer.
    Regulations under section 482 published in the Federal Register (33 
FR 5849) on April 16, 1968, provided guidance with respect to a wide 
range of controlled transactions, including transfers of tangible and 
intangible property and the provision of services. Revised and updated 
transfer pricing regulations were published in the Federal Register (59 
FR 34971, 60 FR 65553, 61 FR 21955, and 68 FR 51171) on July 8, 1994, 
December 20, 1995, May 13, 1996, and August 26, 2003. While 
comprehensive in other respects, these regulations did not modify 
substantively the rules dealing with controlled services transactions. 
On September 10, 2003, proposed regulations relating to the treatment 
of controlled services transactions and the allocation of income from 
intangible property, in particular with respect to contributions by a 
controlled party to the value of intangible property owned by another 
controlled party (the 2003 proposed regulations), were published in the 
Federal Register (68 FR 53448, REG-146893-02 and REG-115037-00).
    On August 4, 2006, temporary regulations relating to the treatment 
of controlled services transactions, the allocation of income from 
intangible property, and stewardship expenses (the 2006 temporary 
regulations) were published in the Federal Register (71 FR 44466, TD 
9278, REG-146893-02, REG-115037-00, and REG-138603-03). A notice of 
proposed rulemaking cross-referencing the temporary regulations was 
published in the Federal Register on the same day (71 FR 44247, REG-
146893-02, REG-115037-00, and REG-138603-03). Written comments 
responding to the notice of proposed rulemaking were received, and a 
public hearing was held on October 27, 2006.
    The 2006 temporary regulations are generally effective with respect 
to taxable years beginning after December 31, 2006, and Notice 2007-5, 
2007-1 C.B. 269, published on January 16, 2007, partially modified the 
effective date of the 2006 temporary regulations as it pertained to the 
identification of controlled services transactions eligible to be 
priced at cost. Accordingly, the 2006 temporary regulations related to 
the new services cost method in Sec.  1.482-9T(b) (described in Section 
A.1 in this preamble) apply to taxable years after December 31, 2007, 
with the exception of the business judgment rule described in Sec.  
1.482-9T(b)(2), which had the same effective date (taxable years after 
December 31, 2006) as the other provisions of the temporary 
regulations.
    By issuing the 2006 temporary regulations in temporary and proposed 
form, the Treasury Department and the IRS provided taxpayers an 
opportunity to submit additional comments prior to the time these 
regulations became effective. See Sec.  601.601(d)(2)(ii)(b). After 
consideration of all the comments, the proposed regulations under 
section 482 are adopted as revised by this Treasury decision, and the 
corresponding temporary regulations are removed.

Explanation of Revisions and Summary of Comments

Introduction

    The Treasury Department and the IRS received a number of comments 
on the 2006 temporary regulations from taxpayers, their 
representatives, as well as industry and professional groups. 
Commentators generally approved of the 2006 temporary regulations and 
found the changes from the 2003 proposed regulations to be useful. 
Specifically, commentators approved of the replacement of the 
simplified cost-based method with the services cost method (SCM) and 
the inclusion of the shared services arrangement provision in the SCM 
rules. Commentators also generally approved of changes made to the 
profit split method. However, commentators did express concerns with 
some aspects of the 2006 temporary regulations.
    While these final regulations reflect some modifications in 
response to comments received on the 2006 temporary regulations, both 
the format and the substance of the final regulations are generally 
consistent with the 2006 temporary regulations. The changes adopted are 
intended to make certain clarifications and improvements without 
fundamentally altering the policies reflected in the 2006 temporary 
regulations.

[[Page 38831]]

Explanation of Provisions

A. Controlled Services

1. Services Cost Method--Treas. Reg. Sec.  1.482-9(b)
a. Applicability of the Services Cost Method
    Most comments focused on the SCM. Several commentators requested 
confirmation that application of the SCM is a matter within the control 
of the taxpayer, provided that the underlying services otherwise 
qualify for the SCM. Some commentators stated that the 2006 temporary 
regulations could be interpreted as requiring a taxpayer to apply the 
SCM if all the conditions for that method were satisfied.
    Notice 2007-5 confirmed that taxpayers control whether the SCM 
applies. The final regulations make this clear. Section 1.482-9(b)(1) 
provides that, if a taxpayer applies the SCM in accordance with the 
rules of Sec.  1.482-9(b), which requires that a statement evidencing 
the taxpayer's intent to apply the SCM be contained in the taxpayer's 
books and records, then the SCM will be considered the best method for 
purposes of Sec.  1.482-1(c).
b. Specified Covered Services
    Several commentators contended that the proposed list of specified 
covered services in Announcement 2006-50, 2006-2 C.B. 321, is too 
narrow. One commentator listed tax planning and public relations 
activities as examples of activities not on the list that illustrated 
the narrowness of the list. Some commentators suggested that the list 
should refer to departments, cost centers, or accounting 
classifications, rather than to specific activities or groups of 
activities. One commentator suggested that all activities in particular 
departments should be identified as eligible for the SCM. Commentators 
also stated that a comprehensive analysis would be required and that it 
would be too burdensome to track employee time for activities that are 
specified covered services vs. non-specified covered services. See 
Sec.  601.601(d)(2)(ii)(b). The Treasury Department and the IRS also 
received suggestions to broaden the general administrative provision 
and add additional specific activities to the list of specified covered 
services, including warehousing and distribution, quality control and 
quality assurance relating to manufacturing and construction, and 
environmental remediation.
    The SCM is intended to provide a practical and administrable means 
of identifying low-margin services that may be evaluated by reference 
to total services cost without a markup. The list of services eligible 
to be priced at cost in the specified covered services portion of the 
SCM was added specifically in response to requests from commentators 
that the former simplified cost-based method be eliminated and replaced 
with just such a list of eligible services. In response to public 
comments, the Treasury Department and the IRS published Rev. Proc. 
2007-13, 2007-1 C.B. 295, which added several categories as well as 
activities within existing categories. In particular, public relations 
and tax planning services were added to the list, and the individual 
categories of specified covered services were expanded to include 
``other similar activities.''
    After careful consideration, the Treasury Department and the IRS 
believe that Rev. Proc. 2007-13 strikes the appropriate balance between 
broadening the list to include services similar to the specific 
services described and expanding the categories of services. The 
Treasury Department and the IRS do not believe that other additional 
services suggested by commentators were appropriate, but will continue 
to consider other recommendations for additional services to be added 
to the list in the future.
    One commentator expressed concern that a review of services to 
determine if they qualify as specified covered services may require a 
more extensive analysis than under previous regulations, including 
interviews of individual employees or of small groups of employees. 
Although the covered services list is not applied on a departmental 
basis, a reasonable aggregation of similar services may be appropriate 
for performing the specified covered services analysis in some cases. 
To determine if the services cost method should apply to a particular 
service (or group of services) performed by a group of employees, the 
aggregation principle of Treas. Reg. Sec.  1.482-1(f)(2)(i)(A) should 
be followed as appropriate. In certain cases, aggregation may assure a 
more accurate result, especially if it recognizes synergies that an 
individual employee analysis might ignore. An aggregation of employee 
services may, thus, efficiently evaluate the work of employees engaged 
in a common function, as well as recognize the added value that their 
collaborative effort might produce. Conversely, analysis on an 
aggregate basis does not permit characterization of an individual 
service as a specified covered service if it, in fact, is not a 
specified covered service.
c. Low Margin Covered Services
    Commentators provided comments on low margin covered services 
described in Sec.  1.482-9T(b)(4)(ii) of the 2006 temporary 
regulations. One commentator believed that the 7 percent limit is too 
high for the SCM. In the commentator's view, the limit should be lower 
because the 7 percent figure will cover activities that are risky. Most 
of the commentators, however, believed that the 7 percent limit is an 
appropriate measure. The Treasury Department and the IRS continue to 
believe that the 7 percent limit is appropriate in light of its 
purpose. That is, it minimizes the compliance burden on taxpayers and 
the IRS for relatively low-margin services.
    Several commentators requested more guidance on low margin covered 
services. One commentator suggested that the Treasury Department and 
the IRS develop an analysis to determine if certain services have a 
markup of 7 percent or less and publish the results. For example, the 
IRS could develop a set of comparables for various groups of low margin 
services, such as human resources, accounting and finance, information 
services, and training. Some commentators requested guidance on when 
and how often a transfer pricing study is needed to support a 
determination that services are low margin covered services. In this 
regard, some commentators requested that the regulations specify a 
period of years (such as three years) for which a transfer pricing 
study may be valid for purposes of determining if a service is a low 
margin covered service. In support of this request, one commentator 
stated that the regulations could provide, for example, that the 
reliance period could apply to taxpayers whose facts and circumstances 
have not changed materially from the time the service was most recently 
established as a covered service.
    The Treasury Department and IRS did not adopt this proposal. 
Because there may be significant differences among services across 
different businesses, a standardized, IRS-developed comparables set 
would not be feasible and would conflict with the fact intensive nature 
of an appropriately robust transfer pricing analysis. For similar 
reasons, the Treasury Department and the IRS did not adopt the proposal 
to specify the frequency or timing of transfer pricing analyses to 
support taxpayer positions. To do so would be inconsistent with a 
proper comparability analysis, including consideration of the time at 
which

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transactions were undertaken, as well as other relevant economic 
circumstances.
    One other commentator requested that the midpoint should be used in 
measuring a comparable markup on total services costs for purposes of 
low margin covered services. While it may be true that, in some cases, 
the midpoint could be used depending on the statistical method used, 
the interquartile range ordinarily provides an acceptable measure of an 
arm's length range. See Sec.  1.482-1(e)(2)(iii)(B). Therefore, the 
Treasury Department and the IRS believe that the interquartile range of 
the comparable median markup is an appropriate measure.
d. Excluded Activities
    One commentator requested that engineering be removed from the list 
of services that are ineligible for the SCM in Sec.  1.482-9T(b)(3) of 
the 2006 temporary regulations. This comment was not adopted, since, in 
the view of the Treasury Department and the IRS, intragroup engineering 
services generally should be subject to a robust transfer pricing 
analysis.
e. Business Judgment Rule
    Several commentators expressed concern over how the business 
judgment rule would be administered. Some commentators requested that 
statements in the preamble about the business judgment rule in the 2006 
temporary regulations be incorporated in final regulations. Other 
commentators suggested that the business judgment rule should be 
applied by reference to one or more trades or business of the 
controlled group rather than of the renderer, recipient, or both. These 
commentators claimed that the business judgment rule may yield 
incorrect results in some cases, for example, where a headquarters 
services company or other legal entity is established solely to provide 
centralized support services. The activities performed by such an 
entity would potentially be ineligible for the SCM under the business 
judgment rule because they would constitute the entity's core 
capability.
    The Treasury Department and the IRS agree that the business 
judgment rule should be determined on a controlled group basis and 
expressed this view in Notice 2007-5. The final regulations clarify 
that the business judgment rule is determined by reference to a trade 
or business of the controlled group.
    Section 3.04 of Notice 2007-5 clarified that the business judgment 
rule ``is satisfied by a reasonable exercise of the taxpayer's business 
judgment, not a reasonable exercise of the IRS's judgment in examining 
the taxpayer.'' The Treasury Department and the IRS reiterate that the 
final regulations incorporate a high threshold for application of the 
business judgment rule to exclude services otherwise eligible for the 
SCM. Section 1.482-9(b)(5) provides that the rule is based on a 
taxpayer's reasonable conclusion in its business judgment that the rule 
is satisfied. It has come to the attention of the Treasury Department 
and the IRS that the clarification in the notice of the business 
judgment rule has been misconstrued as creating a non-rebuttable 
presumption that a taxpayer's determination under the business judgment 
rule is always correct. This construction of the clarification was not 
intended and is not supported by the plain language of the business 
judgment rule. The business judgment rule requires a reasonable 
conclusion by the taxpayer. Thus, the taxpayer's business judgment is 
only the starting point of the analysis, and the taxpayer must make a 
reasonable conclusion in that regard. Whether the taxpayer's conclusion 
is reasonable may be subject to examination by the IRS in the course of 
an audit.
    One commentator suggested that the regulations adopt a ``principal 
activity'' test similar to the test described in the Organisation for 
Economic Cooperation and Development Transfer Pricing Guidelines for 
Multinational Enterprises and Tax Administrations (OECD Guidelines) in 
place of the business judgment rule. The Treasury Department and the 
IRS decline to adopt this suggestion. Another commentator pointed out 
that the examples illustrating the business judgment rule more 
accurately describe a high value service or intangible property, rather 
than a covered service. The Treasury Department and the IRS agree that 
some of the examples in the temporary regulations could be read as 
describing transfers of intangible property rather than provisions of 
services involving the intangible property. Some examples have been 
edited to improve clarity, including to ensure that they cannot be read 
as describing transfers of intangible property.
    Commentators also raised questions concerning how to evidence the 
necessary business judgment; for example, whether an executive's 
representation must be preferred to the tax director's. The business 
judgment rule is applied on a case-by-case basis and takes into account 
the taxpayer's facts and circumstances.
    One other commentator requested that the business judgment rule 
take into account whether a particular activity, such as that of a 
corporate tax department, contributes to the operating profit (as 
defined in Sec.  1.482-5(d)(3)) of one or more controlled parties. 
Notice 2007-5 provided several clarifications to the business judgment 
rule, including a clarification that the business judgment rule should 
take into account whether a particular activity contributes to the 
operating profit of one or more controlled parties. After further 
consideration, the Treasury Department and the IRS decided not to add 
an operating profit consideration to the business judgment rule because 
the operating profit concept is broader than the intended rule and 
because it would implicitly require taxpayers to do the type of 
economic analysis (and create the attendant administrative burden for 
taxpayers) that the business judgment rule is intended to eliminate.
    The Treasury Department and the IRS continue to believe, however, 
that the conclusion in Notice 2007-5 is correct--that activities such 
as back office tax services should not fail the business judgment rule 
because they may affect net income by reducing domestic or foreign 
income taxes. Depending on the facts and circumstances, tax services 
may or may not satisfy the business judgment rule.
f. Reorganization of the SCM
    Section 1.482-9T(b) of the 2006 temporary regulations contains 
several requirements, all of which have to be satisfied in order for 
the SCM to be applicable. In other words, the requirements under Sec.  
1.482-9T(b) are conjunctive; failure to satisfy one of the requirements 
renders a service ineligible for SCM treatment regardless of whether 
any of the other requirements is satisfied. The Treasury Department and 
the IRS are aware that the rules under Sec.  1.482-9T(b) have been 
misinterpreted as disjunctive such that satisfaction of only one of the 
requirements renders a service eligible for the SCM. This view is 
unsupported by the plain language of Sec.  1.482-9T(b). To improve 
clarity, the requirements for the SCM are reorganized in the final 
regulations. Section Sec.  1.482-9(b)(2) lists the conditions necessary 
for a service to be eligible for the SCM and provides a cross-reference 
to the paragraph in Sec.  1.482-9(b) that corresponds to each 
condition. In summary, to be eligible for the SCM, a service must be a 
covered service, the service cannot be an excluded activity, the 
service cannot be precluded from constituting a covered service by 
reason of the business judgment rule, and adequate books and records 
must be maintained with respect to the service. The

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reorganization does not substantively change the SCM rules.
    Modifications have also been made to the list of excluded 
activities to harmonize it with Rev. Proc. 2007-13. In particular, 
instead of referring to ``excluded transactions,'' the regulations now 
refer to ``excluded activities.''
g. Shared Services Arrangements
    In general, commentators supported the shared services arrangement 
(SSA) provision in the 2006 temporary regulations as a useful mechanism 
for allocation of costs from shared or centralized services. 
Commentators called into question, however, the restriction of SSAs to 
covered services priced under the SCM. In response, Notice 2007-5 
provided that a SSA may be used for controlled services transactions 
outside of the SCM context. Specifically, Notice 2007-5 states: ``This 
Notice confirms that taxpayers may also make allocations of arm's 
length charges for services ineligible for the SCM that yield a benefit 
to multiple members of a controlled group. In such a case, however, the 
flexible rules under the SCM for establishing the joint benefits and 
selecting the allocation key are inapplicable. Instead, the more robust 
analysis under the general transfer pricing rules applies for purposes 
of determining the appropriate arm's length charges, benefits, 
allocation keys, etc.'' The Treasury Department and the IRS considered 
providing additional SSA rules to services priced under methods other 
than the SCM, but concluded that such rules would be unnecessary. In 
any event, as stated in Notice 2007-5, the flexible SSA rules for 
establishing the joint benefits and selecting the allocation key are 
inapplicable in the non-SCM context.
    Other commentators requested that a SSA should be respected even if 
a party that reasonably anticipates a benefit makes a payment 
equivalent to its share under an SSA to the service provider pursuant 
to a different arrangement. For example, assume that a controlled 
service provider performs services to ten taxpayers that are members of 
its controlled group. Assume further that nine of the service 
recipients agree in a single written contract to allocate the arm's 
length charge based on a reasonable allocation basis, but the tenth 
service recipient pays for its share of the services pursuant to a 
separate agreement. These comments were not adopted because whether an 
agreement constitutes a SSA requires a case-by-case determination based 
on the facts and circumstances.
    Some commentators observed that the SSA rules require the 
allocation of costs on the basis that ``most reliably reflects'' the 
participants' respective shares of reasonably anticipated benefits, but 
some of the examples use the phrase ``precisely known.'' This led the 
commentators to question whether the SSA rules create an unattainable 
standard or, at least, a higher standard than the reasonable standard 
for allocation of costs described in Treas. Reg. Sec.  1.482-9T(k) and 
to suggest a change to the examples. The examples do not create a 
standard based on precisely known shares of reasonably anticipated 
benefits. Rather, the examples use hypothetical, precisely known 
reasonably anticipated benefits as a measuring stick to provide an 
easily understood comparative analysis of potential allocation keys for 
illustrative purposes. The suggested changes are not adopted.
2. Comparable Uncontrolled Services Price Method--Treas. Reg. Sec.  
1.482-9(c)
    The comparable uncontrolled services price (CUSP) method evaluates 
whether the consideration in a controlled services transaction is arm's 
length by comparison to the price charged in a comparable uncontrolled 
services transaction. This method is closely analogous to the 
comparable uncontrolled price (CUP) method in Sec.  1.482-3(b).
    One commentator objected to the statement in the second sentence of 
Sec.  1.482-9T(c)(1) of the 2006 temporary regulations that, to be 
evaluated under the CUSP method, a controlled service ordinarily must 
be ``identical to or have a high degree of similarity'' to the 
uncontrolled comparable transactions. The commentator claimed that such 
language creates a higher standard for determining the best method than 
in the rest of the section 482 regulations. For example, both Sec.  
1.482-1(c)(1) and Sec.  1.482-9T(c)(2)(i) refer to the ``most reliable 
measure of an arm's length result'' standard. The sentence in question 
was intended merely as a guide to when the CUSP method is applicable. 
It was not intended to change the standard under the best method rule. 
To avoid further confusion, the sentence is removed, but without 
effecting a substantive change.
    The CUSP method in these final regulations is substantially similar 
to the corresponding method in the 2006 temporary regulations.
3. Cost of Services Plus Method--Treas. Reg. Sec.  1.482-9(e)
    The cost of services plus method is generally analogous to the cost 
plus method for transfers of tangible property in existing Sec.  1.482-
3(d). The cost of services plus method evaluates whether the amount 
charged in a controlled services transaction is arm's length by 
reference to the gross services profit markup realized in comparable 
uncontrolled transactions. Section 1.482-9T(e)(3)(ii)(A) provides that, 
if the appropriate gross services profit markup is derived from 
comparable uncontrolled services transactions of other service 
providers, then, in evaluating comparability, the controlled taxpayer 
must consider the results under this method expressed as a markup on 
total services costs of the controlled taxpayer because functional 
differences may be reflected in differences in service costs other than 
those included in comparable transactional costs.
    One commentator objected to the required consideration of the 
results of the cost of services plus method expressed as a markup on 
total services costs of the controlled taxpayer when external 
comparables are utilized. In the commentator's view, this rule requires 
a confirming analysis under a comparable profits method (CPM) and, 
therefore, places an undue burden on the taxpayer. The same commentator 
also expressed the concern that the rule would create an even greater 
burden by requiring two sets of external comparables for application of 
the two methods.
    These comments are not adopted for several reasons. First, the 
restatement of the price does not require researching two sets of 
external comparables under two different methods. The sole purpose of 
the calculation is to determine whether it is necessary to perform 
additional evaluation of functional comparability under the cost of 
services plus method. That is, if the price indicates a markup on the 
renderer's total services cost that is either low or negative when 
restated, this may indicate differences in functions that have not been 
accounted for under the traditional comparability factors under the 
cost of services plus method. Thus, a low or negative markup merely 
suggests the need for additional inquiry, which may lead to a 
determination that the cost of services plus method is not the most 
reliable measure of an arm's length result under the best method rule.
    The cost of services plus method is adopted in the final 
regulations without change.
4. Profit Split Method--Treas. Reg. Sec. Sec.  1.482-9(g) and 1.482-
6(c)(3)(i)(B)
    The final regulations provide additional guidance concerning 
application of the comparable profit

[[Page 38834]]

split and the residual profit split methods to controlled services 
transactions in Sec.  1.482-9(g) and Sec.  1.482-6(c)(3)(i)(B). 
Generally, the comparable profit split and the residual profit split 
methods evaluate whether the allocation of the combined operating 
profit or loss attributable to one or more controlled transactions is 
arm's length by reference to the relative value of each controlled 
taxpayer's contributions to the combined operating profit or loss.
    The Treasury Department and the IRS received several comments on 
the profit split method. One commentator requested that Sec.  1.482-
8T(b), Example 12 of the 2006 temporary regulations explain why the 
profit split method is preferable to using the financial results of a 
set of publicly-traded companies engaged in selling merchandise and 
related promotion and marketing activities. Example 12 is revised in 
the final regulations to address this comment.
    Another commentator argued that the profit split method should not 
apply to a party that does not own valuable intangible property or does 
not use any such property in the related party transaction being 
evaluated. The commentator noted that other parts of the regulations, 
such as the CPM, CUSP method, and costs of services plus method 
reference valuable intangible property in the examples. The same 
commentator asserted that the profit split method should be limited to 
parties that bear substantial risk in their intercompany transactions. 
The Treasury Department and the IRS believe that limiting application 
of the profit split method to contributions of valuable intangible 
property or the bearing of risks would be inappropriate. The changes in 
the 2006 temporary regulations to routine and non-routine contributions 
is an appropriate standard and conformed to the changes to Sec.  1.482-
6T(c)(3)(i)(B)(1), which defines a nonroutine contribution as ``a 
contribution that is not accounted for as a routine contribution.'' In 
other words, a nonroutine contribution is one for which the return 
cannot be determined by reference to market benchmarks.
    The 2006 temporary regulations provide that the residual profit 
split method ordinarily is used where multiple controlled taxpayers 
make significant nonroutine contributions. A commentator requested that 
this provision be removed because it suggests that the method always 
applies where there are no market benchmarks. The provision regarding 
the residual profit split method that the commentator requested be 
removed has been changed to conform to language in the cost sharing 
regulations. Accordingly, Sec.  1.482-9(g)(1) provides that the 
residual profit split method may not be used where only one controlled 
taxpayer makes significant nonroutine contributions. The commentator 
also claimed that the residual profit split method contains an 
inconsistency because, although the method applies when there are no 
market benchmarks, the method includes a market benchmark analysis for 
comparability purposes. Compare Sec. Sec.  1.482-9(g)(1) and 1.482-
6(c)(3)(i)(B)(2). The Treasury Department and the IRS do not consider 
that there is an inconsistency. The method contemplates the use of 
market benchmarks, if available, to determine the profit split that 
will be applied to the return to nonroutine contributions already 
determined under the method. The same commentator requested that the 
sentence in Sec.  1.482-6T(c)(2)(ii)(B) of the 2006 temporary 
regulations relating to the comparable profit split method that states 
that ``the comparable profit split method may not be used if the 
combined operating profit (as a percentage of the combined assets) of 
the uncontrolled comparables varies significantly from that earned by 
the controlled taxpayers'' should be deleted. These comments are not 
adopted, since the stated condition is fundamental to comparability 
under the method.
5. Contingent Payments--Treas. Reg. Sec.  1.482-9(i)
    The 2006 temporary regulations provide detailed guidance concerning 
contingent-payment contractual terms. The rules built on the principle 
that, in structuring controlled transactions, taxpayers are free to 
choose from among a wide range of risk allocations. The provision 
acknowledged that contingent-payment terms--terms requiring 
compensation to be paid only if specified results are obtained--may be 
particularly relevant in the context of controlled services 
transactions.
    Commentators raised several concerns about the substance and scope 
of this provision. One commentator said that the regulations do not 
address whether a taxpayer may, in the absence of a written agreement, 
present facts to demonstrate that a contingent payment arrangement best 
reflects the economic substance of the underlying transactions. The 
Treasury Department and the IRS do not agree that an arrangement may be 
treated as a contingent payment arrangement under Sec.  1.482-9(i)(2) 
if the arrangement does not satisfy the requirements of the contingent 
payment arrangement provision, including the written contract 
requirement. However, where the Commissioner exercises its authority 
pursuant to Sec.  1.482-1(d)(3)(ii)(B) to impute contractual terms, the 
taxpayer may present additional facts to indicate if an alternative 
agreement best reflects the economic substance of the underlying 
transaction, consistent with the parties' course of conduct in a 
particular case. See Sec.  1.482-1(d)(3)(ii)(C), Examples 4 and 6.
    The same commentator also pointed out that the requirement to 
evaluate whether a specified contingency bears a direct relationship to 
the controlled services transaction based on all of the facts and 
circumstances should be combined with the specified contingency 
requirement. The Treasury Department and the IRS agree that the 
language in Sec.  1.482-9(i)(2) should be clarified. Accordingly, the 
regulations remove the last sentence in Sec.  1.482-9T(i)(2)(i)(C) of 
the 2006 temporary regulations relating to a specified contingency and 
combine it with the requirement under Sec.  1.482-9T(i)(2)(i)(B). Thus, 
Sec.  1.482-9(i)(2)(i)(B) now requires that the contract state that 
payment for a controlled services transaction is contingent (in whole 
or in part) upon the happening of a future benefit (within the meaning 
of Sec.  1.482-9(l)(3)) for the recipient directly related to the 
activity or group of activities. For this purpose, whether the future 
benefit is directly related to the activity or group of activities is 
evaluated based on all the facts and circumstances.
6. Total Services Costs--Treas. Reg. Sec.  1.482-9(j)
    In the 2006 temporary regulations, total services costs include all 
costs directly identified with provision of the controlled services, as 
well as all other costs reasonably allocable to such services under 
Sec.  1.482-9(k). ``Costs'' must reflect all resources expended, used, 
or made available to render the service. Generally accepted accounting 
principles (GAAP) or Federal income tax accounting rules may provide an 
appropriate starting point, but neither would necessarily be conclusive 
in evaluating whether an item must be included in total services costs.
    Another commentator requested that value added costs (that is, 
labor costs and depreciation) should be distinguished from total 
services costs. The commentator stated that a markup on value added 
costs may be more reliable than a markup on total costs in certain 
instances and that this could be a useful measure for any of the 
transfer pricing methods, including the cost of services plus method. 
The regulations already provide flexibility in the context of the cost 
of services plus method,

[[Page 38835]]

which is determined by reference to comparable transactional costs, the 
comparable profits method, and unspecified methods. Consequently, the 
comment is not adopted. The definition of total services costs in these 
regulations is, thus, similar to the provisions in the 2006 temporary 
regulations.
    Section 1.482-9T(j) of the 2006 temporary regulations explicitly 
states that total services costs include stock-based compensation, and 
Examples 3 through 6 of Sec.  1.482-9T(f)(3) illustrate when stock-
based compensation constitutes a material difference requiring 
adjustments for comparability and reliability purposes. Commentators 
requested further guidance regarding the valuation, comparability, and 
reliability considerations for stock-based compensation. Other 
commentators objected to the explicit statement that stock-based 
compensation can be a total services cost. These final regulations do 
not provide further guidance regarding stock-based compensation. The 
Treasury Department and the IRS continue to consider technical issues 
involving stock-based compensation in the services and other contexts 
and intend to address those issues in a subsequent guidance project.
7. Controlled Services Transactions and Shareholder Activities--Treas. 
Reg. Sec.  1.482-9(l)
    Section 1.482-9(l) sets forth a threshold test for determining 
whether an activity constitutes a controlled services transaction 
subject to the general framework of Sec.  1.482-9. Section 1.482-
9(l)(3) provides rules for determining whether an activity provides a 
benefit. Paragraphs (l)(3)(ii) through (v) provide guidelines that 
indicate the presence or absence of a benefit. Section 1.482-
9T(l)(3)(iv) of the 2006 temporary regulations provides that an 
activity is a shareholder activity if the sole effect of that activity 
is either to protect the renderer's capital investment in the recipient 
or in other members of the controlled group, or to facilitate 
compliance by the renderer with reporting, legal, or regulatory 
requirements applicable specifically to the renderer, or both.
    The Treasury Department and the IRS received comments on 
shareholder activities. Some commentators asserted that the ``sole 
effect'' language is too restrictive and that the language should be 
replaced by a ``primary effect'' standard. Other commentators argued 
that the language appropriately encompasses shareholder activities. 
Another commentator requested a change to the regulations such that a 
shareholder activity should be considered to have a sole effect only if 
the benefits provided to the other controlled group members are either 
(i) indirect or remote or (ii) duplicative.
    The Treasury Department and the IRS believe that the ``sole 
effect'' language is appropriate. The ``primary effect'' language in 
the 2003 proposed regulations could inappropriately include activities 
that are not true shareholder activities and may even consist of 
substantial activities that are non-shareholder activities. An activity 
that is described in Sec.  1.482-9(l)(3)(ii) through (iv) does not 
produce a benefit, but the mere fact that an activity is not described 
in Sec.  1.482-9(l)(3)(ii) through (iv) does not mean that the activity 
necessarily provides a benefit. An activity not described in Sec.  
1.482-9(l)(3)(ii) through (iv) provides a benefit only if it satisfies 
the incremental value standard of Sec.  1.482-9(l)(3)(i). Furthermore, 
for that purpose, it may be more reliable, depending on the facts and 
circumstances, to measure incremental value on a functional aggregate 
activity, rather than a component activity-by-activity basis.
8. Third Party Costs--Treas. Reg. Sec.  1.482-9(l)(4)
    Under Sec.  1.482-9T(l)(4) of the 2006 temporary regulations, a 
controlled services transaction may be analyzed as a single transaction 
or as two separate transactions depending on which approach provides 
the most reliable measure of the arm's length result under the best 
method rule in existing Sec.  1.482-1(c). Two examples are provided 
illustrating different alternatives when a controlled services 
transaction included expenses related to a third-party contract (third 
party costs) with a controlled taxpayer. In both examples, third party 
costs that could be reliably disaggregated could be charged at cost. 
Commentators requested that all third party costs be treated as ``pass 
through'' items that are not subject to a markup applicable to costs 
incurred by the renderer in its capacity as service provider.
    The Treasury Department and the IRS continue to maintain the view 
that whether to consider ``pass through'' items as disaggregated from, 
or aggregated with, other functions and costs, depends on which 
analysis most reliably reflects an arm's length result. Therefore, the 
rules of Sec.  1.482-9(l)(4) are adopted without change.
9. Coordination With Other Transfer Pricing Rules--Treas. Reg. Sec.  
1.482-9(m) and Guarantees
    Section 1.482-9(m) provides coordination rules applicable to a 
controlled services transaction that is combined with, or includes 
elements of, a non-services transaction. These coordination rules rely 
on the best method rule in existing Sec.  1.482-1(c)(1) to determine 
which method or methods would provide the most reliable measure of an 
arm's length result for a particular controlled transaction.
a. Services Subject to a Qualified Cost Sharing Arrangement--Treas. 
Reg. Sec.  1.482-9(m)(3)
    Section 1.482-9T(m)(3) of the 2006 temporary regulations states 
that services provided by a controlled participant under a qualified 
cost sharing arrangement are subject to existing Sec.  1.482-7. As part 
of the temporary cost sharing regulations (TD 9441, 2009-7 I.R.B. 460, 
74 FR 340) published on January 5, 2009, the Treasury Department and 
the IRS replaced the coordination rules with new Sec.  1.482-9T(m)(3). 
Section 1.482-9(m)(3) is reserved pending finalization of the cost 
sharing regulations.
b. Global Dealing Operations
    The Treasury Department and the IRS are working on new global 
dealing regulations. The intent of the Treasury Department and the IRS 
is that, when final global dealing regulations are issued, those 
regulations will govern the evaluation of the activities performed by a 
global dealing operation. Pending the issuance of new global dealing 
regulations, taxpayers may rely on the proposed global dealing 
regulations to govern financial transactions entered into in connection 
with a global dealing operation as defined in proposed Sec.  1.482-8. 
Thus, the cross-reference under proposed Sec.  1.482-9(m)(6) (71 FR 
44247), which provides that a controlled services transaction does not 
include a financial transaction entered into in connection with a 
global dealing operation as defined in proposed Sec.  1.482-8, remains 
in proposed form. Section 1.482-9(m)(6) in these final regulations is 
reserved pending issuance of global dealing regulations.
c. Guarantees, Including Financial Guarantees
    Financial transactions, including guarantees, are explicitly 
excluded from eligibility for the SCM by Sec.  1.482-9(b)(4)(viii). 
However, no inference is intended that financial transactions 
(including guarantees) would otherwise be considered the provision of 
services

[[Page 38836]]

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

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

    Paragraphs (3) and (4) of Sec.  1.482-4(f) provide rules for 
determining the owner of intangible property for purposes of section 
482 and also provide rules for determining the arm's length 
compensation in situations where a controlled party other than the 
owner makes contributions to the value of intangible property. Section 
1.482-4(f)(3)(i)(A) provides that the legal owner of intangible 
property pursuant to the intellectual property law of the relevant 
jurisdiction, or the holder of rights constituting intangible property 
pursuant to contractual terms (such as the terms of a license) or other 
legal provision, will be considered the sole owner of intangible 
property for purposes of this section unless such ownership is 
inconsistent with the economic substance of the underlying 
transactions. Some commentators believe that the rules should specify 
that a holder of bare legal title to intangible property should not be 
presumed to be the owner when other parties have all of the other 
benefits and burdens of ownership. After considering the public 
comments, the Treasury Department and the IRS continue to believe that 
the legal ownership standard as set forth in Sec.  1.482-4(f)(3)(i)(A) 
is the appropriate framework for determining ownership of intangible 
property under section 482.
    The provisions of Sec.  1.482-4(f)(3) and (4) are adopted without 
change.

C. Economic Substance

    A number of commentators expressed similar and sometimes 
interrelated concerns regarding economic substance considerations, 
imputation of contractual terms, the realistic alternatives principle, 
and the rules for income attributable to intangible property. The 
common thread running through these comments is a concern that the IRS 
will inappropriately treat taxpayers as having engaged in transactions 
different from those in which they actually engaged.
    Section 1.482-4(f)(3)(i)(A) provides that, if no owner of 
intangible property is identified under the intellectual property law 
of the relevant jurisdiction, or pursuant to contractual terms 
(including terms imputed pursuant to Sec.  1.482-1(d)(3)(ii)(B)) or 
other legal provision, then the controlled taxpayer that has control of 
intangible property, based on all the facts and circumstances, will be 
considered the sole owner of intangible property for purposes of this 
section. One commentator believes that the control rule for determining 
ownership of non-legally protected intangibles allows the IRS to 
attribute ownership of intangible property in a manner that is 
inconsistent with economic substance. Accordingly, the comment suggests 
that such control determinations must be consistent with economic 
substance in all cases. In the context of the control rule in Sec.  
1.482-4(f)(3)(i)(A), this is already reflected in the language 
``including terms imputed pursuant to Sec.  1.482-1(d)(3)(ii)(B).''
    Section 1.482-9T(h) of the 2006 temporary regulations provides 
that, consistent with the specified methods, an unspecified method 
should take into account the general principle that uncontrolled 
taxpayers compare the terms of a particular transaction to the 
realistic alternatives to that transaction, including economically 
similar transactions structured as other than services transactions, 
and only enter into a transaction if none of the alternatives is 
preferable to it. The realistic alternatives concept was imported from 
Sec.  1.482-1(f)(2)(ii) to be consistent with the general aim to 
coordinate the analyses under the various sections of the regulations 
under section 482. This provision allows flexibility to consider non-
services alternatives to a services transaction, for example, a 
transfer or license of intangible property, if such an approach 
provides the most reliable measure of an arm's length result.
    Commentators suggested that the realistic alternative principle be 
clarified so that only transactions actually engaged in by the 
controlled taxpayer can constitute realistic alternatives or that the 
principle be removed altogether on the grounds that it inappropriately 
treats taxpayers as engaging in transactions other than those they 
chose. The Treasury Department and the IRS do not agree with the 
assertion that consideration of realistic alternatives improperly 
disregards a taxpayer's chosen arrangement and that the realistic 
alternative principle is limited to internal comparables. It is a 
longstanding principle under Sec.  1.482-1(f)(2)(ii)(A) and in the 
valuation field, generally, that, although the Commissioner will 
evaluate the results of a transaction as actually structured by the 
taxpayer unless it lacks economic substance, the Commissioner may 
consider alternatives available in determining the arm's length 
valuation of the controlled transaction. The realistic alternatives 
principle does not recast the transaction. Rather, it assumes that 
taxpayers are rational and will not choose to price an arrangement in a 
manner that makes them worse off economically than another available 
alternative. Thus, if the price associated with a realistic alternative 
appears preferable in comparison with the price associated with the 
chosen arrangement, the logical implication is that the actual 
arrangement has been priced incorrectly through a flawed application of 
the best method rule. This is further reflected in the example in Sec.  
1.482-9T(h), which illustrates when realistic alternatives may be 
considered to evaluate the arm's length consideration, and explicitly 
states that the best method rule of Sec.  1.482-1(c) governs the 
analysis.
    The unspecified method provisions in these final regulations are 
adopted without change.
    Section 1.482-9(i)(3) provides that, consistent with the authority 
in Sec.  1.482-1(d)(3)(ii)(B), the Commissioner may impute contingent-
payment contractual terms in a controlled services transaction if the 
economic substance of the transaction is consistent with the existence 
of such terms. When the 2003 proposed regulations were issued, 
commentators expressed concerns with the rule for imputing contingent 
payment terms to the extent that it permits the IRS to recast 
arrangements if there is a disagreement about the pricing of a service. 
The temporary regulations responded to this concern by providing a new 
Example 5 in Sec.  1.482-1T(d)(3)(ii)(C) to illustrate that if a 
taxpayer's pricing is outside of the arm's length range, that fact 
alone would not support imputation of additional contractual terms 
based on economic substance grounds. Commentators responded, however, 
that the last sentence of Example 5 perpetuated the same problem of 
allowing the IRS to recast arrangements if there were pricing disputes 
between a taxpayer and the IRS.
    The Treasury Department and the IRS agree that the last sentence of 
Example 5 in Sec.  1.482-1T(d)(3)(ii)(C) did not clearly convey its 
intended meaning, which is that a transfer pricing method and the price 
derived from the application of that method do not inform the terms of 
the transaction or the risks borne by the entities. Rather, the 
selection and application of a transfer pricing method should be based 
on a comparability analysis of the transaction, which must consider the 
risks borne by each entity in the transaction. Thus, the last sentence 
in Sec.  1.482-1T(d)(3)(ii)(C) Example 5,

[[Page 38837]]

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

D. Stewardship Expenses--Sec.  1.861-8

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

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

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

Special Analyses

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

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

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

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1, 31, 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 in part as follows:

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


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


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

    This section contains major captions for Sec. Sec.  1.482-1 through 
1.482-9.


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

    (a) * * *
    (1) Purpose and scope.
* * * * *
    (d) * * *
    (3) * * *
    (ii) * * *
    (C) Examples.
* * * * *
    (v) Property or services.
* * * * *
    (f) * * *
    (2) * * *
    (ii) * * *
    (A) In general.
* * * * *
    (iii) * * *
    (A) * * *
    (B) Circumstances warranting consideration of multiple year data.
* * * * *
    (g) * * *
    (4) * * *
    (iii) Examples.
* * * * *
    (i) Definitions.
    (j) Effective/applicability date.


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

* * * * *
    (b) Rendering of services.
* * * * *
    (e) [Reserved]. For further guidance, see Sec.  1.482-0T, the entry 
for Sec.  1.482-2T(e).
    (f) Effective/applicability date.
* * * * *


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

* * * * *
    (f) * * *
    (3) Ownership of intangible property.
    (i) Identification of owner.
    (A) In general.
    (B) [Reserved]. For further guidance, see Sec.  1.482-0T, the entry 
for Sec.  1.482-4T(f)(3)(i)(B).
    (ii) Examples.
    (4) Contribution to the value of intangible property owned by 
another.
    (i) In general.

[[Page 38838]]

    (ii) Examples.
* * * * *
    (g) [Reserved]. For further guidance, see Sec.  1.482-0T, the entry 
for Sec.  1.482-4T(g).
    (h) Effective/applicability date.
* * * * *


Sec.  1.482-6   Profit split method.

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (B) * * *.
    (1) In general.
* * * * *
    (D) Other factors affecting reliability.
* * * * *
    (3) * * *
    (i) * * *
    (A) Allocate income to routine contributions.
    (B) Allocate residual profit.
    (1) Nonroutine contributions generally.
    (2) Nonroutine contributions of intangible property.
    (ii) * * *
    (D) Other factors affecting reliability.
* * * * *
    (d) Effective/applicability date.


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

* * * * *
    (c) Effective/applicability date.


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

    (a) In general.
    (b) Services cost method.
    (1) In general.
    (2) Eligibility for the services cost method.
    (3) Covered services.
    (i) Specified covered services.
    (ii) Low margin covered services.
    (4) Excluded activities.
    (5) Not services that contribute significantly to fundamental risks 
of business success or failure.
    (6) Adequate books and records.
    (7) Shared services arrangement.
    (i) In general.
    (ii) Requirements for shared services arrangement.
    (A) Eligibility.
    (B) Allocation.
    (C) Documentation.
    (iii) Definitions and special rules.
    (A) Participant.
    (B) Aggregation.
    (C) Coordination with cost sharing arrangements.
    (8) Examples.
    (c) Comparable uncontrolled services price method.
    (1) In general.
    (2) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) In general.
    (B) Adjustments for differences between controlled and uncontrolled 
transactions.
    (iii) Data and assumptions.
    (3) Arm's length range.
    (4) Examples.
    (5) Indirect evidence of the price of a comparable uncontrolled 
services transaction.
    (i) In general.
    (ii) Example.
    (d) Gross services margin method.
    (1) In general.
    (2) Determination of arm's length price.
    (i) In general.
    (ii) Relevant uncontrolled transaction.
    (iii) Applicable uncontrolled price.
    (iv) Appropriate gross services profit.
    (v) Arm's length range.
    (3) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) Functional comparability.
    (B) Other comparability factors.
    (C) Adjustments for differences between controlled and uncontrolled 
transactions.
    (D) Buy-sell distributor.
    (iii) Data and assumptions.
    (A) In general.
    (B) Consistency in accounting.
    (4) Examples.
    (e) Cost of services plus method.
    (1) In general.
    (2) Determination of arm's length price.
    (i) In general.
    (ii) Appropriate gross services profit.
    (iii) Comparable transactional costs.
    (iv) Arm's length range.
    (3) Comparability and reliability considerations.
    (i) In general.
    (ii) Comparability.
    (A) Functional comparability.
    (B) Other comparability factors.
    (C) Adjustments for differences between the controlled and 
uncontrolled transactions.
    (iii) Data and assumptions.
    (A) In general.
    (B) Consistency in accounting.
    (4) Examples.
    (f) Comparable profits method.
    (1) In general.
    (2) Determination of arm's length result.
    (i) Tested party.
    (ii) Profit level indicators.
    (iii) Comparability and reliability considerations--Data and 
assumptions--Consistency
    in accounting.
    (3) Examples.
    (g) Profit split method.
    (1) In general.
    (2) Examples.
    (h) Unspecified methods.
    (i) Contingent-payment contractual terms for services.
    (1) Contingent-payment contractual terms recognized in general.
    (2) Contingent-payment arrangement.
    (i) General requirements.
    (A) Written contract.
    (B) Specified contingency.
    (C) Basis for payment.
    (ii) Economic substance and conduct.
    (3) Commissioner's authority to impute contingent-payment terms.
    (4) Evaluation of arm's length charge.
    (5) Examples.
    (j) Total services costs.
    (k) Allocation of costs.
    (1) In general.
    (2) Appropriate method of allocation and apportionment.
    (i) Reasonable method standard.
    (ii) Use of general practices.
    (3) Examples.
    (l) Controlled services transaction.
    (1) In general.
    (2) Activity.
    (3) Benefit.
    (i) In general.
    (ii) Indirect or remote benefit.
    (iii) Duplicative activities.
    (iv) Shareholder activities.
    (v) Passive association.
    (4) Disaggregation of transactions.
    (5) Examples.
    (m) Coordination with transfer pricing rules for other 
transactions.
    (1) Services transactions that include other types of transactions.
    (2) Services transactions that effect a transfer of intangible 
property.
    (3) [Reserved]. For further guidance, see Sec.  1.482-0T, the entry 
for Sec.  1.482-9T(m)(3).
    (4) Other types of transactions that include controlled services 
transactions.
    (5) Examples.
    (n) Effective/applicability date.
    (1) In general.
    (2) Election to apply regulations to earlier taxable years.

0
Par. 3. Section 1.482-0T is amended as follows:
0
1. Revise the section heading and introductory text.
0
2. Revise the section headings for Sec. Sec.  1.482-1T, 1.482-4T and 
1.482.9T and the entries for Sec. Sec.  1.482-1T, 1.482-2T, 1.482-4T 
and 1.482.9T.
0
3. Remove the entries for Sec.  1.482-6T.
    The revisions read as follows:


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

    This section contains major captions for Sec. Sec.  1.482-1T, 
1.482-2T, 1.482-4T, 1.482-7T, 1.482-8T, and 1.482-9T.

[[Page 38839]]

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

    (a) through (b)(2) [Reserved]. For further guidance, see Sec.  
1.482-0, the entries for Sec.  1.482-1(a) through (b)(2).
    (i) Methods.
    (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 (i) [Reserved]. For further guidance, see Sec.  1.482-
0, the entries for Sec.  1.482-1(c) through (i).
    (j) Effective/applicability date.
    (k) Expiration date.


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

    (a) through (d) [Reserved]. For further guidance, see Sec.  1.482-
0, the entries for Sec.  1.482-2(a) through (d).
    (e) Cost sharing arrangement.
    (f) Effective/applicability date.
    (1) In general.
    (2) Election to apply regulation to earlier taxable years.
    (3) Expiration date.


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

    (a) through (f)(3)(i)(A) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entries for Sec.  1.482-4(a) through (f)(3)(i)(A).
    (B) Cost sharing arrangements.
    (f)(3)(ii) through (f)(6) [Reserved]. For further guidance, see 
Sec.  1.482-0, the entries for Sec.  1.482-4(f)(3)(ii) through (f)(6).
    (g) Coordination with rules governing cost sharing arrangements.
    (h) Effective/applicability date.
    (i) Expiration date.
* * * * *


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

    (a) through (m)(2) [Reserved]. For further guidance, see Sec.  
1.482-0, the entries for Sec.  1.482-9(a) through (m)(2).
    (3) Coordination with rules governing cost sharing arrangements.
    (n) Effective/applicability dates.
    (o) Expiration date.

0
Par. 4. Section 1.482-1 is amended by revising paragraphs (a)(1), 
(d)(3)(ii)(C) Examples 3, 4, 5, and 6, (d)(3)(v), (f)(2)(ii)(A), 
(f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii) Example 1, (i), and (j)(6) to 
read as follows:


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

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

    Example 3. Contractual terms imputed from economic substance. 
(i) FP, a foreign producer of wristwatches, is the registered holder 
of the YY trademark in the United States and in other countries 
worldwide. In year 1, FP enters the United States market by selling 
YY wristwatches to its newly organized United States subsidiary, 
USSub, for distribution in the United States market. USSub pays FP a 
fixed price per wristwatch. USSub and FP undertake, without separate 
compensation, marketing activities to establish the YY trademark in 
the United States market. Unrelated foreign producers of trademarked 
wristwatches and their authorized United States distributors 
respectively undertake similar marketing activities in independent 
arrangements involving distribution of trademarked wristwatches in 
the United States market. In years 1 through 6, USSub markets and 
sells YY wristwatches in the United States. Further, in years 1 
through 6, USSub undertakes incremental marketing activities in 
addition to the activities similar to those observed in the 
independent distribution transactions in the United States market. 
FP does not directly or indirectly compensate USSub for performing 
these incremental activities during years 1 through 6. Assume that, 
aside from these incremental activities, and after any adjustments 
are made to improve the reliability of the comparison, the price 
paid per wristwatch by the independent, authorized distributors of 
wristwatches would provide the most reliable measure of the arm's 
length price paid per YY wristwatch by USSub.
    (ii) By year 7, the wristwatches with the YY trademark generate 
a premium return in the United States market, as compared to 
wristwatches marketed by the independent distributors. In year 7, 
substantially all the premium return from the YY trademark in the 
United States market is attributed to FP, for example through an 
increase in the price paid per watch by USSub, or by some other 
means.
    (iii) In determining whether an allocation of income is 
appropriate in year 7, the Commissioner may consider the economic 
substance of the arrangements between USSub and FP, and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that, ex 
ante, an uncontrolled taxpayer operating at arm's length would 
engage in the incremental marketing activities to develop or enhance 
intangible property owned by another party unless it received 
contemporaneous compensation or otherwise had a reasonable 
anticipation of receiving a future benefit from those activities. In 
this case, USSub's undertaking the incremental marketing activities 
in years 1 through 6 is a course of conduct that is inconsistent 
with the parties' attribution to FP in year 7 of substantially all 
the premium return from the enhanced YY trademark in the United 
States market. Therefore, the Commissioner may impute one or more 
agreements between USSub and FP, consistent with the economic 
substance of their course of conduct, which would afford USSub an 
appropriate portion of the premium return from the YY trademark 
wristwatches. For example, the Commissioner may impute a separate 
services agreement that affords USSub contingent-payment 
compensation for its incremental marketing activities in years 1 
through 6, which benefited FP by contributing to the value of the 
trademark owned by FP. In the alternative, the Commissioner may 
impute a long-term, exclusive agreement to exploit the YY trademark 
in the United States that allows USSub to benefit from the 
incremental marketing activities it performed. As another 
alternative, the Commissioner may require FP to compensate USSub for 
terminating USSub's imputed long-term, exclusive agreement to 
exploit the YY trademark in the United States, an agreement that 
USSub made more valuable at its own expense and risk. The taxpayer 
may present additional facts that could indicate which of these or 
other alternative agreements best reflects the economic substance of 
the underlying transactions, consistent with the parties' course of 
conduct in the particular case.
    Example 4. Contractual terms imputed from economic substance. 
(i) FP, a foreign producer of athletic gear, is the registered 
holder of the AA trademark in the United States and in other 
countries worldwide. In year 1, FP enters into a licensing agreement 
that affords its newly organized United States subsidiary, USSub, 
exclusive rights to certain manufacturing and marketing intangible 
property (including the AA trademark) for purposes of manufacturing 
and marketing athletic gear in the United States under the AA 
trademark. The contractual terms of this

[[Page 38840]]

agreement obligate USSub to pay FP a royalty based on sales, and 
also obligate both FP and USSub to undertake without separate 
compensation specified types and levels of marketing activities. 
Unrelated foreign businesses license independent United States 
businesses to manufacture and market athletic gear in the United 
States, using trademarks owned by the unrelated foreign businesses. 
The contractual terms of these uncontrolled transactions require the 
licensees to pay royalties based on sales of the merchandise, and 
obligate the licensors and licensees to undertake without separate 
compensation specified types and levels of marketing activities. In 
years 1 through 6, USSub manufactures and sells athletic gear under 
the AA trademark in the United States. Assume that, after 
adjustments are made to improve the reliability of the comparison 
for any material differences relating to marketing activities, 
manufacturing or marketing intangible property, and other 
comparability factors, the royalties paid by independent licensees 
would provide the most reliable measure of the arm's length royalty 
owed by USSub to FP, apart from the additional facts in paragraph 
(ii) of this Example 4.
    (ii) In years 1 through 6, USSub performs incremental marketing 
activities with respect to the AA trademark athletic gear, in 
addition to the activities required under the terms of the license 
agreement with FP, that are also incremental as compared to those 
observed in the comparables. FP does not directly or indirectly 
compensate USSub for performing these incremental activities during 
years 1 through 6. By year 7, AA trademark athletic gear generates a 
premium return in the United States, as compared to similar athletic 
gear marketed by independent licensees. In year 7, USSub and FP 
enter into a separate services agreement under which FP agrees to 
compensate USSub on a cost basis for the incremental marketing 
activities that USSub performed during years 1 through 6, and to 
compensate USSub on a cost basis for any incremental marketing 
activities it may perform in year 7 and subsequent years. In 
addition, the parties revise the license agreement executed in year 
1, and increase the royalty to a level that attributes to FP 
substantially all the premium return from sales of the AA trademark 
athletic gear in the United States.
    (iii) In determining whether an allocation of income is 
appropriate in year 7, the Commissioner may consider the economic 
substance of the arrangements between USSub and FP and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that, ex 
ante, an uncontrolled taxpayer operating at arm's length would 
engage in the incremental marketing activities to develop or enhance 
intangible property owned by another party unless it received 
contemporaneous compensation or otherwise had a reasonable 
anticipation of a future benefit. In this case, USSub's undertaking 
the incremental marketing activities in years 1 through 6 is a 
course of conduct that is inconsistent with the parties' adoption in 
year 7 of contractual terms by which FP compensates USSub on a cost 
basis for the incremental marketing activities that it performed. 
Therefore, the Commissioner may impute one or more agreements 
between USSub and FP, consistent with the economic substance of 
their course of conduct, which would afford USSub an appropriate 
portion of the premium return from the AA trademark athletic gear. 
For example, the Commissioner may impute a separate services 
agreement that affords USSub contingent-payment compensation for the 
incremental activities it performed during years 1 through 6, which 
benefited FP by contributing to the value of the trademark owned by 
FP. In the alternative, the Commissioner may impute a long-term, 
exclusive United States license agreement that allows USSub to 
benefit from the incremental activities. As another alternative, the 
Commissioner may require FP to compensate USSub for terminating 
USSub's imputed long-term United States license agreement, a license 
that USSub made more valuable at its own expense and risk. The 
taxpayer may present additional facts that could indicate which of 
these or other alternative agreements best reflects the economic 
substance of the underlying transactions, consistent with the 
parties' course of conduct in this particular case.
    Example 5. Non-arm's length compensation. (i) The facts are the 
same as in paragraph (i) of Example 4. As in Example 4, assume that, 
after adjustments are made to improve the reliability of the 
comparison for any material differences relating to marketing 
activities, manufacturing or marketing intangible property, and 
other comparability factors, the royalties paid by independent 
licensees would provide the most reliable measure of the arm's 
length royalty owed by USSub to FP, apart from the additional facts 
described in paragraph (ii) of this Example 5.
    (ii) In years 1 through 4, USSub performs certain incremental 
marketing activities with respect to the AA trademark athletic gear, 
in addition to the activities required under the terms of the basic 
license agreement, that are also incremental as compared with those 
activities observed in the comparables. At the start of year 1, FP 
enters into a separate services agreement with USSub, which states 
that FP will compensate USSub quarterly, in an amount equal to 
specified costs plus X%, for these incremental marketing functions. 
Further, these written agreements reflect the intent of the parties 
that USSub receive such compensation from FP throughout the term of 
the agreement, without regard to the success or failure of the 
promotional activities. During years 1 through 4, USSub performs 
marketing activities pursuant to the separate services agreement and 
in each year USSub receives the specified compensation from FP on a 
cost of services plus basis.
    (iii) In evaluating year 4, the Commissioner performs an 
analysis of independent parties that perform promotional activities 
comparable to those performed by USSub and that receive separately-
stated compensation on a current basis without contingency. The 
Commissioner determines that the magnitude of the specified cost 
plus X% is outside the arm's length range in each of years 1 through 
4. Based on an evaluation of all the facts and circumstances, the 
Commissioner makes an allocation to require payment of compensation 
to USSub for the promotional activities performed in year 4, based 
on the median of the interquartile range of the arm's length markups 
charged by the uncontrolled comparables described in paragraph 
(e)(3) of this section.
    (iv) Given that based on facts and circumstances, the terms 
agreed by the controlled parties were that FP would bear all risks 
associated with the promotional activities performed by USSub to 
promote the AA trademark product in the United States market, and 
given that the parties' conduct during the years examined was 
consistent with this allocation of risk, the fact that the cost of 
services plus markup on USSub's services was outside the arm's 
length range does not, without more, support imputation of 
additional contractual terms based on alternative views of the 
economic substance of the transaction, such as terms indicating that 
USSub, rather than FP, bore the risk associated with these 
activities.
    Example 6. Contractual terms imputed from economic substance. 
(i) Company X is a member of a controlled group that has been in 
operation in the pharmaceutical sector for many years. In years 1 
through 4, Company X undertakes research and development activities. 
As a result of those activities, Company X developed a compound that 
may be more effective than existing medications in the treatment of 
certain conditions.
    (ii) Company Y is acquired in year 4 by the controlled group 
that includes Company X. Once Company Y is acquired, Company X makes 
available to Company Y a large amount of technical data concerning 
the new compound, which Company Y uses to register patent rights 
with respect to the compound in several jurisdictions, making 
Company Y the legal owner of such patents. Company Y then enters 
into licensing agreements with group members that afford Company Y 
100% of the premium return attributable to use of the intangible 
property by its subsidiaries.
    (iii) In determining whether an allocation is appropriate in 
year 4, the Commissioner may consider the economic substance of the 
arrangements between Company X and Company Y, and the parties' 
course of conduct throughout their relationship. Based on this 
analysis, the Commissioner determines that it is unlikely that an 
uncontrolled taxpayer operating at arm's length would make available 
the results of its research and development or perform services that 
resulted in transfer of valuable know how to another party unless it 
received contemporaneous compensation or otherwise had a reasonable 
anticipation of receiving a future benefit from those activities. In 
this case, Company X's undertaking the research and development 
activities and then providing technical data and know-how to Company 
Y in year 4 is inconsistent with the registration and subsequent 
exploitation of the patent by Company Y. Therefore, the Commissioner 
may impute one or more agreements between Company X and Company Y 
consistent with the economic substance of their course of conduct, 
which would afford Company X an appropriate portion of the premium 
return from the patent rights. For example, the Commissioner

[[Page 38841]]

may impute a separate services agreement that affords Company X 
contingent-payment compensation for its services in year 4 for the 
benefit of Company Y, consisting of making available to Company Y 
technical data, know-how, and other fruits of research and 
development conducted in previous years. These services benefited 
Company Y by giving rise to and contributing to the value of the 
patent rights that were ultimately registered by Company Y. In the 
alternative, the Commissioner may impute a transfer of patentable 
intangible property rights from Company X to Company Y immediately 
preceding the registration of patent rights by Company Y. The 
taxpayer may present additional facts that could indicate which of 
these or other alternative agreements best reflects the economic 
substance of the underlying transactions, consistent with the 
parties' course of conduct in the particular case.
* * * * *
    (v) Property or services. Evaluating the degree of comparability 
between controlled and uncontrolled transactions requires a comparison 
of the property or services transferred in the transactions. This 
comparison may include any intangible property that is embedded in 
tangible property or services being transferred (embedded intangibles). 
The comparability of the embedded intangibles will be analyzed using 
the factors listed in Sec.  1.482-4(c)(2)(iii)(B)(1) (comparable 
intangible property). The relevance of product comparability in 
evaluating the relative reliability of the results will depend on the 
method applied. For guidance concerning the specific comparability 
considerations applicable to transfers of tangible and intangible 
property and performance of services, see Sec. Sec.  1.482-3 through 
1.482-6 and Sec.  1.482-9; see also Sec. Sec.  1.482-3(f), 1.482-
4(f)(4), and 1.482-9(m), dealing with the coordination of the 
intangible and tangible property and performance of services rules.
* * * * *
    (f) * * *
    (2) * * *
    (ii) Allocation based on taxpayer's actual transactions-(A) In 
general. The Commissioner will evaluate the results of a transaction as 
actually structured by the taxpayer unless its structure lacks economic 
substance. However, the Commissioner may consider the alternatives 
available to the taxpayer in determining whether the terms of the 
controlled transaction would be acceptable to an uncontrolled taxpayer 
faced with the same alternatives and operating under comparable 
circumstances. In such cases the Commissioner may adjust the 
consideration charged in the controlled transaction based on the cost 
or profit of an alternative as adjusted to account for material 
differences between the alternative and the controlled transaction, but 
will not restructure the transaction as if the alternative had been 
adopted by the taxpayer. See paragraph (d)(3) of this section (factors 
for determining comparability; contractual terms and risk); Sec. Sec.  
1.482-3(e), 1.482-4(d), and 1.482-9(h) (unspecified methods).
* * * * *
    (iii) * * *
    (B) Circumstances warranting consideration of multiple year data. 
The extent to which it is appropriate to consider multiple year data 
depends on the method being applied and the issue being addressed. 
Circumstances that may warrant consideration of data from multiple 
years include the extent to which complete and accurate data are 
available for the taxable year under review, the effect of business 
cycles in the controlled taxpayer's industry, or the effects of life 
cycles of the product or intangible property being examined. Data from 
one or more years before or after the taxable year under review must 
ordinarily be considered for purposes of applying the provisions of 
paragraph (d)(3)(iii) of this section (risk), paragraph (d)(4)(i) of 
this section (market share strategy), Sec.  1.482-4(f)(2) (periodic 
adjustments), Sec.  1.482-5 (comparable profits method), Sec.  1.482-
9(f) (comparable profits method for services), and Sec.  1.482-9(i) 
(contingent-payment contractual terms for services). On the other hand, 
multiple year data ordinarily will not be considered for purposes of 
applying the comparable uncontrolled price method of Sec.  1.482-3(b) 
or the comparable uncontrolled services price method of Sec.  1.482-
9(c) (except to the extent that risk or market share strategy issues 
are present).
* * * * *
    (g) * * *
    (4) Setoffs--(i) In general. If an allocation is made under section 
482 with respect to a transaction between controlled taxpayers, the 
Commissioner will take into account the effect of any other non-arm's 
length transaction between the same controlled taxpayers in the same 
taxable year which will result in a setoff against the original section 
482 allocation. Such setoff, however, will be taken into account only 
if the requirements of paragraph (g)(4)(ii) of this section are 
satisfied. If the effect of the setoff is to change the 
characterization or source of the income or deductions, or otherwise 
distort taxable income, in such a manner as to affect the U.S. tax 
liability of any member, adjustments will be made to reflect the 
correct amount of each category of income or deductions. For purposes 
of this setoff provision, the term arm's length refers to the amount 
defined in paragraph (b) of this section (arm's length standard), 
without regard to the rules in Sec.  1.482-2(a) that treat certain 
interest rates as arm's length rates of interest.
* * * * *
    (iii) * * *

    Example 1. P, a U.S. corporation, renders construction services 
to S, its foreign subsidiary in Country Y, in connection with the 
construction of S's factory. An arm's length charge for such 
services determined under Sec.  1.482-9 would be $100,000. During 
the same taxable year P makes available to S the use of a machine to 
be used in the construction of the factory, and the arm's length 
rental value of the machine is $25,000. P bills S $125,000 for the 
services, but does not charge S for the use of the machine. No 
allocation will be made with respect to the undercharge for the 
machine if P notifies the district director of the basis of the 
claimed setoff within 30 days after the date of the letter from the 
district director transmitting the examination report notifying P of 
the proposed adjustment, establishes that the excess amount charged 
for services was equal to an arm's length charge for the use of the 
machine and that the taxable income and income tax liabilities of P 
are not distorted, and documents the correlative allocations 
resulting from the proposed setoff.
* * * * *
    (i) Definitions. The definitions set forth in paragraphs (i)(1) 
through (i)(10) of this section apply to this section and Sec. Sec.  
1.482-2 through 1.482-9.
* * * * *
    (j) * * *
    (6)(i) The provisions of paragraphs (a)(1), (d)(3)(ii)(C) Example 
3, Example 4, Example 5, and Example 6, (d)(3)(v), (f)(2)(ii)(A), 
(f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii), and (i) of this section are 
generally applicable for taxable years beginning after July 31, 2009.
    (ii) A person may elect to apply the provisions of paragraphs 
(a)(1), (b)(2)(i), (d)(3)(ii)(C) Example 3, Example 4, Example 5, and 
Example 6, (d)(3)(v), (f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), 
(g)(4)(iii), and (i) of this section to earlier taxable years in 
accordance with the rules set forth in Sec.  1.482-9(n)(2).

0
Par. 5. Section 1.482-1T is amended by revising paragraphs (a), (b)(1), 
the first sentence in paragraph (b)(2)(i), (b)(2)(ii), the second 
sentence in paragraph (b)(2)(iii), (c), (d), (e), (f), (g), (h), (i), 
and (j) to read as follows:


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

    (a) through (b)(1) [Reserved]. For further guidance, see Sec.  
1.482-1(a) through (b)(1).
    (b)(2) * * * (i) * * * Sections 1.482-2 through 1.482-6, 1.482-7T 
and 1.482-

[[Page 38842]]

9 provide specific methods to be used to evaluate whether transactions 
between or among members of the controlled group satisfy the arm's 
length standard, and if they do not, to determine the arm's length 
result. * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.482-1(b)(2)(ii).
    (iii) * * * Sections 1.482-4 and 1.482-9, as appropriate, provide 
the specific methods to be used to determine arm's length results of 
arrangements, including partnerships, for sharing the costs and risks 
of developing intangible property, other that a cost sharing 
arrangement covered by Sec.  1.482-7T. * * *
    (c) through (j)(5) [Reserved]. For further guidance, see Sec.  
1.482-1(c) through (j)(5).
    (j)(6)(i) The provisions of paragraphs (b)(2)(i) and (b)(2)(iii) of 
this section are generally applicable on January 5, 2009.
    (ii) [Reserved]. For further guidance, see Sec.  1.482-1(j)(6)(ii).
    (iii) The applicability of paragraphs (b)(2)(i) and (b)(2)(iii) of 
this section expires on or before December 30, 2011.

0
Par. 6. Section 1.482-2 is amended by revising paragraph (b), (e), and 
adding paragraph (f) to read as follows:


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

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

0
Par. 7. Section 1.482-2T is amended as follows:
0
1. Revise paragraphs (a), (b), (c), (d), and (f)(2).
0
2. Remove the first sentence in both paragraphs (f)(1) and (f)(3).
    The revisions read as follows:


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

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

0
Par. 8. Section 1.482-4 is amended as follows:
0
1. Revise paragraphs (f)(3) and (f)(4).
0
2. Add paragraphs (g) and (h).
    The revisions and addition read as follows:


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

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

    Example 1. FP, a foreign corporation, is the registered holder 
of the AA trademark in the United States. FP licenses to its U.S. 
subsidiary, USSub, the exclusive rights to manufacture and market 
products in the United States under the AA trademark. FP is the 
owner of the trademark pursuant to intellectual property law. USSub 
is the owner of the license pursuant to the terms of the license, 
but is not the owner of the trademark. See paragraphs (b)(3) and (4) 
of this section (defining an intangible as, among other things, a 
trademark or a license).
    Example 2. The facts are the same as in Example 1. As a result 
of its sales and marketing activities, USSub develops a list of 
several hundred creditworthy customers that regularly purchase AA 
trademarked products. Neither the terms of the contract between FP 
and USSub nor the relevant intellectual property law specify which 
party owns the customer list. Because USSub has knowledge of the 
contents of the list, and has practical control over its use and 
dissemination, USSub is considered the sole owner of the customer 
list for purposes of this paragraph (f)(3).

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

    Example 1. A, a member of a controlled group, allows B, another 
member of the controlled group, to use tangible property, such as 
laboratory equipment, in connection with B's development of an 
intangible that B owns. By furnishing tangible property, A makes a 
contribution to the development of intangible property owned by 
another controlled taxpayer, B. Pursuant to paragraph (f)(4)(i) of 
this section, the arm's length charge for A's furnishing of tangible 
property will be determined under the rules for use of tangible 
property in Sec.  1.482-2(c).
    Example 2. (i) Facts. FP, a foreign producer of wristwatches, is 
the registered holder of the YY trademark in the United States and 
in other countries worldwide. FP enters into an exclusive, five-
year, renewable agreement with its newly organized U.S. subsidiary, 
USSub. The contractual terms of the agreement grant USSub the 
exclusive right to re-sell YY trademark wristwatches in the United 
States, obligate USSub to pay a fixed price per wristwatch 
throughout the entire term of the contract, and obligate both FP and 
USSub to undertake without separate compensation specified types and 
levels of marketing activities.
    (ii) The consideration for FP's and USSub's marketing 
activities, as well as the consideration for the exclusive right to 
re-sell YY trademarked merchandise in the United States, are 
embedded in the transfer price paid for the wristwatches. 
Accordingly, pursuant to paragraph (f)(4)(i) of this section, 
ordinarily no separate allocation would be

[[Page 38843]]

appropriate with respect to these embedded contributions.
    (iii) Whether an allocation is warranted with respect to the 
transfer price for the wristwatches is determined under Sec. Sec.  
1.482-1, 1.482-3, and this section through Sec.  1.482-6. The 
comparability analysis would include consideration of all relevant 
factors, including the nature of the intangible property embedded in 
the wristwatches and the nature of the marketing activities required 
under the agreement. This analysis would also take into account that 
the compensation for the activities performed by USSub and FP, as 
well as the consideration for USSub's use of the YY trademark, is 
embedded in the transfer price for the wristwatches, rather than 
provided for in separate agreements. See Sec. Sec.  1.482-3(f) and 
1.482-9(m)(4).
    Example 3. (i) Facts. FP, a foreign producer of athletic gear, 
is the registered holder of the AA trademark in the United States 
and in other countries. In year 1, FP licenses to a newly organized 
U.S. subsidiary, USSub, the exclusive rights to use certain 
manufacturing and marketing intangible property to manufacture and 
market athletic gear in the United States under the AA trademark. 
The license agreement obligates USSub to pay a royalty based on 
sales of trademarked merchandise. The license agreement also 
obligates FP and USSub to perform without separate compensation 
specified types and levels of marketing activities. In year 1, USSub 
manufactures and sells athletic gear under the AA trademark in the 
United States.
    (ii) The consideration for FP's and USSub's respective marketing 
activities is embedded in the contractual terms of the license for 
the AA trademark. Accordingly, pursuant to paragraph (f)(4)(i) of 
this section, ordinarily no separate allocation would be appropriate 
with respect to the embedded contributions in year 1. See Sec.  
1.482-9(m)(4).
    (iii) Whether an allocation is warranted with respect to the 
royalty under the license agreement would be analyzed under Sec.  
1.482-1, and this section through Sec.  1.482-6. The comparability 
analysis would include consideration of all relevant factors, such 
as the term and geographical exclusivity of the license, the nature 
of the intangible property subject to the license, and the nature of 
the marketing activities required to be undertaken pursuant to the 
license. Pursuant to paragraph (f)(4)(i) of this section, the 
analysis would also take into account the fact that the compensation 
for the marketing services is embedded in the royalty paid for use 
of the AA trademark, rather than provided for in a separate services 
agreement. For illustrations of application of the best method rule, 
see Sec.  1.482-8 Examples 10, 11, and 12.
    Example 4. (i) Facts. The year 1 facts are the same as in 
Example 3, with the following exceptions. In year 2, USSub 
undertakes certain incremental marketing activities in addition to 
those required by the contractual terms of the license for the AA 
trademark executed in year 1. The parties do not execute a separate 
agreement with respect to these incremental marketing activities 
performed by USSub. The license agreement executed in year 1 is of 
sufficient duration that it is reasonable to anticipate that USSub 
will obtain the benefit of its incremental activities, in the form 
of increased sales or revenues of trademarked products in the U.S. 
market.
    (ii) To the extent that it was reasonable to anticipate that 
USSub's incremental marketing activities would increase the value 
only of USSub's intangible property (that is, USSub's license to use 
the AA trademark for a specified term), and not the value of the AA 
trademark owned by FP, USSub's incremental activities do not 
constitute a contribution for which an allocation is warranted under 
paragraph (f)(4)(i) of this section.
    Example 5. (i) Facts. The year 1 facts are the same as in 
Example 3. In year 2, FP and USSub enter into a separate services 
agreement that obligates USSub to perform certain incremental 
marketing activities to promote AA trademark athletic gear in the 
United States, above and beyond the activities specified in the 
license agreement executed in year 1. In year 2, USSub begins to 
perform these incremental activities, pursuant to the separate 
services agreement with FP.
    (ii) Whether an allocation is warranted with respect to USSub's 
incremental marketing activities covered by the separate services 
agreement would be evaluated under Sec. Sec.  1.482-1 and 1.482-9, 
including a comparison of the compensation provided for the services 
with the results obtained under a method pursuant to Sec.  1.482-9, 
selected and applied in accordance with the best method rule of 
Sec.  1.482-1(c).
    (iii) Whether an allocation is warranted with respect to the 
royalty under the license agreement is determined under Sec.  1.482-
1, and this section through Sec.  1.482-6. The comparability 
analysis would include consideration of all relevant factors, such 
as the term and geographical exclusivity of the license, the nature 
of the intangible property subject to the license, and the nature of 
the marketing activities required to be undertaken pursuant to the 
license. The comparability analysis would take into account that the 
compensation for the incremental activities by USSub is provided for 
in the separate services agreement, rather than embedded in the 
royalty paid for use of the AA trademark. For illustrations of 
application of the best method rule, see Sec.  1.482-8 Examples 10, 
11, and 12.
    Example 6. (i) Facts. The year 1 facts are the same as in 
Example 3. In year 2, FP and USSub enter into a separate services 
agreement that obligates FP to perform incremental marketing 
activities, not specified in the year 1 license, by advertising AA 
trademarked athletic gear in selected international sporting events, 
such as the Olympics and the soccer World Cup. FP's corporate 
advertising department develops and coordinates these special 
promotions. The separate services agreement obligates USSub to pay 
an amount to FP for the benefit to USSub that may reasonably be 
anticipated as the result of FP's incremental activities. The 
separate services agreement is not a qualified cost sharing 
arrangement under Sec.  1.482-7T. FP begins to perform the 
incremental activities in year 2 pursuant to the separate services 
agreement.
    (ii) Whether an allocation is warranted with respect to the 
incremental marketing activities performed by FP under the separate 
services agreement would be evaluated under Sec.  1.482-9. Under the 
circumstances, it is reasonable to anticipate that FP's activities 
would increase the value of USSub's license as well as the value of 
FP's trademark. Accordingly, the incremental activities by FP may 
constitute in part a controlled services transaction for which USSub 
must compensate FP. The analysis of whether an allocation is 
warranted would include a comparison of the compensation provided 
for the services with the results obtained under a method pursuant 
to Sec.  1.482-9, selected and applied in accordance with the best 
method rule of Sec.  1.482-1(c).
    (iii) Whether an allocation is appropriate with respect to the 
royalty under the license agreement would be evaluated under 
Sec. Sec.  1.482-1 through 1.482-3, this section, and Sec. Sec.  
1.482-5 and 1.482-6. The comparability analysis would include 
consideration of all relevant factors, such as the term and 
geographical exclusivity of USSub's license, the nature of the 
intangible property subject to the license, and the marketing 
activities required to be undertaken by both FP and USSub pursuant 
to the license. This comparability analysis would take into account 
that the compensation for the incremental activities performed by FP 
was provided for in the separate services agreement, rather than 
embedded in the royalty paid for use of the AA trademark. For 
illustrations of application of the best method rule, see Sec.  
1.482-8, Example 10, Example 11, and Example 12.
* * * * *
    (g) [Reserved]. For further guidance, see Sec.  1.482-4T(g).
    (h) Effective/applicability date--(1) In general. The provisions of 
paragraphs (f)(3)(i)(A), (f)(3)(ii), and (f)(4) of this section are 
generally applicable for taxable years beginning after July 31, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraphs (f)(3)(i)(A), 
(f)(3)(ii), and (f)(4) of this section to earlier taxable years in 
accordance with the rules set forth in Sec.  1.482-9(n)(2).

0
Par. 9. Section 1.482-4T is amended as follows:

0
1. Revise paragraphs (a), (b), (c), (d), (e), (f)(1), (f)(2), 
(f)(3)(i)(A), (f)(3)(ii), (f)(4), (f)(5), (f)(6), and (h)(3).
0
2. Redesignate paragraph (h)(1) as paragraph (h), revise the heading 
and remove the first sentence in newly-designated paragraph (h).
0
3. Remove paragraph (h)(2).
0
4. Redesignate paragraph (h)(3) as paragraph (i).
    The revisions read as follows:

[[Page 38844]]

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

    (a) through (f)(3)(i)(A) [Reserved]. For further guidance, see 
Sec.  1.482-4(a) through (f)(3)(i)(A).
    (B) * * *
    (f)(3)(ii) through (f)(6) [Reserved]. For further guidance, see 
Sec.  1.482-4(f)(3)(ii) through (f)(6)
    (g) * * *
    (h) Effective/applicability date. * * *
* * * * *
0
Par. 10. Section 1.482-6 is amended by revising paragraphs 
(c)(2)(ii)(B)(1), (c)(2)(ii)(D), (c)(3)(i)(A), (c)(3)(i)(B), 
(c)(3)(ii)(D), and adding paragraph (d) to read as follows:


Sec.  1.482-6   Profit split method.

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (B) Comparability--(1) In general. The degree of comparability 
between the controlled and uncontrolled taxpayers is determined by 
applying the comparability provisions of Sec.  1.482-1(d). The 
comparable profit split compares the division of operating profits 
among the controlled taxpayers to the division of operating profits 
among uncontrolled taxpayers engaged in similar activities under 
similar circumstances. Although all of the factors described in Sec.  
1.482-1(d)(3) must be considered, comparability under this method is 
particularly dependent on the considerations described under the 
comparable profits method in Sec.  1.482-5(c)(2) or Sec.  1.482-
9(f)(2)(iii) because this method is based on a comparison of the 
operating profit of the controlled and uncontrolled taxpayers. In 
addition, because the contractual terms of the relationship among the 
participants in the relevant business activity will be a principal 
determinant of the allocation of functions and risks among them, 
comparability under this method also depends particularly on the degree 
of similarity of the contractual terms of the controlled and 
uncontrolled taxpayers. Finally, the comparable profit split may not be 
used if the combined operating profit (as a percentage of the combined 
assets) of the uncontrolled comparables varies significantly from that 
earned by the controlled taxpayers.
* * * * *
    (D) Other factors affecting reliability. Like the methods described 
in Sec. Sec.  1.482-3, 1.482-4, 1.482-5, and 1.482-9, the comparable 
profit split relies exclusively on external market benchmarks. As 
indicated in Sec.  1.482-1(c)(2)(i), as the degree of comparability 
between the controlled and uncontrolled transactions increases, the 
relative weight accorded the analysis under this method will increase. 
In addition, the reliability of the analysis under this method may be 
enhanced by the fact that all parties to the controlled transaction are 
evaluated under the comparable profit split. However, the reliability 
of the results of an analysis based on information from all parties to 
a transaction is affected by the reliability of the data and the 
assumptions pertaining to each party to the controlled transaction. 
Thus, if the data and assumptions are significantly more reliable with 
respect to one of the parties than with respect to the others, a 
different method, focusing solely on the results of that party, may 
yield more reliable results.
* * * * *
    (3) * * *
    (i) * * *
    (A) Allocate income to routine contributions. The first step 
allocates operating income to each party to the controlled transactions 
to provide a market return for its routine contributions to the 
relevant business activity. Routine contributions are contributions of 
the same or a similar kind to those made by uncontrolled taxpayers 
involved in similar business activities for which it is possible to 
identify market returns. Routine contributions ordinarily include 
contributions of tangible property, services and intangible property 
that are generally owned by uncontrolled taxpayers engaged in similar 
activities. A functional analysis is required to identify these 
contributions according to the functions performed, risks assumed, and 
resources employed by each of the controlled taxpayers. Market returns 
for the routine contributions should be determined by reference to the 
returns achieved by uncontrolled taxpayers engaged in similar 
activities, consistent with the methods described in Sec. Sec.  1.482-
3, 1.482-4, 1.482-5 and 1.482-9.
    (B) Allocate residual profit--(1) Nonroutine contributions 
generally. The allocation of income to the controlled taxpayer's 
routine contributions will not reflect profits attributable to each 
controlled taxpayer's contributions to the relevant business activity 
that are not routine (nonroutine contributions). A nonroutine 
contribution is a contribution that is not accounted for as a routine 
contribution. Thus, in cases where such nonroutine contributions are 
present there normally will be an unallocated residual profit after the 
allocation of income described in paragraph (c)(3)(i)(A) of this 
section. Under this second step, the residual profit generally should 
be divided among the controlled taxpayers based upon the relative value 
of their nonroutine contributions to the relevant business activity. 
The relative value of the nonroutine contributions of each taxpayer 
should be measured in a manner that most reliably reflects each 
nonroutine contribution made to the controlled transaction and each 
controlled taxpayer's role in the nonroutine contributions. If the 
nonroutine contribution by one of the controlled taxpayers is also used 
in other business activities (such as transactions with other 
controlled taxpayers), an appropriate allocation of the value of the 
nonroutine contribution must be made among all the business activities 
in which it is used.
    (2) Nonroutine contributions of intangible property. In many cases, 
nonroutine contributions of a taxpayer to the relevant business 
activity may be contributions of intangible property. For purposes of 
paragraph (c)(3)(i)(B)(1) of this section, the relative value of 
nonroutine intangible property contributed by taxpayers may be measured 
by external market benchmarks that reflect the fair market value of 
such intangible property. Alternatively, the relative value of 
nonroutine intangible property contributions may be estimated by the 
capitalized cost of developing the intangible property and all related 
improvements and updates, less an appropriate amount of amortization 
based on the useful life of each intangible property. Finally, if the 
intangible property development expenditures of the parties are 
relatively constant over time and the useful life of the intangible 
property contributed by all parties is approximately the same, the 
amount of actual expenditures in recent years may be used to estimate 
the relative value of nonroutine intangible property contributions.
* * * * *
    (ii) * * *
    (D) Other factors affecting reliability. Like the methods described 
in Sec. Sec.  1.482-3, 1.482-4, 1.482-5, and 1.482-9, the first step of 
the residual profit split relies exclusively on external market 
benchmarks. As indicated in Sec.  1.482-1(c)(2)(i), as the degree of 
comparability between the controlled and uncontrolled transactions 
increases, the relative weight accorded the analysis under this method 
will increase. In addition, to the extent the allocation of profits in 
the second step is not based on external market benchmarks, the 
reliability of the analysis will be decreased in relation to an 
analysis

[[Page 38845]]

under a method that relies on market benchmarks. Finally, the 
reliability of the analysis under this method may be enhanced by the 
fact that all parties to the controlled transaction are evaluated under 
the residual profit split. However, the reliability of the results of 
an analysis based on information from all parties to a transaction is 
affected by the reliability of the data and the assumptions pertaining 
to each party to the controlled transaction. Thus, if the data and 
assumptions are significantly more reliable with respect to one of the 
parties than with respect to the others, a different method, focusing 
solely on the results of that party, may yield more reliable results.
* * * * *
    (d) Effective/applicability date--(1) In general. The provisions of 
paragraphs (c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and 
(c)(3)(ii)(D) of this section are generally applicable for taxable 
years beginning after July 31, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraphs (c)(2)(ii)(B)(1) and 
(D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section to earlier 
taxable years in accordance with the rules set forth in Sec.  1.482-
9(n)(2).


Sec.  1.482-6T  [Removed]

0
Par. 11. Section 1.482-6T is removed.

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


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

* * * * *
    (b) * * *

    Example 10. Cost of services plus method preferred to other 
methods. (i) FP designs and manufactures consumer electronic devices 
that incorporate advanced technology. In year 1, FP introduces 
Product X, an entertainment device targeted primarily at the youth 
market. FP's wholly-owned, exclusive U.S. distributor, USSub, sells 
Product X in the U.S. market. USSub hires an independent marketing 
firm, Agency A, to promote Product X in the U.S. market. Agency A 
has successfully promoted other electronic products on behalf of 
other uncontrolled parties. USSub executes a one-year, renewable 
contract with Agency A that requires it to develop the market for 
Product X, within an annual budget set by USSub. In years 1 through 
3, Agency A develops advertising, buys media, and sponsors events 
featuring Product X. Agency A receives a markup of 25% on all 
expenses of promoting Product X, with the exception of media buys, 
which are reimbursed at cost. During year 3, sales of Product X 
decrease sharply, as Product X is displaced by competitors' 
products. At the end of year 3, sales of Product X are discontinued.
    (ii) Prior to the start of year 4, FP develops a new 
entertainment device, Product Y. Like Product X, Product Y is 
intended for sale to the youth market, but it is marketed under a 
new trademark distinct from that used for Product X. USSub decides 
to perform all U.S. market promotion for Product Y. USSub hires key 
Agency A staff members who handled the successful Product X 
campaign. To promote Product Y, USSub intends to use methods similar 
to those used successfully by Agency A to promote Product X (print 
advertising, media, event sponsorship, etc.). FP and USSub enter 
into a one-year, renewable agreement concerning promotion of Product 
Y in the U.S. market. Under the agreement, FP compensates USSub for 
promoting Product Y, based on a cost of services plus markup of A%. 
Third-party media buys by USSub in connection with Product Y are 
reimbursed at cost.
    (iii) Assume that under the contractual arrangements between FP 
and USSub, the arm's length consideration for Product Y and the 
trademark or other intangible property may be determined reliably 
under one or more transfer pricing methods. At issue in this example 
is the separate evaluation of the arm's length compensation for the 
year 4 promotional activities performed by USSub pursuant to its 
contract with FP.
    (iv) USSub's accounting records contain reliable data that 
separately state the costs incurred to promote Product Y. A 
functional analysis indicates that USSub's activities to promote 
Product Y in year 4 are similar to activities performed by Agency A 
during years 1 through 3 under the contract with FP. In other 
respects, no material differences exist in the market conditions or 
the promotional activities performed in year 4, as compared to those 
in years 1 through 3.
    (v) It is possible to identify uncontrolled distributors or 
licensees of electronic products that perform, as one component of 
their business activities, promotional activities similar to those 
performed by USSub. However, it is unlikely that publicly available 
accounting data from these companies would allow computation of the 
comparable transactional costs or total services costs associated 
with the marketing or promotional activities that these entities 
perform, as one component of business activities. If that were 
possible, the comparable profits method for services might provide a 
reliable measure of an arm's length result. The functional analysis 
of the marketing activities performed by USSub in year 4 indicates 
that they are similar to the activities performed by Agency A in 
years 1 through 3 for Product X. Because reliable information is 
available concerning the markup on costs charged in a comparable 
uncontrolled transaction, the most reliable measure of an arm's 
length price is the cost of services plus method in Sec.  1.482-
9(e).
    Example 11. CPM for services preferred to other methods. (i) FP 
manufactures furniture and accessories for residential use. FP sells 
its products to retailers in Europe under the trademark, ``Moda.'' 
FP holds all worldwide rights to the trademark, including in the 
United States. USSub is FP's wholly-owned subsidiary in the U.S. 
market and the exclusive U.S. distributor of FP's merchandise. 
Historically, USSub dealt only with specialized designers in the 
U.S. market and advertised in trade publications targeted to this 
market. Although items sold in the U.S. and Europe are physically 
identical, USSub's U.S. customers generally resell the merchandise 
as non-branded merchandise.
    (ii) FP retains an independent firm to evaluate the feasibility 
of selling FP's trademarked merchandise in the general wholesale and 
retail market in the United States. The study concludes that this 
segment of the U.S. market, which is not exploited by USSub, may 
generate substantial profits. Based on this study, FP enters into a 
separate agreement with USSub, which provides that USSub will 
develop this market in the United States for the benefit of FP. 
USSub separately accounts for personnel expenses, overhead, and out-
of-pocket costs attributable to the initial stage of the marketing 
campaign (Phase I). USSub receives as compensation its costs, plus a 
markup of X%, for activities in Phase I. At the end of Phase I, FP 
will evaluate the program. If success appears likely, USSub will 
begin full-scale distribution of trademarked merchandise in the new 
market segment, pursuant to agreements negotiated with FP at that 
time.
    (iii) Assume that under the contractual arrangements in effect 
between FP and USSub, the arm's length consideration for the 
merchandise and the trademark or other intangible property may be 
determined reliably under one or more transfer pricing methods. At 
issue in this example is the separate evaluation of the arm's length 
compensation for the marketing activities conducted by USSub in 
years 1 and following.
    (iv) A functional analysis reveals that USSub's activities 
consist primarily of modifying the promotional materials created by 
FP, negotiating media buys, and arranging promotional events. FP 
separately compensates USSub for all Phase I activities, and 
detailed accounting information is available regarding the costs of 
these activities. The Phase I activities of USSub are similar to 
those of uncontrolled companies that perform, as their primary 
business activity, a range of advertising and media relations 
activities on a contract basis for uncontrolled parties.
    (v) No information is available concerning the comparable 
uncontrolled prices for services in transactions similar to those 
engaged in by FP and USSub. Nor is any information available 
concerning uncontrolled transactions that would allow application of 
the cost of services plus method. It is possible to identify 
uncontrolled distributors or licensees of home furnishings that 
perform, as one component of their business activities, promotional 
activities similar to those performed by USSub. However, it is 
unlikely that publicly available accounting data from these 
companies would allow computation of the comparable transactional 
costs or total services costs associated with the marketing or 
promotional activities that these entities performed, as one 
component of their business activities. On the other hand, it is 
possible to identify uncontrolled advertising and media relations 
companies, the principal

[[Page 38846]]

business activities of which are similar to the Phase I activities 
of USSub. Under these circumstances, the most reliable measure of an 
arm's length price is the comparable profits method of Sec.  1.482-
9(f). The uncontrolled advertising comparables' treatment of 
material items, such as classification of items as cost of goods 
sold or selling, general, and administrative expenses, may differ 
from that of USSub. Such inconsistencies in accounting treatment 
between the uncontrolled comparables and the tested party, or among 
the comparables, are less important when using the ratio of 
operating profit to total services costs under the comparable 
profits method for services in Sec.  1.482-9(f). Under this method, 
the operating profit of USSub from the Phase I activities is 
compared to the operating profit of uncontrolled parties that 
perform general advertising and media relations as their primary 
business activity.
    Example 12. Residual profit split preferred to other methods. 
(i) USP is a manufacturer of athletic apparel sold under the AA 
trademark, to which FP owns the worldwide rights. USP sells AA 
trademark apparel in countries throughout the world, but prior to 
year 1, USP did not sell its merchandise in Country X. In year 1, 
USP acquires an uncontrolled Country X company which becomes its 
wholly-owned subsidiary, XSub. USP enters into an exclusive 
distribution arrangement with XSub in Country X. Before being 
acquired by USP in year 1, XSub distributed athletic apparel 
purchased from uncontrolled suppliers and resold that merchandise to 
retailers. After being acquired by USP in year 1, XSub continues to 
distribute merchandise from uncontrolled suppliers and also begins 
to distribute AA trademark apparel. Under a separate agreement with 
USP, XSub uses its best efforts to promote the AA trademark in 
Country X, with the goal of maximizing sales volume and revenues 
from AA merchandise.
    (ii) Prior to year 1, USP executed long-term endorsement 
contracts with several prominent professional athletes. These 
contracts give USP the right to use the names and likenesses of the 
athletes in any country in which AA merchandise is sold during the 
term of the contract. These contracts remain in effect for five 
years, starting in year 1. Before being acquired by USP, XSub 
renewed a long-term agreement with SportMart, an uncontrolled 
company that owns a nationwide chain of sporting goods retailers in 
Country X. XSub has been SportMart's primary supplier from the time 
that SportMart began operations. Under the agreement, SportMart will 
provide AA merchandise preferred shelf-space and will feature AA 
merchandise at no charge in its print ads and seasonal promotions. 
In consideration for these commitments, USP and XSub grant SportMart 
advance access to new products and the right to use the professional 
athletes under contract with USP in SportMart advertisements 
featuring AA merchandise (subject to approval of content by USP).
    (iii) Assume that it is possible to segregate all transactions 
by XSub that involve distribution of merchandise acquired from 
uncontrolled distributors (non-controlled transactions). In 
addition, assume that, apart from the activities undertaken by USP 
and XSub to promote AA apparel in Country X, the arm's length 
compensation for other functions performed by USP and XSub in the 
Country X market in years 1 and following can be reliably 
determined. At issue in this Example 12 is the application of the 
residual profit split analysis to determine the appropriate division 
between USP and XSub of the balance of the operating profits from 
the Country X market, that is the portion attributable to nonroutine 
contributions to the marketing and promotional activities.
    (iv) A functional analysis of the marketing and promotional 
activities conducted in the Country X market, as described in this 
example, indicates that both USP and XSub made nonroutine 
contributions to the business activity. USP contributed the long-
term endorsement contracts with professional athletes. XSub 
contributed its long-term contractual rights with SportMart, which 
were made more valuable by its successful, long-term relationship 
with SportMart.
    (v) Based on the facts and circumstances, including the fact 
that both USP and XSub made valuable nonroutine contributions to the 
marketing and promotional activities and an analysis of the 
availability (or lack thereof) of comparable and reliable market 
benchmarks, the Commissioner determines that the most reliable 
measure of an arm's length result is the residual profit split 
method in Sec.  1.482-9(g). The residual profit split analysis would 
take into account both routine and nonroutine contributions by USP 
and XSub, in order to determine an appropriate allocation of the 
combined operating profits in the Country X market from the sale of 
AA merchandise and from related promotional and marketing 
activities.

    Examples 13 through 18. [Reserved]. For further guidance, see Sec.  
1.482-8T(b) Examples 13 through 18.
    (c) Effective/applicability date--(1) In general. The provisions of 
paragraph (b) Examples 10, 11, and 12 of this section are generally 
applicable for taxable years beginning after July 31, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraph (b) Examples 10, 11, and 
12 of this section to earlier taxable years in accordance with the 
rules set forth in Sec.  1.482-9(n)(2).

0
Par. 13. Section 1.482-8T is amended as follows:
0
1. Revise paragraph (b) Examples 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 and 
12.
0
2. Redesignate paragraph (c)(1) as paragraph (c), revise the heading 
and remove the first sentence in newly-designated paragraph (c).
0
3. Remove paragraph (c)(2).
0
4. Redesignate paragraph (c)(3) as paragraph (d) and remove the first 
sentence.
    The revisions read as follows:


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

* * * * *
    (b) Examples 1 through 12. [Reserved]. For further guidance, see 
Sec.  1.482-8(b) Examples 1 through 12.
* * * * *
    (c) Effective/applicability date. * * *
* * * * *

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


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

    (a) In general. The arm's length amount charged in a controlled 
services transaction must be determined under one of the methods 
provided for in this section. Each method must be applied in accordance 
with the provisions of Sec.  1.482-1, including the best method rule of 
Sec.  1.482-1(c), the comparability analysis of Sec.  1.482-1(d), and 
the arm's length range of Sec.  1.482-1(e), except as those provisions 
are modified in this section. The methods are--
    (1) The services cost method, described in paragraph (b) of this 
section;
    (2) The comparable uncontrolled services price method, described in 
paragraph (c) of this section;
    (3) The gross services margin method, described in paragraph (d) of 
this section;
    (4) The cost of services plus method, described in paragraph (e) of 
this section;
    (5) The comparable profits method, described in Sec.  1.482-5 and 
in paragraph (f) of this section;
    (6) The profit split method, described in Sec.  1.482-6 and in 
paragraph (g) of this section; and
    (7) Unspecified methods, described in paragraph (h) of this 
section.
    (b) Services cost method--(1) In general. The services cost method 
evaluates whether the amount charged for certain services is arm's 
length by reference to the total services costs (as defined in 
paragraph (j) of this section) with no markup. If a taxpayer applies 
the services cost method in accordance with the rules of this paragraph 
(b), then it will be considered the best method for purposes of Sec.  
1.482-1(c), and the Commissioner's allocations will be limited to 
adjusting the amount charged for such services to the properly 
determined amount of such total services costs.
    (2) Eligibility for the services cost method. To apply the services 
cost method to a service in accordance with the rules of this paragraph 
(b), all of the following requirements must be satisfied with respect 
to the service--

[[Page 38847]]

    (i) The service is a covered service as defined in paragraph (b)(3) 
of this section;
    (ii) The service is not an excluded activity as defined in 
paragraph (b)(4) of this section;
    (iii) The service is not precluded from constituting a covered 
service by the business judgment rule described in paragraph (b)(5) of 
this section; and
    (iv) Adequate books and records are maintained as described in 
paragraph (b)(6) of this section.
    (3) Covered services. For purposes of this paragraph (b), covered 
services consist of a controlled service transaction or a group of 
controlled service transactions (see Sec.  1.482-1(f)(2)(i) 
(aggregation of transactions)) that meet the definition of specified 
covered services or low margin covered services.
    (i) Specified covered services. Specified covered services are 
controlled services transactions that the Commissioner specifies by 
revenue procedure. Services will be included in such revenue procedure 
based upon the Commissioner's determination that the specified covered 
services are support services common among taxpayers across industry 
sectors and generally do not involve a significant median comparable 
markup on total services costs. For the definition of the median 
comparable markup on total services costs, see paragraph (b)(3)(ii) of 
this section. The Commissioner may add to, subtract from, or otherwise 
revise the specified covered services described in the revenue 
procedure by subsequent revenue procedure, which amendments will 
ordinarily be prospective only in effect.
    (ii) Low margin covered services. Low margin covered services are 
controlled services transactions for which the median comparable markup 
on total services costs is less than or equal to seven percent. For 
purposes of this paragraph (b), the median comparable markup on total 
services costs means the excess of the arm's length price of the 
controlled services transaction determined under the general section 
482 regulations without regard to this paragraph (b), using the 
interquartile range described in Sec.  1.482-1(e)(2)(iii)(C) and as 
necessary adjusting to the median of such interquartile range, over 
total services costs, expressed as a percentage of total services 
costs.
    (4) Excluded activity. The following types of activities are 
excluded activities:
    (i) Manufacturing.
    (ii) Production.
    (iii) Extraction, exploration, or processing of natural resources.
    (iv) Construction.
    (v) Reselling, distribution, acting as a sales or purchasing agent, 
or acting under a commission or other similar arrangement.
    (vi) Research, development, or experimentation.
    (vii) Engineering or scientific.
    (viii) Financial transactions, including guarantees.
    (ix) Insurance or reinsurance.
    (5) Not services that contribute significantly to fundamental risks 
of business success or failure. A service cannot constitute a covered 
service unless the taxpayer reasonably concludes in its business 
judgment that the service does not contribute significantly to key 
competitive advantages, core capabilities, or fundamental risks of 
success or failure in one or more trades or businesses of the 
controlled group, as defined in Sec.  1.482-1(i)(6). In evaluating the 
reasonableness of the conclusion required by this paragraph (b)(5), 
consideration will be given to all the facts and circumstances.
    (6) Adequate books and records. Permanent books of account and 
records are maintained for as long as the costs with respect to the 
covered services are incurred by the renderer. Such books and records 
must include a statement evidencing the taxpayer's intention to apply 
the services cost method to evaluate the arm's length charge for such 
services. Such books and records must be adequate to permit 
verification by the Commissioner of the total services costs incurred 
by the renderer, including a description of the services in question, 
identification of the renderer and the recipient of such services, and 
sufficient documentation to allow verification of the methods used to 
allocate and apportion such costs to the services in question in 
accordance with paragraph (k) of this section.
    (7) Shared services arrangement--(i) In general. If the services 
cost method is used to evaluate the amount charged for covered 
services, and such services are the subject of a shared services 
arrangement, then the arm's length charge to each participant for such 
services will be the portion of the total costs of the services 
otherwise determined under the services cost method of this paragraph 
(b) that is properly allocated to such participant pursuant to the 
arrangement.
    (ii) Requirements for shared services arrangement. A shared 
services arrangement must meet the requirements described in this 
paragraph (b)(7).
    (A) Eligibility. To be eligible for treatment under this paragraph 
(b)(7), a shared services arrangement must--
    (1) Include two or more participants;
    (2) Include as participants all controlled taxpayers that 
reasonably anticipate a benefit (as defined under paragraph (l)(3)(i) 
of this section) from one or more covered services specified in the 
shared services arrangement; and
    (3) Be structured such that each covered service (or each 
reasonable aggregation of services within the meaning of paragraph 
(b)(7)(iii)(B) of this section) confers a benefit on at least one 
participant in the shared services arrangement.
    (B) Allocation. The costs for covered services must be allocated 
among the participants based on their respective shares of the 
reasonably anticipated benefits from those services, without regard to 
whether the anticipated benefits are in fact realized. Reasonably 
anticipated benefits are benefits as defined in paragraph (l)(3)(i) of 
this section. The allocation of costs must provide the most reliable 
measure of the participants' respective shares of the reasonably 
anticipated benefits under the principles of the best method rule. See 
Sec.  1.482-1(c). The allocation must be applied on a consistent basis 
for all participants and services. The allocation to each participant 
in each taxable year must reasonably reflect that participant's 
respective share of reasonably anticipated benefits for such taxable 
year. If the taxpayer reasonably concluded that the shared services 
arrangement (including any aggregation pursuant to paragraph 
(b)(7)(iii)(B) of this section) allocated costs for covered services on 
a basis that most reliably reflects the participants' respective shares 
of the reasonably anticipated benefits attributable to such services, 
as provided for in this paragraph (b)(7), then the Commissioner may not 
adjust such allocation basis.
    (C) Documentation. The taxpayer must maintain sufficient 
documentation to establish that the requirements of this paragraph 
(b)(7) are satisfied, and include--
    (1) A statement evidencing the taxpayer's intention to apply the 
services cost method to evaluate the arm's length charge for covered 
services pursuant to a shared services arrangement;
    (2) A list of the participants and the renderer or renderers of 
covered services under the shared services arrangement;
    (3) A description of the basis of allocation to all participants, 
consistent with the participants' respective shares of reasonably 
anticipated benefits; and

[[Page 38848]]

    (4) A description of any aggregation of covered services for 
purposes of the shared services arrangement, and an indication whether 
this aggregation (if any) differs from the aggregation used to evaluate 
the median comparable markup for any low margin covered services 
described in paragraph (b)(3)(ii) of this section.
    (iii) Definitions and special rules--(A) Participant. A participant 
is a controlled taxpayer that reasonably anticipates benefits from 
covered services subject to a shared services arrangement that 
substantially complies with the requirements described in this 
paragraph (b)(7).
    (B) Aggregation. Two or more covered services may be aggregated in 
a reasonable manner taking into account all the facts and 
circumstances, including whether the relative magnitude of reasonably 
anticipated benefits of the participants sharing the costs of such 
aggregated services may be reasonably reflected by the allocation basis 
employed pursuant to paragraph (b)(7)(ii)(B) of this section. The 
aggregation of services under a shared services arrangement may differ 
from the aggregation used to evaluate the median comparable markup for 
any low margin covered services described in paragraph (b)(3)(ii) of 
this section, provided that such alternative aggregation can be 
implemented on a reasonable basis, including appropriately identifying 
and isolating relevant costs, as necessary.
    (C) Coordination with cost sharing arrangements. To the extent that 
an allocation is made to a participant in a shared services arrangement 
that is also a participant in a cost sharing arrangement subject to 
Sec.  1.482-7T, such amount with respect to covered services is first 
allocated pursuant to the shared services arrangement under this 
paragraph (b)(7). Costs allocated pursuant to a shared services 
arrangement may (if applicable) be further allocated between the 
intangible property development activity under Sec.  1.482-7T and other 
activities of the participant.
    (8) Examples. The application of this section is illustrated by the 
following examples. No inference is intended whether the presence or 
absence of one or more facts is determinative of the conclusion in any 
example. For purposes of Examples 1 through 14, assume that Company P 
and its subsidiaries, Company Q and Company R, are corporations and 
members of the same group of controlled entities (PQR Controlled 
Group). For purposes of Example 15, assume that Company P and its 
subsidiary, Company S, are corporations and members of the same group 
of controlled entities (PS Controlled Group). For purposes of Examples 
16 through 24, assume that Company P and its subsidiaries, Company X, 
Company Y, and Company Z, are corporations and members of the same 
group of controlled entities (PXYZ Group) and that Company P and its 
subsidiaries satisfy all of the requirements for a shared services 
arrangement specified in paragraphs (b)(7)(ii) and (iii) of this 
section.

    Example 1. Data entry services. (i) Company P, Company Q, and 
Company R own and operate hospitals. Each owns an electronic 
database of medical information gathered by doctors and nurses 
during interviews and treatment of its patients. All three databases 
are maintained and updated by Company P's administrative support 
employees who perform data entry activities by entering medical 
information from the paper records of Company P, Company Q, and 
Company R into their respective databases.
    (ii) Assume that these services relating to data entry are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of this paragraph (b), 
Company P will be eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 2. Data entry services. (i) Company P, Company Q, and 
Company R specialize in data entry, data processing, and data 
conversion. Company Q and Company R's data entry activities involve 
converting medical information data contained in paper records to a 
digital format. Company P specializes in data entry activities. This 
specialization reflects, in part, proprietary quality control 
systems and specially trained data entry experts used to ensure the 
highest degree of accuracy of data entry services. Company P is 
engaged by Company Q and Company R to perform these data entry 
activities for them. Company Q and Company R then charge their 
customers for the data entry activities performed by Company P.
    (ii) Assume that these services performed by Company P relating 
to data entry are specified covered services within the meaning of 
paragraph (b)(3)(i) of this section. Under the facts and 
circumstances, the taxpayer is unable to reasonably conclude that 
these services do not contribute significantly to the controlled 
group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. 
Company P is not eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 3. Recruiting services. (i) Company P, Company Q, and 
Company R are manufacturing companies that sell their products to 
unrelated retail establishments. Company P's human resources 
department recruits mid-level managers and engineers for itself as 
well as for Company Q and Company R by attending job fairs and other 
recruitment events. For recruiting higher-level managers and 
engineers, each of these companies uses recruiters from unrelated 
executive search firms.
    (ii) Assume that these services relating to recruiting are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of this paragraph (b), 
Company P will be eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 4. Recruiting services. (i) Company Q and Company R are 
executive recruiting service companies that are hired by other 
companies to recruit professionals. Company P is a recruiting agency 
that is engaged by Company Q and Company R to perform recruiting 
activities on their behalf in certain geographic areas.
    (ii) Assume that the services performed by Company P are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 5. Credit analysis services. (i) Company P is a 
manufacturer and distributor of clothing for retail stores. Company 
Q and Company R are distributors of clothing for retail stores. As 
part of its operations, personnel in Company P perform credit 
analysis on its customers. Most of the customers have a history of 
purchases from Company P, and the credit analysis involves a review 
of the recent payment history of the customer's account. For new 
customers, the personnel in Company P perform a basic credit check 
of the customer using reports from a credit reporting agency. On 
behalf of Company Q and Company R, Company P performs credit 
analysis on customers who order clothing from Company Q and Company 
R using the same method as Company P uses for itself.
    (ii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances of the business 
of the PQR Controlled Group, the taxpayer could reasonably conclude 
that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success

[[Page 38849]]

or failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    Example 6. Credit analysis services. (i) Company P, Company Q, 
and Company R lease furniture to retail customers who present a 
significant credit risk and are generally unable to lease furniture 
from other providers. As part of its leasing operations, personnel 
in Company P perform credit analysis on each of the potential 
lessees. The personnel have developed special expertise in 
determining whether a particular customer who presents a significant 
credit risk (as indicated by credit reporting agencies) will be 
likely to make the requisite lease payments on a timely basis. Also, 
as part of its operations, Company P performs similar credit 
analysis services for Company Q and Company R, which charge 
correspondingly high monthly lease payments.
    (ii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 7. Credit analysis services. (i) Company P is a large 
full-service bank, which provides products and services to corporate 
and consumer markets, including unsecured loans, secured loans, 
lines of credit, letters of credit, conversion of foreign currency, 
consumer loans, trust services, and sales of certificates of 
deposit. Company Q makes routine consumer loans to individuals, such 
as auto loans and home equity loans. Company R makes only business 
loans to small businesses.
    (ii) Company P performs credit analysis and prepares credit 
reports for itself, as well as for Company Q and Company R. Company 
P, Company Q and Company R regularly employ these credit reports in 
the ordinary course of business in making decisions regarding 
extensions of credit to potential customers (including whether to 
lend, rate of interest, and loan terms).
    (iii) Assume that these services relating to credit analysis are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances, the credit 
analysis services constitute part of a ``financial transaction'' 
described in paragraph (b)(4)(viii) of this section. Company P is 
not eligible to charge these services to Company Q and Company R in 
accordance with the services cost method.
    Example 8. Data verification services. (i) Company P, Company Q 
and Company R are manufacturers of industrial supplies. Company P's 
accounting department performs periodic reviews of the accounts 
payable information of Company P, Company Q and Company R, and 
identifies any inaccuracies in the records, such as double-payments 
and double-charges.
    (ii) Assume that these services relating to verification of data 
are specified covered services within the meaning of paragraph 
(b)(3)(i) of this section. Under the facts and circumstances of the 
business of the PQR Controlled Group, the taxpayer could reasonably 
conclude that these services do not contribute significantly to the 
controlled group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. If 
these services meet the other requirements of this paragraph (b), 
Company P will be eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 9. Data verification services. (i) Company P gathers and 
inputs information regarding accounts payable and accounts 
receivable from unrelated parties and utilizes its own computer 
system to analyze that information for purposes of identifying 
errors in payment and receipts (data mining). Company P is 
compensated for these services based on a fee that reflects a 
percentage of amounts collected by customers as a result of the data 
mining services. These activities constitute a significant portion 
of Company P's business. Company P performs similar activities for 
Company Q and Company R by analyzing their accounts payable and 
accounts receivable records.
    (ii) Assume that these services relating to data mining are 
specified covered services within the meaning of paragraph (b)(3)(i) 
of this section. Under the facts and circumstances, the taxpayer is 
unable to reasonably conclude that these services do not contribute 
significantly to the controlled group's key competitive advantages, 
core capabilities, or fundamental risks of success or failure in the 
group's business. Company P is not eligible to charge these services 
to Company Q and Company R in accordance with the services cost 
method.
    Example 10. Legal services. (i) Company P is a domestic 
corporation with two wholly-owned foreign subsidiaries, Company Q 
and Company R. Company P and its subsidiaries manufacture and 
distribute equipment used by industrial customers. Company P 
maintains an in-house legal department consisting of attorneys 
experienced in a wide range of business and commercial matters. 
Company Q and Company R maintain small legal departments, consisting 
of attorneys experienced in matters that most frequently arise in 
the normal course of business of Company Q and Company R in their 
respective jurisdictions.
    (ii) Company P seeks to maintain in-house legal staff with the 
ability to address the majority of legal matters that arise in the 
United States with respect to the operations of Company P, as well 
as any U.S. reporting or compliance obligations of Company Q or 
Company R. These include the preparation and review of corporate 
contracts relating to, for example, product sales, equipment 
purchases and leases, business liability insurance, real estate, 
employee salaries and benefits. Company P relies on outside 
attorneys for major business transactions and highly technical 
matters such as patent licenses. The in-house legal staffs of 
Company Q and Company R are much more limited. It is necessary for 
Company P to retain several local law firms to handle litigation and 
business disputes arising from the activities of Company Q and 
Company R. Although Company Q and Company R pay the fees of these 
law firms, the hiring authority and general oversight of the firms' 
representation is in the legal department of Company P.
    (iii) In determining what portion of the legal expenses of 
Company P may be allocated to Company Q and Company R, Company P 
first excludes any expenses relating to legal services that 
constitute shareholder activities and other items that are not 
properly analyzed as controlled services. Assume that the remaining 
services relating to general legal functions performed by in-house 
legal counsel are specified covered services within the meaning of 
paragraph (b)(3)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these latter services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    Example 11. Legal services. (i) Company P is a domestic holding 
company whose operating companies, Company Q and Company R, generate 
electric power for consumers by operating nuclear plants. Assume 
that, although Company P owns 100% of the stock of Companies Q and 
R, the companies do not elect to file a consolidated Federal income 
tax return with Company P.
    (ii) Company P maintains an in-house legal department that 
includes attorneys who are experts in the areas of Federal utilities 
regulation, Federal labor and environmental law, and securities law. 
Companies Q and R maintain their own, smaller in-house legal staffs 
comprising experienced attorneys in the areas of state and local 
utilities regulation, state labor and employment law, and general 
commercial law. The legal department of Company P performs general 
oversight of the legal affairs of the company and determines whether 
a particular matter would be more efficiently handled by the Company 
P legal department, by the legal staffs in the operating companies, 
or in rare cases, by retained outside counsel. In general, Company P 
has succeeded in minimizing duplication and overlap of functions 
between the legal staffs of the various companies or by retained 
outside counsel.
    (iii) The domestic nuclear power plant operations of Companies Q 
and R are subject to extensive regulation by the U.S. Nuclear 
Regulatory Commission (NRC). Operators are required to obtain pre-
construction approval, operating licenses, and, at the end of the 
operational life of the nuclear reactor, nuclear decommissioning 
certificates. Company P files consolidated financial statements on 
behalf of itself, as well as Companies Q and R, with the United 
States

[[Page 38850]]

Securities and Exchange Commission (SEC). In these SEC filings, 
Company P discloses that failure to obtain any of these licenses 
(and the related periodic renewals) or agreeing to licenses on terms 
less favorable than those granted to competitors would have a 
material adverse impact on the operations of Company Q or Company R. 
Company Q and Company R do not have in-house legal staff with 
experience in the NRC area. Company P maintains a group of in-house 
attorneys with specialized expertise in the NRC area that 
exclusively represents Company Q and Company R before the NRC. 
Although Company P occasionally hires an outside law firm or 
industry expert to assist on particular NRC matters, the majority of 
the work is performed by the specialized legal staff of Company P.
    (iv) Certain of the legal services performed by Company P 
constitute duplicative or shareholder activities that do not confer 
a benefit on the other companies and therefore do not need to be 
allocated to the other companies, while certain other legal services 
are eligible to be charged to Company Q and Company R in accordance 
with the services cost method.
    (v) Assume that the specialized legal services relating to 
nuclear licenses performed by in-house legal counsel of Company P 
are specified covered services within the meaning of paragraph 
(b)(3)(i) of this section. Under the facts and circumstances, the 
taxpayer is unable to reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. Company P is not eligible to charge 
these services to Company Q and Company R in accordance with the 
services cost method.
    Example 12. Group of services. (i) Company P, Company Q, and 
Company R are manufacturing companies that sell their products to 
unrelated retail establishments. Company P has an enterprise 
resource planning (ERP) system that maintains data relating to 
accounts payable and accounts receivable information for all three 
companies. Company P's personnel perform the daily operations on 
this ERP system such as inputting data relating to accounts payable 
and accounts receivable into the system and extracting data relating 
to accounts receivable and accounts payable in the form of reports 
or electronic media and providing those data to all three companies. 
Periodically, Company P's computer specialists also modify the ERP 
system to adapt to changing business functions in all three 
companies. Company P's computer specialists make these changes by 
either modifying the underlying software program or by purchasing 
additional software or hardware from unrelated third party vendors.
    (ii) Assume that the services relating to accounts payable and 
accounts receivable are specified covered services within the 
meaning of paragraph (b)(3)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    (iii) Assume that the services performed by Company P's computer 
specialists that relate to modifying the ERP system are specifically 
excluded from the services described in a revenue procedure 
referenced in paragraph (b)(3) of this section as developing 
hardware or software solutions (such as systems integration, Web 
site design, writing computer programs, modifying general 
applications software, or recommending the purchase of commercially 
available hardware or software). If these services do not constitute 
low margin covered services within the meaning of paragraph 
(b)(3)(ii) of this section, then Company P is not eligible to charge 
these services to Company Q and Company R in accordance with the 
services cost method.
    Example 13. Group of services. (i) Company P manufactures and 
sells widgets under an exclusive contract to Customer 1. Company Q 
and Company R sell widgets under exclusive contracts to Customer 2 
and Customer 3, respectively. At least one year in advance, each of 
these customers can accurately forecast its need for widgets. Using 
these forecasts, each customer over the course of the year places 
orders for widgets with the appropriate company, Company P, Company 
Q, or Company R. A customer's actual need for widgets seldom 
deviates from that customer's forecasted need.
    (ii) It is most efficient for the PQR Controlled Group companies 
to manufacture and store an inventory of widgets in advance of 
delivery. Although all three companies sell widgets, only Company P 
maintains a centralized warehouse for widgets. Pursuant to a 
contract, Company P provides storage of these widgets to Company Q 
and Company R at an arm's length price.
    (iii) Company P's personnel also obtain orders from all three 
companies' customers to draw up purchase orders for widgets as well 
as make payment to suppliers for widget replacement parts. In 
addition, Company P's personnel use data entry to input information 
regarding orders and sales of widgets and replacement parts for all 
three companies into a centralized computer system. Company P's 
personnel also maintain the centralized computer system and extract 
data for all three companies when necessary.
    (iv) Assume that these services relating to tracking purchases 
and sales of inventory are specified covered services within the 
meaning of paragraph (b)(3)(i) of this section. Under the facts and 
circumstances of the business of the PQR Controlled Group, the 
taxpayer could reasonably conclude that these services do not 
contribute significantly to the controlled group's key competitive 
advantages, core capabilities, or fundamental risks of success or 
failure in the group's business. If these services meet the other 
requirements of this paragraph (b), Company P will be eligible to 
charge these services to Company Q and Company R in accordance with 
the services cost method.
    Example 14. Group of services. (i) Company P, Company Q, and 
Company R assemble and sell gadgets to unrelated customers. Each of 
these companies purchases the components necessary for assembly of 
the gadgets from unrelated suppliers. As a service to its 
subsidiaries, Company P's personnel obtain orders for components 
from all three companies, prepare purchase orders, and make payment 
to unrelated suppliers for the components. In addition, Company P's 
personnel use data entry to input information regarding orders and 
sales of gadgets for all three companies into a centralized 
computer. Company P's personnel also maintain the centralized 
computer system and extract data for all three companies on an as-
needed basis. The services provided by Company P personnel, in 
conjunction with the centralized computer system, constitute a 
state-of-the-art inventory management system that allows Company P 
to order components necessary for assembly of the gadgets on a 
``just-in-time'' basis.
    (ii) Unrelated suppliers deliver the components directly to 
Company P, Company Q and Company R. Each company stores the 
components in its own facilities for use in filling specific 
customer orders. The companies do not maintain any inventory that is 
not identified in specific customer orders. Because of the 
efficiencies associated with services provided by personnel of 
Company P, all three companies are able to significantly reduce 
their inventory-related costs. Company P's Chief Executive Officer 
makes a statement in one of its press conferences with industry 
analysts that its inventory management system is critical to the 
company's success.
    (iii) Assume that these services relating to tracking purchases 
and sales of inventory are specified covered services within the 
meaning of paragraph (b)(3)(i) of this section. Under the facts and 
circumstances, the taxpayer is unable to reasonably conclude that 
these services do not contribute significantly to the controlled 
group's key competitive advantages, core capabilities, or 
fundamental risks of success or failure in the group's business. 
Company P is not eligible to charge these services to Company Q and 
Company R in accordance with the services cost method.
    Example 15. Low margin covered services. Company P renders 
certain accounting services to Company S. Company P uses the 
services cost method for the accounting services, and determines the 
amount charged as its total cost of rendering the services, with no 
markup. Based on an application of the section 482 regulations 
without regard to this paragraph (b), the interquartile range of 
arm's length markups on total services costs for these accounting 
services is between 3% and 9%, and the median is 6%. Because the 
median comparable markup on total services costs is 6%, which is 
less than 7%, the accounting services constitute low margin covered 
services within the meaning of paragraph (b)(3)(ii) of this section.
    Example 16. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
operates a centralized data processing facility that performs 
automated

[[Page 38851]]

invoice processing and order generation for all of its subsidiaries, 
Companies X, Y, Z, pursuant to a shared services arrangement.
    (ii) In evaluating the shares of reasonably anticipated benefits 
from the centralized data processing services, the total value of 
the merchandise on the invoices and orders may not provide the most 
reliable measure of reasonably anticipated benefits shares, because 
value of merchandise sold does not bear a relationship to the 
anticipated benefits from the underlying covered services.
    (iii) The total volume of orders and invoices processed may 
provide a more reliable basis for evaluating the shares of 
reasonably anticipated benefits from the data processing services. 
Alternatively, depending on the facts and circumstances, total 
central processing unit time attributable to the transactions of 
each subsidiary may provide a more reliable basis on which to 
evaluate the shares of reasonably anticipated benefits.
    Example 17. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
operates a centralized center that performs human resources 
functions, such as administration of pension, retirement, and health 
insurance plans that are made available to employees of its 
subsidiaries, Companies X, Y, Z, pursuant to a shared services 
arrangement.
    (ii) In evaluating the shares of reasonably anticipated benefits 
from these centralized services, the total revenues of each 
subsidiary may not provide the most reliable measure of reasonably 
anticipated benefit shares, because total revenues do not bear a 
relationship to the shares of reasonably anticipated benefits from 
the underlying services.
    (iii) Employee headcount or total compensation paid to employees 
may provide a more reliable basis for evaluating the shares of 
reasonably anticipated benefits from the covered services.
    Example 18. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
performs human resource services (service A) on behalf of the PXYZ 
Group that qualify for the services cost method. Under that method, 
Company P determines the amount charged for these services pursuant 
to a shared services arrangement based on an application of 
paragraph (b)(7) of this section. Service A constitutes a specified 
covered service described in a revenue procedure pursuant to 
paragraph (b)(3)(i) of this section. The total services costs for 
service A otherwise determined under the services cost method is 
300.
    (ii) Companies X, Y and Z reasonably anticipate benefits from 
service A. Company P does not reasonably anticipate benefits from 
service A. Assume that if relative reasonably anticipated benefits 
were precisely known, the appropriate allocation of charges pursuant 
to paragraph (k) of this section to Company X, Y and Z for service A 
is as follows:

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

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

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

    (v) Based on these facts, Company P may reasonably conclude that 
the employee headcount allocation basis most reliably reflects the 
participants' respective shares of the reasonably anticipated benefits 
attributable to service A.

    Example 19. Shared services arrangement and reliable measure of 
reasonably anticipated benefit (allocation key). (i) Company P 
performs accounts payable services (service B) on behalf of the PXYZ 
Group and determines the amount charged for the services under such 
method pursuant to a shared services arrangement based on an 
application of paragraph (b)(7) of this section. Service B is a 
specified covered service described in a revenue procedure pursuant 
to paragraph (b)(3)(i) of this section. The total services costs for 
service B otherwise determined under the services cost method is 
500.

    (ii) Companies X, Y and Z reasonably anticipate benefits from 
service B. Company P does not reasonably anticipate benefits from 
service B. Assume that if relative reasonably anticipated benefits were 
precisely known, the appropriate allocation of charges pursuant to 
paragraph (k) of this section to Companies X, Y and Z for service B is 
as follows:

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

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

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

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

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

    (vii) Based on these facts, Company P may reasonably conclude that 
the transaction volume, but not the employee headcount, allocation 
basis most reliably reflects the participants' respective shares of the 
reasonably anticipated benefits attributable to service B.

    Example 20. Shared services arrangement and aggregation. (i) 
Company P performs human resource services (service A) and accounts 
payable services (service B) on behalf of the PXYZ Group that 
qualify for the services cost method. Company P determines the 
amount charged for these services under such method pursuant to a 
shared services arrangement based on an application of paragraph 
(b)(7) of this section. Service A and service B are specified 
covered services described in a revenue procedure pursuant to 
paragraph (b)(3)(i) of this section. The total services costs 
otherwise determined under the services cost method for service A is 
300 and for service B is 500; total services costs

[[Page 38852]]

for services A and B are 800. Company P determines that aggregation 
of services A and B for purposes of the arrangement is appropriate.

    (ii) Companies X, Y and Z reasonably anticipate benefits from 
services A and B. Company P does not reasonably anticipate benefits 
from services A and B. Assume that if relative reasonably anticipated 
benefits were precisely known, the appropriate allocation of total 
charges pursuant to paragraph (k) of this section to Companies X, Y and 
Z for services A and B is as follows:

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

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

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

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

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

     (vii) Based on these facts, Company P may reasonably conclude that 
the trade sales, but not the transaction volume or the employee 
headcount, allocation basis most reliably reflects the participants' 
respective shares of the reasonably anticipated benefits attributable 
to services AB.
    Example 21. Shared services arrangement and aggregation. (i) 
Company P performs services A through P on behalf of the PXYZ Group 
that qualify for the services cost method. Company P determines the 
amount charged for these services under such method pursuant to a 
shared services arrangement based on an application of paragraph 
(b)(7) of this section. All of these services A through P constitute 
either specified covered services or low margin covered services 
described in paragraph (b)(3) of this section. The total services 
costs for services A through P otherwise determined under the 
services cost method is 500. Company P determines that aggregation 
of services A through P for purposes of the arrangement is 
appropriate.
    (ii) Companies X and Y reasonably anticipate benefits from 
services A through P and Company Z reasonably anticipates benefits 
from services A through M but not from services N through P (Company 
Z performs services similar to services N through P on its own 
behalf). Company P does not reasonably anticipate benefits from 
services A through P. Assume that if relative reasonably anticipated 
benefits were precisely known, the appropriate allocation of total 
charges pursuant to paragraph (k) of this section to Company X, Y, 
and Z for services A through P is as follows:

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

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

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

     (v) Based on these facts, Company P may reasonably conclude 
that the transaction volume allocation basis most reliably reflects 
the participants' respective shares of the reasonably anticipated 
benefits attributable to services A through P.
    Example 22. Renderer reasonably anticipates benefits. (i) 
Company P renders services on behalf of the PXYZ Group that qualify 
for the services cost method. Company P determines the amount 
charged for these services under such method. Company P's share of 
reasonably anticipated benefits from services A, B, C, and D is 20% 
of the total reasonably anticipated benefits of all participants. 
Company P's total services cost for services A, B, C, and D charged 
within the Group is 100.

[[Page 38853]]

    (ii) Based on an application of paragraph (b)(7) of this 
section, Company P charges 80 which is allocated among Companies X, 
Y, and Z. No charge is made to Company P under the shared services 
arrangement for activities that it performs on its own behalf.
    Example 23. Coordination with cost sharing arrangement. (i) 
Company P performs human resource services (service A) on behalf of 
the PXYZ Group that qualify for the services cost method. Company P 
determines the amount charged for these services under such method 
pursuant to a shared services arrangement based on an application of 
paragraph (b)(7) of this section. Service A constitutes a specified 
covered service described in a revenue procedure pursuant to 
paragraph (b)(3)(i) of this section. The total services costs for 
service A otherwise determined under the services cost method is 
300.
    (ii) Company X, Y, Z, and P reasonably anticipate benefits from 
service A. Using a basis of allocation that is consistent with the 
controlled participants' respective shares of the reasonably 
anticipated benefits from the shared services, the total charge of 
300 is allocated as follows:
    X--100.
    Y--50.
    Z--25.
    P--125.
    (ii) In addition to performing services, P undertakes 500 of R&D 
and incurs manufacturing and other costs of 1,000.
    (iii) Companies P and X enter into a cost sharing arrangement in 
accordance with Sec.  1.482-7T. Under the arrangement, Company P 
will undertake all intangible property development activities. All 
of Company P's research and development (R&D) activity is devoted to 
the intangible property development activity under the cost sharing 
arrangement. Company P will manufacture, market, and otherwise 
exploit the product in its defined territory. Companies P and X will 
share intangible property development costs in accordance with their 
reasonably anticipated benefits from the intangible property, and 
Company X will make payments to Company P as required under Sec.  
1.482-7T. Company X will manufacture, market, and otherwise exploit 
the product in the rest of the world.
    (iv) A portion of the charge under the shared services 
arrangement is in turn allocable to the intangible property 
development activity undertaken by Company P. The most reliable 
estimate of the proportion allocable to the intangible property 
development activity is determined to be 500 (Company P's R&D 
expenses) divided by 1,500 (Company P's total non-covered services 
costs), or one-third. Accordingly, one-third of Company P's charge 
of 125, or 42, is allocated to the intangible property development 
activity. Companies P and X must share the intangible property 
development costs of the cost shared intangible property (including 
the charge of 42 that is allocated under the shared services 
arrangement) in proportion to their respective shares of reasonably 
anticipated benefits under the cost sharing arrangement. That is, 
the reasonably anticipated benefit shares under the cost sharing 
arrangement are determined separately from reasonably anticipated 
benefit shares under the shared services arrangement.
    Example 24. Coordination with cost sharing arrangement. (i) The 
facts and analysis are the same as in Example 25, except that 
Company X also performs intangible property development activities 
related to the cost sharing arrangement. Using a basis of allocation 
that is consistent with the controlled participants' respective 
shares of the reasonably anticipated benefits from the shared 
services, the 300 of service costs is allocated as follows:
    X--100.
    Y--50.
    Z--25.
    P--125.
    (ii) In addition to performing services, Company P undertakes 
500 of R&D and incurs manufacturing and other costs of 1,000. 
Company X undertakes 400 of R&D and incurs manufacturing and other 
costs of 600.
    (iii) Companies P and X enter into a cost sharing arrangement in 
accordance with Sec.  1.482-7T. Under the arrangement, both 
Companies P and X will undertake intangible property development 
activities. All of the research and development activity conducted 
by Companies P and X is devoted to the intangible property 
development activity under the cost sharing arrangement. Both 
Companies P and X will manufacture, market, and otherwise exploit 
the product in their respective territories and will share 
intangible property development costs in accordance with their 
reasonably anticipated benefits from the intangible property, and 
both will make payments as required under Sec.  1.482-7T.
    (iv) A portion of the charge under the shared services 
arrangement is in turn allocable to the intangible property 
development activities undertaken by Companies P and X. The most 
reliable estimate of the portion allocable to Company P's intangible 
property development activity is determined to be 500 (Company P's 
R&D expenses) divided by 1,500 (P's total non-covered services 
costs), or one-third. Accordingly, one-third of Company P's 
allocated services cost method charge of 125, or 42, is allocated to 
its intangible property development activity.
    (v) In addition, it is necessary to determine the portion of the 
charge under the shared services arrangement to Company X that 
should be further allocated to Company X's intangible property 
development activities under the cost sharing arrangement. The most 
reliable estimate of the portion allocable to Company X's intangible 
property development activity is 400 (Company X's R&D expenses) 
divided by 1,000 (Company X's costs), or 40%. Accordingly, 40% of 
the 100 that was allocated to Company X, or 40, is allocated in turn 
to Company X's intangible property development activities. Company X 
makes a payment to Company P of 100 under the shared services 
arrangement and includes 40 of services cost method charges in the 
pool of intangible property development costs.
    (vi) The parties' respective contributions to intangible 
property development costs under the cost sharing arrangement are as 
follows:
P: 500 + (0.333 * 125) = 542
X: 400 + (0.40 * 100) = 440

    (c) Comparable uncontrolled services price method--(1) In general. 
The comparable uncontrolled services price method evaluates whether the 
amount charged in a controlled services transaction is arm's length by 
reference to the amount charged in a comparable uncontrolled services 
transaction.
    (2) Comparability and reliability considerations--(i) In general. 
Whether results derived from application of this method are the most 
reliable measure of the arm's length result must be determined using 
the factors described under the best method rule in Sec.  1.482-1(c). 
The application of these factors under the comparable uncontrolled 
services price method is discussed in paragraphs (c)(2)(ii) and (iii) 
of this section.
    (ii) Comparability--(A) In general. The degree of comparability 
between controlled and uncontrolled transactions is determined by 
applying the provisions of Sec.  1.482-1(d). Although all of the 
factors described in Sec.  1.482-1(d)(3) must be considered, similarity 
of the services rendered, and of the intangible property (if any) used 
in performing the services, generally will have the greatest effects on 
comparability under this method. In addition, because even minor 
differences in contractual terms or economic conditions could 
materially affect the amount charged in an uncontrolled transaction, 
comparability under this method depends on close similarity with 
respect to these factors, or adjustments to account for any 
differences. The results derived from applying the comparable 
uncontrolled services price method generally will be the most direct 
and reliable measure of an arm's length price for the controlled 
transaction if an uncontrolled transaction has no differences from the 
controlled transaction that would affect the price, or if there are 
only minor differences that have a definite and reasonably 
ascertainable effect on price and for which appropriate adjustments are 
made. If such adjustments cannot be made, or if there are more than 
minor differences between the controlled and uncontrolled transactions, 
the comparable uncontrolled services price method may be used, but the 
reliability of the results as a measure of the arm's length price will 
be reduced. Further, if there are material differences for which 
reliable adjustments cannot be made, this method ordinarily will not 
provide

[[Page 38854]]

a reliable measure of an arm's length result.
    (B) Adjustments for differences between controlled and uncontrolled 
transactions. If there are differences between the controlled and 
uncontrolled transactions that would affect price, adjustments should 
be made to the price of the uncontrolled transaction according to the 
comparability provisions of Sec.  1.482-1(d)(2). Specific examples of 
factors that may be particularly relevant to application of this method 
include--
    (1) Quality of the services rendered;
    (2) Contractual terms (for example, scope and terms of warranties 
or guarantees regarding the services, volume, credit and payment terms, 
allocation of risks, including any contingent-payment terms and whether 
costs were incurred without a provision for current reimbursement);
    (3) Intangible property (if any) used in rendering the services;
    (4) Geographic market in which the services are rendered or 
received;
    (5) Risks borne (for example, costs incurred to render the 
services, without provision for current reimbursement);
    (6) Duration or quantitative measure of services rendered;
    (7) Collateral transactions or ongoing business relationships 
between the renderer and the recipient, including arrangement for the 
provision of tangible property in connection with the services; and
    (8) Alternatives realistically available to the renderer and the 
recipient.
    (iii) Data and assumptions. The reliability of the results derived 
from the comparable uncontrolled services price method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply the method. See Sec.  1.482-1(c) (best 
method rule).
    (3) Arm's length range. See Sec.  1.482-1(e)(2) for the 
determination of an arm's length range.
    (4) Examples. The principles of this paragraph (c) are illustrated 
by the following examples:

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

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

     (iii) Thus, for example, a project involving 100 hours of the 
time of project managers and 400 hours of technical staff time would 
result in the following project fees (without regard to any out-of-
pocket expenses): ([100 hrs. x $400/hr.] + [400 hrs. x $300/hr.]) = 
$40,000 + $120,000 = $160,000.
    (iv) Company B, a Country X subsidiary of Company A, contracts 
to perform consulting services for a Country X client in the banking 
industry. In undertaking this engagement, Company B uses its own 
consultants and also uses Company A project managers and technical 
staff that specialize in the banking industry for 75 hours and 380 
hours, respectively. In determining an arm's length charge, the 
price that Company A charges for consulting services as a 
subcontractor in comparable uncontrolled transactions will be 
considered evidence of a comparable uncontrolled services price. 
Thus, in this case, a payment of $144,000, (or [75 hrs. x $400/hr.] 
+ [380 hrs. x $300/hr.] = $30,000 + $114,000) may be used as a 
measure of the arm's length price for the work performed by Company 
A project mangers and technical staff. In addition, if the 
comparable uncontrolled services price method is used, then, 
consistent with the practices employed by the comparables with 
respect to similar types of expenses, Company B must reimburse 
Company A for appropriate out-of-pocket expenses. See paragraph 
(c)(2)(ii)(A) of this section.
    Example 6. Adjustments for differences. (i) The facts are the 
same as in Example 5,

[[Page 38855]]

except that the engagement is undertaken with the client on a fixed 
fee basis. That is, prior to undertaking the engagement Company B 
and Company A estimate the resources required to undertake the 
engagement, and, based on hourly fee rates, charge the client a 
single fee for completion of the project. Company A's portion of the 
engagement results in fees of $144,000.
    (ii) The engagement, once undertaken, requires 20% more hours by 
each of Companies A and B than originally estimated. Nevertheless, 
the unrelated client pays the fixed fee that was agreed upon at the 
start of the engagement. Company B pays Company A $144,000, in 
accordance with the fixed fee arrangement.
    (iii) Company A often enters into similar fixed fee engagements 
with clients. In addition, Company A's records for similar 
engagements show that when it experiences cost overruns, it does not 
collect additional fees from the client for the difference between 
projected and actual hours. Accordingly, in evaluating whether the 
fees paid by Company B to Company A are arm's length, it is 
determined that no adjustments to the intercompany service charge 
are warranted. See Sec.  1.482-1(d)(3)(ii) and paragraph 
(c)(2)(ii)(A) of this section.

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

    Example. Indirect evidence of comparable uncontrolled services 
price.
    (i) Company A is a United States insurance company. Company A's 
wholly-owned Country X subsidiary, Company B, performs specialized 
risk analysis for Company A as well as for uncontrolled parties. In 
determining the price actually charged to uncontrolled entities for 
performing such risk analysis, Company B uses a proprietary, multi-
factor computer program, which relies on the gross value of the 
policies in the customer's portfolio, the relative composition of 
those policies, their location, and the estimated number of 
personnel hours necessary to complete the project. Uncontrolled 
companies that perform comparable risk analysis in the same industry 
or market-segment use similar proprietary computer programs to price 
transactions with uncontrolled customers (the competitors' programs 
may incorporate different inputs, or may assign different weights or 
values to individual inputs, in arriving at the price).
    (ii) During the taxable year subject to audit, Company B 
performed risk analysis for uncontrolled parties as well as for 
Company A. Because prices charged to uncontrolled customers 
reflected the composition of each customer's portfolio together with 
other factors, the prices charged in Company B's uncontrolled 
transactions do not provide a reliable basis for determining the 
comparable uncontrolled services price for the similar services 
rendered to Company A. However, in evaluating an arm's length price 
for the studies performed by Company B for Company A, Company B's 
proprietary computer program may be considered as indirect evidence 
of the comparable uncontrolled services price that would be charged 
to perform the services for Company A. The reliability of the 
results obtained by application of this internal computer program as 
a measure of an arm's length price for the services will be 
increased to the extent that Company A used the internal computer 
program to generate actual transaction prices for risk-analysis 
studies performed for uncontrolled parties during the same taxable 
year under audit; Company A used data that are widely and routinely 
used in the ordinary course of business in the insurance industry to 
determine the price charged; and Company A reliably adjusted the 
price charged in the controlled services transaction to reflect 
differences that may affect the price to which uncontrolled 
taxpayers would agree.

    (d) Gross services margin method--(1) In general. The gross 
services margin method evaluates whether the amount charged in a 
controlled services transaction is arm's length by reference to the 
gross profit margin realized in comparable uncontrolled transactions. 
This method ordinarily is used in cases where a controlled taxpayer 
performs services or functions in connection with an uncontrolled 
transaction between a member of the controlled group and an 
uncontrolled taxpayer. This method may be used where a controlled 
taxpayer renders services (agent services) to another member of the 
controlled group in connection with a transaction between that other 
member and an uncontrolled taxpayer. This method also may be used in 
cases where a controlled taxpayer contracts to provide services to an 
uncontrolled taxpayer (intermediary function) and another member of the 
controlled group actually performs a portion of the services provided.
    (2) Determination of arm's length price--(i) In general. The gross 
services margin method evaluates whether the price charged or amount 
retained by a controlled taxpayer in the controlled services 
transaction in connection with the relevant uncontrolled transaction is 
arm's length by determining the appropriate gross profit of the 
controlled taxpayer.
    (ii) Relevant uncontrolled transaction. The relevant uncontrolled 
transaction is a transaction between a member of the controlled group 
and an uncontrolled taxpayer as to which the controlled taxpayer 
performs agent services or an intermediary function.
    (iii) Applicable uncontrolled price. The applicable uncontrolled 
price is the price paid or received by the uncontrolled taxpayer in the 
relevant uncontrolled transaction.
    (iv) Appropriate gross services profit. The appropriate gross 
services profit is computed by multiplying the applicable uncontrolled 
price by the gross services profit margin in comparable uncontrolled 
transactions. The determination of the appropriate gross services 
profit will take into account any functions performed by other members 
of the controlled group, as well as any other relevant factors 
described in Sec.  1.482-1(d)(3). The comparable gross services profit 
margin may be determined by reference to the commission in an 
uncontrolled transaction, where that commission is stated as a 
percentage of the price charged in the uncontrolled transaction.
    (v) Arm's length range. See Sec.  1.482-1(e)(2) for determination 
of the arm's length range.
    (3) Comparability and reliability considerations--(i) In general. 
Whether results derived from application of this method are the most 
reliable measure of the arm's length result must be determined using 
the factors described under the best method rule in Sec.  1.482-1(c). 
The application of these factors under the gross services margin method 
is discussed in paragraphs (d)(3)(ii) and (iii) of this section.
    (ii) Comparability--(A) Functional comparability. The degree of 
comparability between an uncontrolled transaction and a controlled 
transaction is determined by applying the comparability provisions of 
Sec.  1.482-1(d). A gross services profit provides compensation for 
services or functions that bear a relationship to the relevant 
uncontrolled transaction, including an

[[Page 38856]]

operating profit in return for the investment of capital and the 
assumption of risks by the controlled taxpayer performing the services 
or functions under review. Therefore, although all of the factors 
described in Sec.  1.482-1(d)(3) must be considered, comparability 
under this method is particularly dependent on similarity of services 
or functions performed, risks borne, intangible property (if any) used 
in providing the services or functions, and contractual terms, or 
adjustments to account for the effects of any such differences. If 
possible, the appropriate gross services profit margin should be 
derived from comparable uncontrolled transactions by the controlled 
taxpayer under review, because similar characteristics are more likely 
found among different transactions by the same controlled taxpayer than 
among transactions by other parties. In the absence of comparable 
uncontrolled transactions involving the same controlled taxpayer, an 
appropriate gross services profit margin may be derived from 
transactions of uncontrolled taxpayers involving comparable services or 
functions with respect to similarly related transactions.
    (B) Other comparability factors. Comparability under this method is 
not dependent on close similarity of the relevant uncontrolled 
transaction to the related transactions involved in the uncontrolled 
comparables. However, substantial differences in the nature of the 
relevant uncontrolled transaction and the relevant transactions 
involved in the uncontrolled comparables, such as differences in the 
type of property transferred or service provided in the relevant 
uncontrolled transaction, may indicate significant differences in the 
services or functions performed by the controlled and uncontrolled 
taxpayers with respect to their respective relevant transactions. Thus, 
it ordinarily would be expected that the services or functions 
performed in the controlled and uncontrolled transactions would be with 
respect to relevant transactions involving the transfer of property 
within the same product categories or the provision of services of the 
same general type (for example, information-technology systems design). 
Furthermore, significant differences in the intangible property (if 
any) used by the controlled taxpayer in the controlled services 
transaction as distinct from the uncontrolled comparables may also 
affect the reliability of the comparison. Finally, the reliability of 
profit measures based on gross services profit may be adversely 
affected by factors that have less effect on prices. For example, gross 
services profit may be affected by a variety of other factors, 
including cost structures or efficiency (for example, differences in 
the level of experience of the employees performing the service in the 
controlled and uncontrolled transactions). Accordingly, if material 
differences in these factors are identified based on objective 
evidence, the reliability of the analysis may be affected.
    (C) Adjustments for differences between controlled and uncontrolled 
transactions. If there are material differences between the controlled 
and uncontrolled transactions that would affect the gross services 
profit margin, adjustments should be made to the gross services profit 
margin, according to the comparability provisions of Sec.  1.482-
1(d)(2). For this purpose, consideration of the total services costs 
associated with functions performed and risks assumed may be necessary 
because differences in functions performed are often reflected in these 
costs. If there are differences in functions performed, however, the 
effect on gross services profit of such differences is not necessarily 
equal to the differences in the amount of related costs. Specific 
examples of factors that may be particularly relevant to this method 
include--
    (1) Contractual terms (for example, scope and terms of warranties 
or guarantees regarding the services or function, volume, credit and 
payment terms, and allocation of risks, including any contingent-
payment terms);
    (2) Intangible property (if any) used in performing the services or 
function;
    (3) Geographic market in which the services or function are 
performed or in which the relevant uncontrolled transaction takes 
place; and
    (4) Risks borne, including, if applicable, inventory-type risk.
    (D) Buy-sell distributor. If a controlled taxpayer that performs an 
agent service or intermediary function is comparable to a distributor 
that takes title to goods and resells them, the gross profit margin 
earned by such distributor on uncontrolled sales, stated as a 
percentage of the price for the goods, may be used as the comparable 
gross services profit margin.
    (iii) Data and assumptions--(A) In general. The reliability of the 
results derived from the gross services margin method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply this method. See Sec.  1.482-1(c) (best 
method rule).
    (B) Consistency in accounting. The degree of consistency in 
accounting practices between the controlled transaction and the 
uncontrolled comparables that materially affect the gross services 
profit margin affects the reliability of the results under this method.
    (4) Examples. The principles of this paragraph (d) are illustrated 
by the following examples:

    Example 1. Agent services. Company A and Company B are members 
of a controlled group. Company A is a foreign manufacturer of 
industrial equipment. Company B is a U.S. company that acts as a 
commission agent for Company A by arranging for Company A to make 
direct sales of the equipment it manufactures to unrelated 
purchasers in the U.S. market. Company B does not take title to the 
equipment but instead receives from Company A commissions that are 
determined as a specified percentage of the sales price for the 
equipment that is charged by Company A to the unrelated purchaser. 
Company B also arranges for direct sales of similar equipment by 
unrelated foreign manufacturers to unrelated purchasers in the U.S. 
market. Company B charges these unrelated foreign manufacturers a 
commission fee of 5% of the sales price charged by the unrelated 
foreign manufacturers to the unrelated U.S. purchasers for the 
equipment. Information regarding the comparable agent services 
provided by Company B to unrelated foreign manufacturers is 
sufficiently complete to conclude that it is likely that all 
material differences between the controlled and uncontrolled 
transactions have been identified and adjustments for such 
differences have been made. If the comparable gross services profit 
margin is 5% of the price charged in the relevant transactions 
involved in the uncontrolled comparables, then the appropriate gross 
services profit that Company B may earn and the arm's length price 
that it may charge Company A for its agent services is equal to 5% 
of the applicable uncontrolled price charged by Company A in sales 
of equipment in the relevant uncontrolled transactions.
    Example 2. Agent services. The facts are the same as in Example 
1, except that Company B does not act as a commission agent for 
unrelated parties and it is not possible to obtain reliable 
information concerning commission rates charged by uncontrolled 
commission agents that engage in comparable transactions with 
respect to relevant sales of property. It is possible, however, to 
obtain reliable information regarding the gross profit margins 
earned by unrelated parties that briefly take title to and then 
resell similar property in uncontrolled transactions, in which they 
purchase the property from foreign manufacturers and resell the 
property to purchasers in the U.S. market. Analysis of the facts and 
circumstances indicates that, aside from certain minor differences 
for which adjustments can be made, the uncontrolled parties that 
resell property perform similar functions and assume similar risks 
as Company B performs and assumes when it acts as a commission agent 
for Company A's sales of property. Under these circumstances, the 
gross profit margin earned by the

[[Page 38857]]

unrelated distributors on the purchase and resale of property may be 
used, subject to any adjustments for any material differences 
between the controlled and uncontrolled transactions, as a 
comparable gross services profit margin. The appropriate gross 
services profit that Company B may earn and the arm's length price 
that it may charge Company A for its agent services is therefore 
equal to this comparable gross services margin, multiplied by the 
applicable uncontrolled price charged by Company A in its sales of 
equipment in the relevant uncontrolled transactions.
    Example 3. Agent services. (i) Company A and Company B are 
members of a controlled group. Company A is a U.S. corporation that 
renders computer consulting services, including systems integration 
and networking, to business clients.
    (ii) In undertaking engagements with clients, Company A in some 
cases pays a commission of 3% of its total fees to unrelated parties 
that assist Company A in obtaining consulting engagements. 
Typically, such fees are paid to non-computer consulting firms that 
provide strategic management services for their clients. When 
Company A obtains a consulting engagement with a client of a non-
computer consulting firm, Company A does not subcontract with the 
other consulting firm, nor does the other consulting firm play any 
role in Company A's consulting engagement.
    (iii) Company B, a Country X subsidiary of Company A, assists 
Company A in obtaining an engagement to perform computer consulting 
services for a Company B banking industry client in Country X. 
Although Company B has an established relationship with its Country 
X client and was instrumental in arranging for Company A's 
engagement with the client, Company A's particular expertise was the 
primary consideration in motivating the client to engage Company A. 
Based on the relative contributions of Companies A and B in 
obtaining and undertaking the engagement, Company B's role was 
primarily to facilitate the consulting engagement between Company A 
and the Country X client. Information regarding the commissions paid 
by Company A to unrelated parties for providing similar services to 
facilitate Company A's consulting engagements is sufficiently 
complete to conclude that it is likely that all material differences 
between these uncontrolled transactions and the controlled 
transaction between Company B and Company A have been identified and 
that appropriate adjustments have been made for any such 
differences. If the comparable gross services margin earned by 
unrelated parties in providing such agent services is 3% of total 
fees charged in the relevant transactions involved in the 
uncontrolled comparables, then the appropriate gross services profit 
that Company B may earn and the arm's length price that it may 
charge Company A for its agent services is equal to this comparable 
gross services margin (3%), multiplied by the applicable 
uncontrolled price charged by Company A in its relevant uncontrolled 
consulting engagement with Company B's client.
    Example 4. Intermediary function. (i) The facts are the same as 
in Example 3, except that Company B contracts directly with its 
Country X client to provide computer consulting services and Company 
A performs the consulting services on behalf of Company B. Company A 
does not enter into a consulting engagement with Company B's Country 
X client. Instead, Company B charges its Country X client an 
uncontrolled price for the consulting services, and Company B pays a 
portion of the uncontrolled price to Company A for performing the 
consulting services on behalf of Company B.
    (ii) Analysis of the relative contributions of Companies A and B 
in obtaining and undertaking the consulting contract indicates that 
Company B functioned primarily as an intermediary contracting party, 
and the gross services margin method is the most reliable method for 
determining the amount that Company B may retain as compensation for 
its intermediary function with respect to Company A's consulting 
services. In this case, therefore, because Company B entered into 
the relevant uncontrolled transaction to provide services, Company B 
receives the applicable uncontrolled price that is paid by the 
Country X client for the consulting services. Company A technically 
performs services for Company B when it performs, on behalf of 
Company B, the consulting services Company B contracted to provide 
to the Country X client. The arm's length amount that Company A may 
charge Company B for performing the consulting services on Company 
B's behalf is equal to the applicable uncontrolled price received by 
Company B in the relevant uncontrolled transaction, less Company B's 
appropriate gross services profit, which is the amount that Company 
B may retain as compensation for performing the intermediary 
function.
    (iii) Reliable data concerning the commissions that Company A 
paid to uncontrolled parties for assisting it in obtaining 
engagements to provide consulting services similar to those it has 
provided on behalf of Company B provide useful information in 
applying the gross services margin method. However, consideration 
should be given to whether the third party commission data may need 
to be adjusted to account for any additional risk that Company B may 
have assumed as a result of its function as an intermediary 
contracting party, compared with the risk it would have assumed if 
it had provided agent services to assist Company A in entering into 
an engagement to provide its consulting service directly. In this 
case, the information regarding the commissions paid by Company A to 
unrelated parties for providing agent services to facilitate its 
performance of consulting services for unrelated parties is 
sufficiently complete to conclude that all material differences 
between these uncontrolled transactions and the controlled 
performance of an intermediary function, including possible 
differences in the amount of risk assumed in connection with 
performing that function, have been identified and that appropriate 
adjustments have been made. If the comparable gross services margin 
earned by unrelated parties in providing such agent services is 3% 
of total fees charged in Company B's relevant uncontrolled 
transactions, then the appropriate gross services profit that 
Company B may retain as compensation for performing an intermediary 
function (and the amount, therefore, that is deducted from the 
applicable uncontrolled price to arrive at the arm's length price 
that Company A may charge Company B for performing consulting 
services on Company B's behalf) is equal to this comparable gross 
services margin (3%), multiplied by the applicable uncontrolled 
price charged by Company B in its contract to provide services to 
the uncontrolled party.
    Example 5. External comparable. (i) The facts are the same as in 
Example 4, except that neither Company A nor Company B engages in 
transactions with third parties that facilitate similar consulting 
engagements.
    (ii) Analysis of the relative contributions of Companies A and B 
in obtaining and undertaking the contract indicates that Company B's 
role was primarily to facilitate the consulting arrangement between 
Company A and the Country X client. Although no reliable internal 
data are available regarding comparable transactions with 
uncontrolled entities, reliable data exist regarding commission 
rates for similar facilitating services between uncontrolled 
parties. These data indicate that a 3% commission (3% of total 
engagement fee) is charged in such transactions. Information 
regarding the uncontrolled comparables is sufficiently complete to 
conclude that it is likely that all material differences between the 
controlled and uncontrolled transactions have been identified and 
adjusted for. If the appropriate gross services profit margin is 3% 
of total fees, then an arm's length result of the controlled 
services transaction is for Company B to retain an amount equal to 
3% of total fees paid to it.

    (e) Cost of services plus method--(1) In general. The cost of 
services plus method evaluates whether the amount charged in a 
controlled services transaction is arm's length by reference to the 
gross services profit markup realized in comparable uncontrolled 
transactions. The cost of services plus method is ordinarily used in 
cases where the controlled service renderer provides the same or 
similar services to both controlled and uncontrolled parties. This 
method is ordinarily not used in cases where the controlled services 
transaction involves a contingent-payment arrangement, as described in 
paragraph (i)(2) of this section.
    (2) Determination of arm's length price--(i) In general. The cost 
of services plus method measures an arm's length price by adding the 
appropriate gross services profit to the controlled taxpayer's 
comparable transactional costs.
    (ii) Appropriate gross services profit. The appropriate gross 
services profit is computed by multiplying the controlled taxpayer's 
comparable transactional costs by the gross services profit

[[Page 38858]]

markup, expressed as a percentage of the comparable transactional costs 
earned in comparable uncontrolled transactions.
    (iii) Comparable transactional costs. Comparable transactional 
costs consist of the costs of providing the services under review that 
are taken into account as the basis for determining the gross services 
profit markup in comparable uncontrolled transactions. Depending on the 
facts and circumstances, such costs typically include all compensation 
attributable to employees directly involved in the performance of such 
services, materials and supplies consumed or made available in 
rendering such services, and may include as well other costs of 
rendering the services. Comparable transactional costs must be 
determined on a basis that will facilitate comparison with the 
comparable uncontrolled transactions. For that reason, comparable 
transactional costs may not necessarily equal total services costs, as 
defined in paragraph (j) of this section, and in appropriate cases may 
be a subset of total services costs. Generally accepted accounting 
principles or Federal income tax accounting rules (where Federal income 
tax data for comparable transactions or business activities are 
available) may provide useful guidance but will not conclusively 
establish the appropriate comparable transactional costs for purposes 
of this method.
    (iv) Arm's length range. See Sec.  1.482-1(e)(2) for determination 
of an arm's length range.
    (3) Comparability and reliability considerations--(i) In general. 
Whether results derived from the application of this method are the 
most reliable measure of the arm's length result must be determined 
using the factors described under the best method rule in Sec.  1.482-
1(c).
    (ii) Comparability--(A) Functional comparability. The degree of 
comparability between controlled and uncontrolled transactions is 
determined by applying the comparability provisions of Sec.  1.482-
1(d). A service renderer's gross services profit provides compensation 
for performing services related to the controlled services transaction 
under review, including an operating profit for the service renderer's 
investment of capital and assumptions of risks. Therefore, although all 
of the factors described in Sec.  1.482-1(d)(3) must be considered, 
comparability under this method is particularly dependent on similarity 
of services or functions performed, risks borne, intangible property 
(if any) used in providing the services or functions, and contractual 
terms, or adjustments to account for the effects of any such 
differences. If possible, the appropriate gross services profit markup 
should be derived from comparable uncontrolled transactions of the same 
taxpayer participating in the controlled services transaction because 
similar characteristics are more likely to be found among services 
provided by the same service provider than among services provided by 
other service providers. In the absence of such services transactions, 
an appropriate gross services profit markup may be derived from 
comparable uncontrolled services transactions of other service 
providers. If the appropriate gross services profit markup is derived 
from comparable uncontrolled services transactions of other service 
providers, in evaluating comparability the controlled taxpayer must 
consider the results under this method expressed as a markup on total 
services costs of the controlled taxpayer, because differences in 
functions performed may be reflected in differences in service costs 
other than those included in comparable transactional costs.
    (B) Other comparability factors. Comparability under this method is 
less dependent on close similarity between the services provided than 
under the comparable uncontrolled services price method. Substantial 
differences in the services may, however, indicate significant 
functional differences between the controlled and uncontrolled 
taxpayers. Thus, it ordinarily would be expected that the controlled 
and uncontrolled transactions would involve services of the same 
general type (for example, information-technology systems design). 
Furthermore, if a significant amount of the controlled taxpayer's 
comparable transactional costs consists of service costs incurred in a 
tax accounting period other than the tax accounting period under 
review, the reliability of the analysis would be reduced. In addition, 
significant differences in the value of the services rendered, due for 
example to the use of valuable intangible property, may also affect the 
reliability of the comparison. Finally, the reliability of profit 
measures based on gross services profit may be adversely affected by 
factors that have less effect on prices. For example, gross services 
profit may be affected by a variety of other factors, including cost 
structures or efficiency-related factors (for example, differences in 
the level of experience of the employees performing the service in the 
controlled and uncontrolled transactions). Accordingly, if material 
differences in these factors are identified based on objective 
evidence, the reliability of the analysis may be affected.
    (C) Adjustments for differences between the controlled and 
uncontrolled transactions. If there are material differences between 
the controlled and uncontrolled transactions that would affect the 
gross services profit markup, adjustments should be made to the gross 
services profit markup earned in the comparable uncontrolled 
transaction according to the provisions of Sec.  1.482-1(d)(2). For 
this purpose, consideration of the comparable transactional costs 
associated with the functions performed and risks assumed may be 
necessary, because differences in the functions performed are often 
reflected in these costs. If there are differences in functions 
performed, however, the effect on gross services profit of such 
differences is not necessarily equal to the differences in the amount 
of related comparable transactional costs. Specific examples of the 
factors that may be particularly relevant to this method include--
    (1) The complexity of the services;
    (2) The duration or quantitative measure of services;
    (3) Contractual terms (for example, scope and terms of warranties 
or guarantees provided, volume, credit and payment terms, allocation of 
risks, including any contingent-payment terms);
    (4) Economic circumstances; and
    (5) Risks borne.
    (iii) Data and assumptions--(A) In general. The reliability of the 
results derived from the cost of services plus method is affected by 
the completeness and accuracy of the data used and the reliability of 
the assumptions made to apply this method. See Sec.  1.482-1(c) (Best 
method rule).
    (B) Consistency in accounting. The degree of consistency in 
accounting practices between the controlled transaction and the 
uncontrolled comparables that materially affect the gross services 
profit markup affects the reliability of the results under this method. 
Thus, for example, if differences in cost accounting practices would 
materially affect the gross services profit markup, the ability to make 
reliable adjustments for such differences would affect the reliability 
of the results obtained under this method. Further, reliability under 
this method depends on the extent to which the controlled and 
uncontrolled transactions reflect consistent reporting of comparable 
transactional costs. For purposes of this paragraph (e)(3)(iii)(B), the 
term comparable transactional costs includes the cost of acquiring 
tangible

[[Page 38859]]

property that is transferred (or used) with the services, to the extent 
that the arm's length price of the tangible property is not separately 
evaluated as a controlled transaction under another provision.
    (4) Examples. The principles of this paragraph (e) are illustrated 
by the following examples:

    Example 1. Internal comparable. (i) Company A designs and 
assembles information-technology networks and systems. When Company 
A renders services for uncontrolled parties, it receives 
compensation based on time and materials as well as certain other 
related costs necessary to complete the project. This fee includes 
the cost of hardware and software purchased from uncontrolled 
vendors and incorporated in the final network or system, plus a 
reasonable allocation of certain specified overhead costs incurred 
by Company A in providing these services. Reliable accounting 
records maintained by Company A indicate that Company A earned a 
gross services profit markup of 10% on its time, materials and 
specified overhead in providing design services during the year 
under examination on information technology projects for 
uncontrolled entities.
    (ii) Company A designed an information-technology network for 
its Country X subsidiary, Company B. The services rendered to 
Company B are similar in scope and complexity to services that 
Company A rendered to uncontrolled parties during the year under 
examination. Using Company A's accounting records (which are 
determined to be reliable under paragraph (e)(3) of this section), 
it is possible to identify the comparable transactional costs 
involved in the controlled services transaction with reference to 
the costs incurred by Company A in rendering similar design services 
to uncontrolled parties. Company A's records indicate that it does 
not incur any additional types of costs in rendering similar 
services to uncontrolled customers. The data available are 
sufficiently complete to conclude that it is likely that all 
material differences between the controlled and uncontrolled 
transactions have been identified and adjusted for. Based on the 
gross services profit markup data derived from Company A's 
uncontrolled transactions involving similar design services, an 
arm's length result for the controlled services transaction is equal 
to the price that will allow Company A to earn a 10% gross services 
profit markup on its comparable transactional costs.
    Example 2. Inability to adjust for differences in comparable 
transactional costs. The facts are the same as in Example 1, except 
that Company A's staff that rendered the services to Company B 
consisted primarily of engineers in training status or on temporary 
rotation from other Company A subsidiaries. In addition, the Company 
B network incorporated innovative features, including specially 
designed software suited to Company B's requirements. The use of 
less-experienced personnel and staff on temporary rotation, together 
with the special features of the Company B network, significantly 
increased the time and costs associated with the project as compared 
to time and costs associated with similar projects completed for 
uncontrolled customers. These factors constitute material 
differences between the controlled and the uncontrolled transactions 
that affect the determination of Company A's comparable 
transactional costs associated with the controlled services 
transaction, as well as the gross services profit markup. Moreover, 
it is not possible to perform reliable adjustments for these 
differences on the basis of the available accounting data. Under 
these circumstances, the reliability of the cost of services plus 
method as a measure of an arm's length price is substantially 
reduced.
    Example 3. Operating loss by reference to total services costs. 
The facts and analysis are the same as in Example 1, except that an 
unrelated Company C, instead of Company A, renders similar services 
to uncontrolled parties and publicly available information indicates 
that Company C earned a gross services profit markup of 10% on its 
time, materials and certain specified overhead in providing those 
services. As in Example 1, Company A still provides services for its 
Country X subsidiary, Company B. In accordance with the requirements 
in paragraph (e)(3)(ii) of this section, the taxpayer performs 
additional analysis and restates the results of Company A's 
controlled services transaction with its Country X subsidiary, 
Company B, in the form of a markup on Company A's total services 
costs. This analysis by reference to total services costs shows that 
Company A generated an operating loss on the controlled services 
transaction, which indicates that functional differences likely 
exist between the controlled services transaction performed by 
Company A and uncontrolled services transactions performed by 
Company C, and that these differences may not be reflected in the 
comparable transactional costs. Upon further scrutiny, the presence 
of such functional differences between the controlled and 
uncontrolled transactions may indicate that the cost of services 
plus method does not provide the most reliable measure of an arm's 
length result under the facts and circumstances.
    Example 4. Internal comparable. (i) Company A, a U.S. 
corporation, and its subsidiaries perform computer consulting 
services relating to systems integration and networking for business 
clients in various countries. Company A and its subsidiaries render 
only consulting services and do not manufacture or distribute 
computer hardware or software to clients. The controlled group is 
organized according to industry specialization, with key industry 
specialists working for Company A. These personnel typically form 
the core consulting group that teams with consultants from the 
local-country subsidiaries to serve clients in the subsidiaries' 
respective countries.
    (ii) On some occasions, Company A and its subsidiaries undertake 
engagements directly for clients. On other occasions, they work as 
subcontractors for uncontrolled parties on more extensive consulting 
engagements for clients. In undertaking the latter engagements with 
third-party consultants, Company A typically prices its services at 
four times the compensation costs of its consultants, defined as the 
consultants' base salary plus estimated fringe benefits, as defined 
in this table:

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

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

    (f) Comparable profits method--(1) In general. The comparable 
profits method evaluates whether the amount charged in a controlled 
transaction is arm's length, based on objective measures of 
profitability (profit level indicators) derived from uncontrolled 
taxpayers that engage in similar business activities under similar 
circumstances. The rules in Sec.  1.482-5 relating to the comparable 
profits method apply to controlled services transactions, except as 
modified in this paragraph (f).
    (2) Determination of arm's length result--(i) Tested party. This 
paragraph (f) applies where the relevant business activity of the 
tested party as determined under Sec.  1.482-5(b)(2) is the rendering 
of services in a controlled services transaction. Where the tested 
party determined under Sec.  1.482-5(b)(2) is instead the recipient of 
the controlled

[[Page 38860]]

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

    Example 1. Ratio of operating profit to total services costs as 
the appropriate profit level indicator. (i) A Country T parent firm, 
Company A, and its Country Y subsidiary, Company B, both engage in 
manufacturing as their principal business activity. Company A also 
performs certain advertising services for itself and its affiliates. 
In year 1, Company A renders advertising services to Company B.
    (ii) Based on the facts and circumstances, it is determined that 
the comparable profits method will provide the most reliable measure 
of an arm's length result. Company A is selected as the tested 
party. No data are available for comparable independent 
manufacturing firms that render advertising services to third 
parties. Financial data are available, however, for ten independent 
firms that render similar advertising services as their principal 
business activity in Country X. The ten firms are determined to be 
comparable under Sec.  1.482-5(c). Neither Company A nor the 
comparable companies use valuable intangible property in rendering 
the services.
    (iii) Based on the available financial data of the comparable 
companies, it cannot be determined whether these comparable 
companies report costs for financial accounting purposes in the same 
manner as the tested party. The publicly available financial data of 
the comparable companies segregate total services costs into cost of 
goods sold and sales, general and administrative costs, with no 
further segmentation of costs provided. Due to the limited 
information available regarding the cost accounting practices used 
by the comparable companies, the ratio of operating profits to total 
services costs is determined to be the most appropriate profit level 
indicator. This ratio includes total services costs to minimize the 
effect of any inconsistency in accounting practices between Company 
A and the comparable companies.
    Example 2. Application of the operating profit to total services 
costs profit level indicator. (i) Company A is a foreign subsidiary 
of Company B, a U.S. corporation. Company B is under examination for 
its year 1 taxable year. Company B renders management consulting 
services to Company A. Company B's consulting function includes 
analyzing Company A's operations, benchmarking Company A's financial 
performance against companies in the same industry, and to the 
extent necessary, developing a strategy to improve Company A's 
operational performance. The accounting records of Company B allow 
reliable identification of the total services costs of the 
consulting staff associated with the management consulting services 
rendered to Company A. Company A reimburses Company B for its costs 
associated with rendering the consulting services, with no markup.
    (ii) Based on all the facts and circumstances, it is determined 
that the comparable profits method will provide the most reliable 
measure of an arm's length result. Company B is selected as the 
tested party, and its rendering of management consulting services is 
identified as the relevant business activity. Data are available 
from ten domestic companies that operate in the industry segment 
involving management consulting and that perform activities 
comparable to the relevant business activity of Company B. These 
comparables include entities that primarily perform management 
consulting services for uncontrolled parties. The comparables incur 
similar risks as Company B incurs in performing the consulting 
services and do not make use of valuable intangible property or 
special processes.
    (iii) Based on the available financial data of the comparables, 
it cannot be determined whether the comparables report their costs 
for financial accounting purposes in the same manner as Company B 
reports its costs in the relevant business activity. The available 
financial data for the comparables report only an aggregate figure 
for costs of goods sold and operating expenses, and do not segment 
the underlying services costs. Due to this limitation, the ratio of 
operating profits to total services costs is determined to be the 
most appropriate profit level indicator.
    (iv) For the taxable years 1 through 3, Company B shows the 
following results for the services performed for Company A:

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

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

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


[[Page 38861]]

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

------------------------------------------------------------------------
                                                OP/Total
                                                 service
       Uncontrolled service  provider          costs (for     Company B
                                                 year 3)         COP
                                                (percent)
------------------------------------------------------------------------
Company 1...................................         15.00      $195,000
Company 2...................................         14.75       191,750
Company 3...................................         14.00       182,000
Company 4...................................         13.50       175,500
Company 5...................................         12.30       159,900
Company 6...................................         11.05       143,650
Company 7...................................         11.03       143,390
Company 8...................................         11.00       143,000
Company 9...................................         10.50       136,500
Company 10..................................         10.25       133,250
------------------------------------------------------------------------

    (viii) Based on these results, the median of the comparable 
operating profits for year 3 is $151,775. Therefore, Company B's 
income for year 3 is increased by $151,775, the difference between 
Company B's reported operating profit for year 3 of zero and the 
median of the comparable operating profits for year 3.
    Example 3. Material difference in accounting for stock-based 
compensation. (i) Taxpayer, a U.S. corporation the stock of which is 
publicly traded, performs controlled services for its wholly-owned 
subsidiaries. The arm's length price of these controlled services is 
evaluated under the comparable profits method for services in 
paragraph (f) of this section by reference to the net cost plus 
profit level indicator (PLI). Taxpayer is the tested party under 
paragraph (f)(2)(i) of this section. The Commissioner identifies the 
most narrowly identifiable business activity of the tested party for 
which data are available that incorporate the controlled transaction 
(the relevant business activity). The Commissioner also identifies 
four uncontrolled domestic service providers, Companies A, B, C, and 
D, each of which performs exclusively activities similar to the 
relevant business activity of Taxpayer that is subject to analysis 
under paragraph (f) of this section. The stock of Companies A, B, C, 
and D is publicly traded on a U.S. stock exchange. Assume that 
Taxpayer makes an election to apply these regulations to earlier 
taxable years.
    (ii) Stock options are granted to the employees of Taxpayer that 
engage in the relevant business activity. Assume that, as determined 
under a method in accordance with U.S. generally accepted accounting 
principles, the fair value of such stock options attributable to the 
employees' performance of the relevant business activity is 500 for 
the taxable year in question. In evaluating the controlled services, 
Taxpayer includes salaries, fringe benefits, and related 
compensation of these employees in ``total services costs,'' as 
defined in paragraph (j) of this section. Taxpayer does not include 
any amount attributable to stock options in total services costs, 
nor does it deduct that amount in determining ''reported operating 
profit'' within the meaning of Sec.  1.482-5(d)(5), for the year 
under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D. Under a fair value method in accordance with U.S. 
generally accepted accounting principles, the comparables include in 
total compensation the value of the stock options attributable to 
the employees' performance of the relevant business activity for the 
annual financial reporting period, and treat this amount as an 
expense in determining operating profit for financial accounting 
purposes. The treatment of employee stock options is summarized in 
the following table:

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

     (iv) A material difference in accounting for stock-based 
compensation (within the meaning of Sec.  1.482-7T(d)(3)(i)) exists. 
Analysis indicates that this difference would materially affect the 
measure of an arm's length result under this paragraph (f). In 
making an adjustment to improve comparability under Sec. Sec.  
1.482-1(d)(2) and 1.482-5(c)(2)(iv), the Commissioner includes in 
total services costs of the tested party the total compensation 
costs of 1,500 (including stock option fair value). In addition, the 
Commissioner calculates the net cost plus PLI by reference to the 
financial-accounting data of Companies A, B, C, and D, which take 
into account compensatory stock options.
    Example 4. Material difference in utilization of stock-based 
compensation.
    (i) The facts are the same as in paragraph (i) of Example 3.
    (ii) No stock options are granted to the employees of Taxpayer 
that engage in the relevant business activity. Thus, no deduction 
for stock options is made in determining ``reported operating 
profit'' (within the meaning of Sec.  1.482-5(d)(5)) for the taxable 
year under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D, but none of these companies expense stock options for 
financial accounting purposes. Under a method in accordance with 
U.S. generally accepted accounting principles, however, Companies A, 
B, C, and D disclose the fair value of the stock options for 
financial accounting purposes. The utilization and treatment of 
employee stock options is summarized in the following table:

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


[[Page 38862]]

     (iv) A material difference in the utilization of stock-based 
compensation (within the meaning of Sec.  1.482-7T(d)(3)(i)) exists. 
Analysis indicates that these differences would materially affect 
the measure of an arm's length result under this paragraph (f). In 
evaluating the comparable operating profits of the tested party, the 
Commissioner uses Taxpayer's total services costs, which include 
total compensation costs of 1,000. In considering whether an 
adjustment is necessary to improve comparability under Sec. Sec.  
1.482-1(d)(2) and 1.482-5(c)(2)(iv), the Commissioner recognizes 
that the total compensation provided to employees of Taxpayer is 
comparable to the total compensation provided to employees of 
Companies A, B, C, and D. Because Companies A, B, C, and D do not 
expense stock-based compensation for financial accounting purposes, 
their reported operating profits must be adjusted in order to 
improve comparability with the tested party. The Commissioner 
increases each comparable's total services costs, and also reduces 
its reported operating profit, by the fair value of the stock-based 
compensation incurred by the comparable company.
    (v) The adjustments to the data of Companies A, B, C, and D 
described in paragraph (iv) of this Example 4 are summarized in the 
following table:

----------------------------------------------------------------------------------------------------------------
                                   Salaries and
                                    other non-     Stock options  Total services     Operating     Net cost plus
                                      option        fair value       costs (A)      profit (B)       PLI (B/A)
                                   compensation                                                      (Percent)
----------------------------------------------------------------------------------------------------------------
Per financial statements:
    Company A...................           7,000           2,000          25,000           6,000           24.00
    Company B...................           4,300             250          12,500           2,500           20.00
    Company C...................          12,000           4,500          36,000          11,000           30.56
    Company D...................          15,000           2,000          27,000           7,000           25.93
As adjusted:
    Company A...................           7,000           2,000          27,000           4,000           14.81
    Company B...................           4,300             250          12,750           2,250           17.65
    Company C...................          12,000           4,500          40,500           6,500           16.05
    Company D...................          15,000           2,000          29,000           5,000           17.24
----------------------------------------------------------------------------------------------------------------

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

----------------------------------------------------------------------------------------------------------------
                                                                   Salaries and
                                                                    other non-     Stock options   Stock options
                                                                      option        fair value       expensed
                                                                   compensation
----------------------------------------------------------------------------------------------------------------
Taxpayer........................................................           1,000              50              50
Company A.......................................................           7,000             100               0
Company B.......................................................           4,300              40               0
Company C.......................................................          12,000             130               0
Company D.......................................................          15,000              75               0
----------------------------------------------------------------------------------------------------------------

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

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

     (v) Under the circumstances, the difference in utilization of 
stock-based compensation would not materially affect the 
determination of the arm's length result under this paragraph (f). 
Accordingly, in calculating the net cost plus PLI, no comparability

[[Page 38863]]

adjustment is made to the data of Companies A, B, C, or D pursuant 
to Sec. Sec.  1.482-1(d)(2) and 1.482-5(c)(2)(iv).
    Example 6. Material difference in comparables' accounting for 
stock-based compensation. (i) The facts are the same as in paragraph 
(i) of Example 3.
    (ii) Stock options are granted to the employees of Taxpayer that 
engage in the relevant business activity. Assume that, as determined 
under a method in accordance with U.S. generally accepted accounting 
principles, the fair value of such stock options attributable to 
employees' performance of the relevant business activity is 500 for 
the taxable year. Taxpayer includes salaries, fringe benefits, and 
all other compensation of these employees (including the stock 
option fair value) in ``total services costs,'' as defined in 
paragraph (j) of this section, and deducts these amounts in 
determining ``reported operating profit'' (within the meaning of 
Sec.  1.482-5(d)(5)) for the taxable year under examination.
    (iii) Stock options are granted to the employees of Companies A, 
B, C, and D. Companies A and B expense the stock options for 
financial accounting purposes in accordance with U.S. generally 
accepted accounting principles. Companies C and D do not expense the 
stock options for financial accounting purposes. Under a method in 
accordance with U.S. generally accepted accounting principles, 
however, Companies C and D disclose the fair value of these options 
in their financial statements. The utilization and accounting 
treatment of options are depicted in the following table:

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

     (iv) A material difference in accounting for stock-based 
compensation (within the meaning of Sec.  1.482-7T(d)(3)(i)) exists. 
Analysis indicates that this difference would materially affect the 
measure of the arm's length result under paragraph (f) of this 
section. In evaluating the comparable operating profits of the 
tested party, the Commissioner includes in total services costs 
Taxpayer's total compensation costs of 1,500 (including stock option 
fair value of 500). In considering whether an adjustment is 
necessary to improve comparability under Sec. Sec.  1.482-1(d)(2) 
and 1.482-5(c)(2)(iv), the Commissioner recognizes that the total 
employee compensation (including stock options provided by Taxpayer 
and Companies A, B, C, and D) provides a reliable basis for 
comparison. Because Companies A and B expense stock-based 
compensation for financial accounting purposes, whereas Companies C 
and D do not, an adjustment to the comparables' operating profit is 
necessary. In computing the net cost plus PLI, the Commissioner uses 
the financial-accounting data of Companies A and B, as reported. The 
Commissioner increases the total services costs of Companies C and D 
by amounts equal to the fair value of their respective stock 
options, and reduces the operating profits of Companies C and D 
accordingly.
    (v) The adjustments described in paragraph (iv) of this Example 
6 are depicted in the following table. For purposes of illustration, 
the unadjusted data of Companies A and B are also included.

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

    (g) Profit split method--(1) In general. The profit split method 
evaluates whether the allocation of the combined operating profit or 
loss attributable to one or more controlled transactions is arm's 
length by reference to the relative value of each controlled taxpayer's 
contribution to that combined operating profit or loss. The relative 
value of each controlled taxpayer's contribution is determined in a 
manner that reflects the functions performed, risks assumed and 
resources employed by such controlled taxpayer in the relevant business 
activity. For application of the profit split method (both the 
comparable profit split and the residual profit split), see Sec.  
1.482-6. The residual profit split method may not be used where only 
one controlled taxpayer makes significant nonroutine contributions.
    (2) Examples. The principles of this paragraph (g) are illustrated 
by the following examples:

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

[[Page 38864]]

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

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

[[Page 38865]]

function itself). As with any method, an unspecified method will not be 
applied unless it provides the most reliable measure of an arm's length 
result under the principles of the best method rule. See Sec.  1.482-
1(c). Therefore, in accordance with Sec.  1.482-1(d) (comparability), 
to the extent that an unspecified method relies on internal data rather 
than uncontrolled comparables, its reliability will be reduced. 
Similarly, the reliability of a method will be affected by the 
reliability of the data and assumptions used to apply the method, 
including any projections used.

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

    (i) Contingent-payment contractual terms for services--(1) 
Contingent-payment contractual terms recognized in general. In the case 
of a contingent-payment arrangement, the arm's length result for the 
controlled services transaction generally would not require payment by 
the recipient to the renderer in the tax accounting period in which the 
service is rendered if the specified contingency does not occur in that 
period. If the specified contingency occurs in a tax accounting period 
subsequent to the period in which the service is rendered, the arm's 
length result for the controlled services transaction generally would 
require payment by the recipient to the renderer on a basis that 
reflects the recipient's benefit from the services rendered and the 
risks borne by the renderer in performing the activities in the absence 
of a provision that unconditionally obligates the recipient to pay for 
the activities performed in the tax accounting period in which the 
service is rendered.
    (2) Contingent-payment arrangement. For purposes of this paragraph 
(i), an arrangement will be treated as a contingent-payment arrangement 
if it meets all of the requirements in paragraph (i)(2)(i) of this 
section and is consistent with the economic substance and conduct 
requirement in paragraph (i)(2)(ii) of this section.
    (i) General requirements--(A) Written contract. The arrangement is 
set forth in a written contract entered into prior to, or 
contemporaneous with, the start of the activity or group of activities 
constituting the controlled services transaction.
    (B) Specified contingency. The contract states that payment for a 
controlled services transaction is contingent (in whole or in part) 
upon the happening of a future benefit (within the meaning of Sec.  
1.482-9(l)(3)) for the recipient directly related to the activity or 
group of activities. For purposes of the preceding sentence, whether 
the future benefit is directly related to the activity or group of 
activities is evaluated based on all the facts and circumstances.
    (C) Basis for payment. The contract provides for payment on a basis 
that reflects the recipient's benefit from the services rendered and 
the risks borne by the renderer.
    (ii) Economic substance and conduct. The arrangement, including the 
contingency and the basis for payment, is consistent with the economic 
substance of the controlled transaction and the conduct of the 
controlled parties. See Sec.  1.482-1(d)(3)(ii)(B).
    (3) Commissioner's authority to impute contingent-payment terms. 
Consistent with the authority in Sec.  1.482-1(d)(3)(ii)(B), the 
Commissioner may impute contingent-payment contractual terms in a 
controlled services transaction if the economic substance of the 
transaction is consistent with the existence of such terms.
    (4) Evaluation of arm's length charge. Whether the amount charged 
in a contingent-payment arrangement is arm's length will be evaluated 
in accordance with this section and other applicable regulations under 
section 482. In evaluating whether the amount charged in a contingent-
payment arrangement for the manufacture, construction, or development 
of tangible or intangible property owned by the recipient is arm's 
length, the charge determined under the rules of Sec. Sec.  1.482-3 and 
1.482-4 for the transfer of similar property may be considered. See 
Sec.  1.482-1(f)(2)(ii).
    (5) Examples. The principles of this paragraph (i) are illustrated 
by the following examples:

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

[[Page 38866]]

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

    (j) Total services costs. For purposes of this section, total 
services costs means all costs of rendering those services for which 
total services costs are being determined. Total services costs include 
all costs in cash or in kind (including stock-based compensation) that, 
based on analysis of the facts and circumstances, are directly 
identified with, or reasonably allocated in accordance with the 
principles of paragraph (k)(2) of this section to, the services. In 
general, costs for this purpose should comprise provision for all 
resources expended, used, or made available to achieve the specific 
objective for which the service is rendered. Reference to generally 
accepted accounting principles or Federal income tax accounting rules 
may provide a useful starting point but will not necessarily be 
conclusive regarding inclusion of costs in total services costs. Total 
services costs do not include interest expense, foreign income taxes 
(as defined in Sec.  1.901-2(a)), or domestic income taxes.
    (k) Allocation of costs--(1) In general. In any case where the 
renderer's activity that results in a benefit (within the meaning of 
paragraph (l)(3) of this section) for one recipient in a controlled 
services transaction also generates a benefit for one or more other 
members of a controlled group (including the benefit, if any, to the 
renderer), and the amount charged under this section in the controlled 
services transaction is determined under a method that makes reference 
to costs, costs must be allocated among the portions of the activity 
performed for the benefit of the

[[Page 38867]]

first mentioned recipient and such other members of the controlled 
group under this paragraph (k). The principles of this paragraph (k) 
must also be used whenever it is appropriate to allocate and apportion 
any class of costs (for example, overhead costs) in order to determine 
the total services costs of rendering the services. In no event will an 
allocation of costs based on a generalized or non-specific benefit be 
appropriate.
    (2) Appropriate method of allocation and apportionment--(i) 
Reasonable method standard. Any reasonable method may be used to 
allocate and apportion costs under this section. In establishing the 
appropriate method of allocation and apportionment, consideration 
should be given to all bases and factors, including, for example, total 
services costs, total costs for a relevant activity, assets, sales, 
compensation, space utilized, and time spent. The costs incurred by 
supporting departments may be apportioned to other departments on the 
basis of reasonable overall estimates, or such costs may be reflected 
in the other departments' costs by applying reasonable departmental 
overhead rates. Allocations and apportionments of costs must be made on 
the basis of the full cost, as opposed to the incremental cost.
    (ii) Use of general practices. The practices used by the taxpayer 
to apportion costs in connection with preparation of statements and 
analyses for the use of management, creditors, minority shareholders, 
joint venturers, clients, customers, potential investors, or other 
parties or agencies in interest will be considered as potential 
indicators of reliable allocation methods, but need not be accorded 
conclusive weight by the Commissioner. In determining the extent to 
which allocations are to be made to or from foreign members of a 
controlled group, practices employed by the domestic members in 
apportioning costs among themselves will also be considered if the 
relationships with the foreign members are comparable to the 
relationships among the domestic members of the controlled group. For 
example, if for purposes of reporting to public stockholders or to a 
governmental agency, a corporation apportions the costs attributable to 
its executive officers among the domestic members of a controlled group 
on a reasonable and consistent basis, and such officers exercise 
comparable control over foreign members of the controlled group, such 
domestic apportionment practice will be considered in determining the 
allocations to be made to the foreign members.
    (3) Examples. The principles of this paragraph (k) are illustrated 
by the following examples:

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

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

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

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

    (l) Controlled services transaction--(1) In general. A controlled 
services transaction includes any activity (as defined in paragraph 
(l)(2) of this section) by one member of a group of controlled 
taxpayers (the renderer) that results in a benefit (as defined in 
paragraph (l)(3) of this section) to one or more other members of the 
controlled group (the recipient(s)).
    (2) Activity. An activity includes the performance of functions, 
assumptions of risks, or use by a renderer of tangible or intangible 
property or other resources, capabilities, or knowledge, such as 
knowledge of and ability to take advantage of particularly advantageous 
situations or circumstances. An activity also includes making available 
to the recipient any property or other resources of the renderer.
    (3) Benefit--(i) In general. An activity is considered to provide a 
benefit to the recipient if the activity directly results in a 
reasonably identifiable increment of economic or commercial value that 
enhances the recipient's commercial position, or that may reasonably be 
anticipated to do so. An activity is generally considered to confer a 
benefit if, taking into account the facts and circumstances, an 
uncontrolled taxpayer in circumstances comparable to those of the 
recipient would be willing to pay an uncontrolled party to perform the 
same or similar activity on either a fixed or contingent-payment basis, 
or if the recipient otherwise would have performed for itself the same 
activity or a similar activity. A benefit may result to the owner of 
intangible property if the renderer engages in an activity that

[[Page 38868]]

is reasonably anticipated to result in an increase in the value of that 
intangible property. Paragraphs (l)(3)(ii) through (v) of this section 
provide guidelines that indicate the presence or absence of a benefit 
for the activities in the controlled services transaction.
    (ii) Indirect or remote benefit. An activity is not considered to 
provide a benefit to the recipient if, at the time the activity is 
performed, the present or reasonably anticipated benefit from that 
activity is so indirect or remote that the recipient would not be 
willing to pay, on either a fixed or contingent-payment basis, an 
uncontrolled party to perform a similar activity, and would not be 
willing to perform such activity for itself for this purpose. The 
determination whether the benefit from an activity is indirect or 
remote is based on the nature of the activity and the situation of the 
recipient, taking into consideration all facts and circumstances.
    (iii) Duplicative activities. If an activity performed by a 
controlled taxpayer duplicates an activity that is performed, or that 
reasonably may be anticipated to be performed, by another controlled 
taxpayer on or for its own account, the activity is generally not 
considered to provide a benefit to the recipient, unless the 
duplicative activity itself provides an additional benefit to the 
recipient.
    (iv) Shareholder activities. An activity is not considered to 
provide a benefit if the sole effect of that activity is either to 
protect the renderer's capital investment in the recipient or in other 
members of the controlled group, or to facilitate compliance by the 
renderer with reporting, legal, or regulatory requirements applicable 
specifically to the renderer, or both. Activities in the nature of day-
to-day management generally do not relate to protection of the 
renderer's capital investment. Based on analysis of the facts and 
circumstances, activities in connection with a corporate reorganization 
may be considered to provide a benefit to one or more controlled 
taxpayers.
    (v) Passive association. A controlled taxpayer generally will not 
be considered to obtain a benefit where that benefit results from the 
controlled taxpayer's status as a member of a controlled group. A 
controlled taxpayer's status as a member of a controlled group may, 
however, be taken into account for purposes of evaluating comparability 
between controlled and uncontrolled transactions.
    (4) Disaggregation of transactions. A controlled services 
transaction may be analyzed as two separate transactions for purposes 
of determining the arm's length consideration, if that analysis is the 
most reliable means of determining the arm's length consideration for 
the controlled services transaction. See the best method rule under 
Sec.  1.482-1(c).
    (5) Examples. The principles of this paragraph (l) are illustrated 
by the following examples. In each example, assume that Company X is a 
U.S. corporation and Company Y is a wholly-owned subsidiary of Company 
X in Country B.

    Example 1. In general. In developing a worldwide advertising and 
promotional campaign for a consumer product, Company X pays for and 
obtains designation as an official sponsor of the Olympics. This 
designation allows Company X and all its subsidiaries, including 
Company Y, to identify themselves as sponsors and to use the Olympic 
logo in advertising and promotional campaigns. The Olympic 
sponsorship campaign generates benefits to Company X, Company Y, and 
other subsidiaries of Company X.
    Example 2. Indirect or remote benefit. Based on recommendations 
contained in a study performed by its internal staff, Company X 
implements certain changes in its management structure and the 
compensation of managers of divisions located in the United States. 
No changes were recommended or considered for Company Y in Country 
B. The internal study and the resultant changes in its management 
may increase the competitiveness and overall efficiency of Company 
X. Any benefits to Company Y as a result of the study are, however, 
indirect or remote. Consequently, Company Y is not considered to 
obtain a benefit from the study.
    Example 3. Indirect or remote benefit. Based on recommendations 
contained in a study performed by its internal staff, Company X 
decides to make changes to the management structure and management 
compensation of its subsidiaries, in order to increase their 
profitability. As a result of the recommendations in the study, 
Company X implements substantial changes in the management structure 
and management compensation scheme of Company Y. The study and the 
changes implemented as a result of the recommendations are 
anticipated to increase the profitability of Company X and its 
subsidiaries. The increased management efficiency of Company Y that 
results from these changes is considered to be a specific and 
identifiable benefit, rather than remote or speculative.
    Example 4. Duplicative activities. At its corporate headquarters 
in the United States, Company X performs certain treasury functions 
for Company X and for its subsidiaries, including Company Y. These 
treasury functions include raising capital, arranging medium and 
long-term financing for general corporate needs, including cash 
management. Under these circumstances, the treasury functions 
performed by Company X do not duplicate the functions performed by 
Company Y's staff. Accordingly, Company Y is considered to obtain a 
benefit from the functions performed by Company X.
    Example 5. Duplicative activities. The facts are the same as in 
Example 4, except that Company Y's functions include ensuring that 
the financing requirements of its own operations are met. Analysis 
of the facts and circumstances indicates that Company Y 
independently administers all financing and cash-management 
functions necessary to support its operations, and does not utilize 
financing obtained by Company X. Under the circumstances, the 
treasury functions performed by Company X are duplicative of similar 
functions performed by Company Y's staff, and the duplicative 
functions do not enhance Company Y's position. Accordingly, Company 
Y is not considered to obtain a benefit from the duplicative 
activities performed by Company X.
    Example 6. Duplicative activities. Company X's in-house legal 
staff has specialized expertise in several areas, including 
intellectual property. The intellectual property legal staff 
specializes in technology licensing, patents, copyrights, and 
negotiating and drafting intellectual property agreements. Company Y 
is involved in negotiations with an unrelated party to enter into a 
complex joint venture that includes multiple licenses and cross-
licenses of patents and copyrights. Company Y retains outside 
counsel that specializes in intellectual property law to review the 
transaction documents. Company Y does not have in-house counsel of 
its own to review intellectual property transaction documents. 
Outside counsel advises that the terms for the proposed transaction 
are advantageous to Company Y and that the contracts are valid and 
fully enforceable. Company X's intellectual property legal staff 
possess valuable knowledge of Company Y's patents and technological 
achievements. They are capable of identifying particular scientific 
attributes protected under patent that strengthen Company Y's 
negotiating position, and of discovering flaws in the patents 
offered by the unrelated party. To reduce risk associated with the 
transaction, Company X's intellectual property legal staff reviews 
the transaction documents before Company Y executes the contracts. 
Company X's intellectual property legal staff also separately 
evaluates the patents and copyrights with respect to the licensing 
arrangements and concurs in the opinion provided by outside counsel. 
The activities performed by Company X substantially duplicate the 
legal services obtained by Company Y, but they also reduce risk 
associated with the transaction in a way that confers an additional 
benefit on Company Y.
    Example 7. Shareholder activities. Company X is a publicly held 
corporation. U.S. laws and regulations applicable to publicly held 
corporations such as Company X require the preparation and filing of 
periodic reports that show, among other things, profit and loss 
statements, balance sheets, and other material financial information 
concerning the company's operations. Company X, Company Y and each 
of the other subsidiaries maintain their own separate accounting 
departments that record individual transactions and prepare 
financial statements in accordance with their local accounting 
practices. Company Y, and

[[Page 38869]]

the other subsidiaries, forward the results of their financial 
performance to Company X, which analyzes and compiles these data 
into periodic reports in accordance with U.S. laws and regulations. 
Because Company X's preparation and filing of the reports relate 
solely to its role as an investor of capital or shareholder in 
Company Y or to its compliance with reporting, legal, or regulatory 
requirements, or both, these activities constitute shareholder 
activities and therefore Company Y is not considered to obtain a 
benefit from the preparation and filing of the reports.
    Example 8. Shareholder activities. The facts are the same as in 
Example 7, except that Company Y's accounting department maintains a 
general ledger recording individual transactions, but does not 
prepare any financial statements (such as profit and loss statements 
and balance sheets). Instead, Company Y forwards the general ledger 
data to Company X, and Company X analyzes and compiles financial 
statements for Company Y, as well as for Company X's overall 
operations, for purposes of complying with U.S. reporting 
requirements. Company Y is subject to reporting requirements in 
Country B similar to those applicable to Company X in the United 
States. Much of the data that Company X analyzes and compiles 
regarding Company Y's operations for purposes of complying with the 
U.S. reporting requirements are made available to Company Y for its 
use in preparing reports that must be filed in Country B. Company Y 
incorporates these data, after minor adjustments for differences in 
local accounting practices, into the reports that it files in 
Country B. Under these circumstances, because Company X's analysis 
and compilation of Company Y's financial data does not relate solely 
to its role as an investor of capital or shareholder in Company Y, 
or to its compliance with reporting, legal, or regulatory 
requirements, or both, these activities do not constitute 
shareholder activities.
    Example 9. Shareholder activities. Members of Company X's 
internal audit staff visit Company Y on a semiannual basis in order 
to review the subsidiary's adherence to internal operating 
procedures issued by Company X and its compliance with U.S. anti-
bribery laws, which apply to Company Y on account of its ownership 
by a U.S. corporation. Because the sole effect of the reviews by 
Company X's audit staff is to protect Company X's investment in 
Company Y, or to facilitate Company X's compliance with U.S. anti-
bribery laws, or both, the visits are shareholder activities and 
therefore Company Y is not considered to obtain a benefit from the 
visits.
    Example 10. Shareholder activities. Country B recently enacted 
legislation that changed the foreign currency exchange controls 
applicable to foreign shareholders of Country B corporations. 
Company X concludes that it may benefit from changing the capital 
structure of Company Y, thus taking advantage of the new foreign 
currency exchange control laws in Country B. Company X engages an 
investment banking firm and a law firm to review the Country B 
legislation and to propose possible changes to the capital structure 
of Company Y. Because Company X's retention of the firms facilitates 
Company Y's ability to pay dividends and other amounts and has the 
sole effect of protecting Company X's investment in Company Y, these 
activities constitute shareholder activities and Company Y is not 
considered to obtain a benefit from the activities.
    Example 11. Shareholder activities. The facts are the same as in 
Example 10, except that Company Y bears the full cost of retaining 
the firms to evaluate the new foreign currency control laws in 
Country B and to make appropriate changes to its stock ownership by 
Company X. Company X is considered to obtain a benefit from the 
rendering by Company Y of these activities, which would be 
shareholder activities if conducted by Company X (see Example 10).
    Example 12. Shareholder activities. The facts are the same as in 
Example 10, except that the new laws relate solely to corporate 
governance in Country B, and Company X retains the law firm and 
investment banking firm in order to evaluate whether restructuring 
would increase Company Y's profitability, reduce the number of legal 
entities in Country B, and increase Company Y's ability to introduce 
new products more quickly in Country B. Because Company X retained 
the law firm and the investment banking firm primarily to enhance 
Company Y's profitability and the efficiency of its operations, and 
not solely to protect Company X's investment in Company Y or to 
facilitate Company X's compliance with Country B's corporate laws, 
or to both, these activities do not constitute shareholder 
activities.
    Example 13. Shareholder activities. Company X establishes 
detailed personnel policies for its subsidiaries, including Company 
Y. Company X also reviews and approves the performance appraisals of 
Company Y's executives, monitors levels of compensation paid to all 
Company Y personnel, and is involved in hiring and firing decisions 
regarding the senior executives of Company Y. Because this 
personnel-related activity by Company X involves day-to-day 
management of Company Y, this activity does not relate solely to 
Company X's role as an investor of capital or a shareholder of 
Company Y, and therefore does not constitute a shareholder activity.
    Example 14. Shareholder activities. Each year, Company X 
conducts a two-day retreat for its senior executives. The purpose of 
the retreat is to refine the long-term business strategy of Company 
X and its subsidiaries, including Company Y, and to produce a 
confidential strategy statement. The strategy statement identifies 
several potential growth initiatives for Company X and its 
subsidiaries and lists general means of increasing the profitability 
of the company as a whole. The strategy statement is made available 
without charge to Company Y and the other subsidiaries of Company X. 
Company Y independently evaluates whether to implement some, all, or 
none of the initiatives contained in the strategy statement. Because 
the preparation of the strategy statement does not relate solely to 
Company X's role as an investor of capital or a shareholder of 
Company Y, the expense of preparing the document is not a 
shareholder expense.
    Example 15. Passive association/benefit. Company X is the parent 
corporation of a large controlled group that has been in operation 
in the information-technology sector for ten years. Company Y is a 
small corporation that was recently acquired by the Company X 
controlled group from local Country B owners. Several months after 
the acquisition of Company Y, Company Y obtained a contract to 
redesign and assemble the information-technology networks and 
systems of a large financial institution in Country B. The project 
was significantly larger and more complex than any other project 
undertaken to date by Company Y. Company Y did not use Company X's 
marketing intangible property to solicit the contract, and Company X 
had no involvement in the solicitation, negotiation, or anticipated 
execution of the contract. For purposes of this section, Company Y 
is not considered to obtain a benefit from Company X or any other 
member of the controlled group because the ability of Company Y to 
obtain the contract, or to obtain the contract on more favorable 
terms than would have been possible prior to its acquisition by the 
Company X controlled group, was due to Company Y's status as a 
member of the Company X controlled group and not to any specific 
activity by Company X or any other member of the controlled group.
    Example 16. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X executes a performance 
guarantee with respect to the contract, agreeing to assist in the 
project if Company Y fails to meet certain mileposts. This 
performance guarantee allowed Company Y to obtain the contract on 
materially more favorable terms than otherwise would have been 
possible. Company Y is considered to obtain a benefit from Company 
X's execution of the performance guarantee.
    Example 17. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X began the process of 
negotiating the contract with the financial institution in Country B 
before acquiring Company Y. Once Company Y was acquired by Company 
X, the contract with the financial institution was entered into by 
Company Y. Company Y is considered to obtain a benefit from Company 
X's negotiation of the contract.
    Example 18. Passive association/benefit. The facts are the same 
as in Example 15, except that Company X sent a letter to the 
financial institution in Country B, which represented that Company X 
had a certain percentage ownership in Company Y and that Company X 
would maintain that same percentage ownership interest in Company Y 
until the contract was completed. This letter allowed Company Y to 
obtain the contract on more favorable terms than otherwise would 
have been possible. Since this letter from Company X to the 
financial institution simply affirmed Company Y's status as a member 
of the controlled group and represented that this status would be 
maintained until the contract was completed,

[[Page 38870]]

Company Y is not considered to obtain a benefit from Company X's 
furnishing of the letter.
    Example 19. Passive association/benefit. (i) S is a company that 
supplies plastic containers to companies in various industries. S 
establishes the prices for its containers through a price list that 
offers customers discounts based solely on the volume of containers 
purchased.
    (ii) Company X is the parent corporation of a large controlled 
group in the information technology sector. Company Y is a wholly-
owned subsidiary of Company X located in Country B. Company X and 
Company Y both purchase plastic containers from unrelated supplier 
S. In year 1, Company X purchases 1 million units and Company Y 
purchases 100,000 units. S, basing its prices on purchases by the 
entire group, completes the order for 1.1 million units at a price 
of $0.95 per unit, and separately bills and ships the orders to each 
company. Companies X and Y undertake no bargaining with supplier S 
with respect to the price charged, and purchase no other products 
from supplier S.
    (iii) R1 and its wholly-owned subsidiary R2 are a controlled 
group of taxpayers (unrelated to Company X or Company Y) each of 
which carries out functions comparable to those of Companies X and Y 
and undertakes purchases of plastic containers from supplier S, 
identical to those purchased from S by Company X and Company Y, 
respectively. S, basing its prices on purchases by the entire group, 
charges R1 and R2 $0.95 per unit for the 1.1 million units ordered. 
R1 and R2 undertake no bargaining with supplier S with respect to 
the price charged, and purchase no other products from supplier S.
    (iv) U is an uncontrolled taxpayer that carries out comparable 
functions and undertakes purchases of plastic containers from 
supplier S identical to Company Y. U is not a member of a controlled 
group, undertakes no bargaining with supplier S with respect to the 
price charged, and purchases no other products from supplier S. U 
purchases 100,000 plastic containers from S at the price of $1.00 
per unit.
    (v) Company X charges Company Y a fee of $5,000, or $0.05 per 
unit of plastic containers purchased by Company Y, reflecting the 
fact that Company Y receives the volume discount from supplier S.
    (vi) In evaluating the fee charged by Company X to Company Y, 
the Commissioner considers whether the transactions between R1, R2, 
and S or the transactions between U and S provide a more reliable 
measure of the transactions between Company X, Company Y and S. The 
Commissioner determines that Company Y's status as a member of a 
controlled group should be taken into account for purposes of 
evaluating comparability of the transactions, and concludes that the 
transactions between R1, R2, and S are more reliably comparable to 
the transactions between Company X, Company Y, and S. The comparable 
charge for the purchase was $0.95 per unit. Therefore, obtaining the 
plastic containers at a favorable rate (and the resulting $5,000 
savings) is entirely due to Company Y's status as a member of the 
Company X controlled group and not to any specific activity by 
Company X or any other member of the controlled group. Consequently, 
Company Y is not considered to obtain a benefit from Company X or 
any other member of the controlled group.
    Example 20. Disaggregation of transactions. (i) X, a domestic 
corporation, is a pharmaceutical company that develops and 
manufactures ethical pharmaceutical products. Y, a Country B 
corporation, is a distribution and marketing company that also 
performs clinical trials for X in Country B. Because Y does not 
possess the capability to conduct the trials, it contracts with a 
third party to undertake the trials at a cost of $100. Y also incurs 
$25 in expenses related to the third-party contract (for example, in 
hiring and working with the third party).
    (ii) Based on a detailed functional analysis, the Commissioner 
determines that Y performed functions beyond merely facilitating the 
clinical trials for X, such as audit controls of the third party 
performing those trials. In determining the arm's length price, the 
Commissioner may consider a number of alternatives. For example, for 
purposes of determining the arm's length price, the Commissioner may 
determine that the intercompany service is most reliably analyzed on 
a disaggregated basis as two separate transactions: in this case, 
the contract between Y and the third party could constitute an 
internal CUSP with a price of $100. Y would be further entitled to 
an arm's length remuneration for its facilitating services. If the 
most reliable method is one that provides a markup on Y's costs, 
then ``total services cost'' in this context would be $25. 
Alternatively, the Commissioner may determine that the intercompany 
service is most reliably analyzed as a single transaction, based on 
comparable uncontrolled transactions involving the facilitation of 
similar clinical trial services performed by third parties. If the 
most reliable method is one that provides a markup on all of Y's 
costs, and the base of the markup determined by the comparable 
companies includes the third-party clinical trial costs, then such a 
markup would be applied to Y's total services cost of $125.
    Example 21. Disaggregation of transactions. (i) X performs a 
number of administrative functions for its subsidiaries, including 
Y, a distributor of widgets in Country B. These services include 
those relating to working capital (inventory and accounts 
receivable/payable) management. To facilitate provision of these 
services, X purchases an ERP system specifically dedicated to 
optimizing working capital management. The system, which entails 
significant third-party costs and which includes substantial 
intellectual property relating to its software, costs $1,000.
    (ii) Based on a detailed functional analysis, the Commissioner 
determines that in providing administrative services for Y, X 
performed functions beyond merely operating the ERP system itself, 
since X was effectively using the ERP as an input to the 
administrative services it was providing to Y. In determining arm's 
length price for the services, the Commissioner may consider a 
number of alternatives. For example, if the most reliable 
uncontrolled data is derived from companies that use similar ERP 
systems purchased from third parties to perform similar 
administrative functions for uncontrolled parties, the Commissioner 
may determine that a CPM is the best method for measuring the 
functions performed by X, and, in addition, that a markup on total 
services costs, based on the markup from the comparable companies, 
is the most reliable PLI. In this case, total services cost, and the 
basis for the markup, would include appropriate reflection of the 
ERP costs of $1,000. Alternatively, X's functions may be most 
reliably measured based on comparable uncontrolled companies that 
perform similar administrative functions using their customers' own 
ERP systems. Under these circumstances, the total services cost 
would equal X's costs of providing the administrative services 
excluding the ERP cost of $1,000.

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

[[Page 38871]]

    (3) [Reserved]. For further guidance, see Sec.  1.482-9T(m)(3).
    (4) Other types of transactions that include controlled services 
transactions. A transaction structured other than as a controlled 
services transaction may include one or more elements for which 
separate pricing methods are provided in this section. Whether such an 
integrated transaction is evaluated under another section of the 
section 482 regulations or whether one or more elements should be 
evaluated separately under this section depends on which approach will 
provide the most reliable measure of an arm's length result. 
Ordinarily, a single method may be applied to such an integrated 
transaction, and the separate services component of the transaction 
need not be separately analyzed under this section, provided that the 
controlled services may be adequately accounted for in evaluating the 
comparability of the controlled transaction to the uncontrolled 
comparables and, accordingly, in determining the arm's length results 
in the controlled transaction. See Sec.  1.482-1(d)(3).
    (5) Examples. The principles of this paragraph (m) are illustrated 
by the following examples:

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

    (6) Global dealing operations. [Reserved].
    (n) Effective/applicability date--(1) In general. This section is 
generally applicable for taxable years beginning after July 31, 2009. 
In addition, a person may elect to apply the provisions of this section 
to earlier taxable years. See paragraph (n)(2) of this section.
    (2) Election to apply regulations to earlier taxable years--(i) 
Scope of election. A taxpayer may elect to apply Sec.  1.482-1(a)(1), 
(b)(2)(i), (d)(3)(ii)(C) Examples 3 through 6, (d)(3)(v), 
(f)(2)(ii)(A), (f)(2)(iii)(B), (g)(4)(i), (g)(4)(iii) Example 1, (i), 
(j)(6)(i) and (j)(6)(ii), Sec.  1.482-2(b), (f)(1) and (2), Sec.  
1.482-4(f)(3)(i)(A), (f)(3)(ii) Examples 1 and 2, (f)(4), (h)(1) and 
(2), Sec.  1.482-6(c)(2)(ii)(B)(1), (c)(2)(ii)(D), (c)(3)(i)(A), 
(c)(3)(i)(B), (c)(3)(ii)(D), and (d), Sec.  1.482-8(b) Examples 10 
through 12, (c)(1) and (c)(2), Sec.  1.482-9(a) through (m)(2), and 
(m)(4) through (n)(2), Sec.  1.861-8(a)(5)(ii), (b)(3), (e)(4), 
(f)(4)(i), (g) Examples 17, 18, and 30, Sec.  1.6038A-3(a)(3) Example 4 
and (i), Sec.  1.6662-6(d)(2)(ii)(B), (d)(2)(iii)(B)(4), 
(d)(2)(iii)(B)(6), and (g), and Sec.  31.3121(s)-1(c)(2)(iii) and (d) 
of this chapter to any taxable year

[[Page 38872]]

beginning after September 10, 2003. Such election requires that all of 
the provisions of such sections be applied to such taxable year and all 
subsequent taxable years (earlier taxable years) of the taxpayer making 
the election.
    (ii) Effect of election. An election to apply the regulations to 
earlier taxable years has no effect on the limitations on assessment 
and collection or on the limitations on credit or refund (see Chapter 
66 of the Internal Revenue Code).
    (iii) Time and manner of making election. An election to apply the 
regulations to earlier taxable years must be made by attaching a 
statement to the taxpayer's timely filed U.S. tax return (including 
extensions) for its first taxable year beginning after July 31, 2009.
    (iv) Revocation of election. An election to apply the regulations 
to earlier taxable years may not be revoked without the consent of the 
Commissioner.
0
Par. 15. Section 1.482-9T is amended by revising paragraphs (a), (b), 
(c), (d), (e), (f), (g), (h), (i), (j), (k), (l), (m)(1), (m)(2), 
(m)(4), (m)(5), and (n), and adding paragraph (o) to read as follows:


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

    (a) through (m)(2) [Reserved]. For further guidance, see Sec.  
1.482-9(a) through (m)(2).
    (3) * * *
    (4) and (m)(5) [Reserved]. For further guidance, see Sec.  1.482-
9(m)(4) and (m)(5).
    (n) Effective/applicability date. Paragraph (m)(3) of this section 
is generally applicable on January 5, 2009.
    (o) Expiration date. The applicability of paragraph (m)(3) of this 
section expires on December 30, 2011.

0
Par. 16. Section 1.861-8 is amended by revising paragraphs (a)(5)(ii), 
(b)(3), (e)(4), (f)(4), (g) Examples 17, 18 and 30, and (h) to read as 
follows:


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

* * * * *
    (a) * * *
    (5) * * *
    (ii) Paragraph (e)(4), the last sentence of paragraph (f)(4)(i), 
and paragraph (g), Examples 17, 18, and 30 of this section are 
generally applicable for taxable years beginning after July 31, 2009. 
In addition, a person may elect to apply the provisions of paragraph 
(e)(4) of this section to earlier years. Such election shall be made in 
accordance with the rules set forth in Sec.  1.482-9(n)(2).
* * * * *
    (b) * * *
    (3) Supportive functions. Deductions which are supportive in nature 
(such as overhead, general and administrative, and supervisory 
expenses) may relate to other deductions which can more readily be 
allocated to gross income. In such instance, such supportive deductions 
may be allocated and apportioned along with the deductions to which 
they relate. On the other hand, it would be equally acceptable to 
attribute supportive deductions on some reasonable basis directly to 
activities or property which generate, have generated or could 
reasonably be expected to generate gross income. This would ordinarily 
be accomplished by allocating the supportive expenses to all gross 
income or to another broad class of gross income and apportioning the 
expenses in accordance with paragraph (c)(1) of this section. For this 
purpose, reasonable departmental overhead rates may be utilized. For 
examples of the application of the principles of this paragraph (b)(3) 
to expenses other than expenses attributable to stewardship activities, 
see Examples 19 through 21 of paragraph (g) of this section. See 
paragraph (e)(4)(ii) of this section for the allocation and 
apportionment of deductions attributable to stewardship expenses. 
However, supportive deductions that are described in Sec.  1.861-
14T(e)(3) shall be allocated and apportioned in accordance with the 
rules of Sec.  1.861-14T and shall not be allocated and apportioned by 
reference only to the gross income of a single member of an affiliated 
group of corporations as defined in Sec.  1.861-14T(d).
* * * * *
    (e) * * *
    (4) Stewardship and controlled services--(i) Expenses attributable 
to controlled services. If a corporation performs a controlled services 
transaction (as defined in Sec.  1.482-9(l)(3)), which includes any 
activity by one member of a group of controlled taxpayers that results 
in a benefit to a related corporation, and the rendering corporation 
charges the related corporation for such services, section 482 and 
these regulations provide for an allocation where the charge is not 
consistent with an arm's length result as determined. The deductions 
for expenses of the corporation attributable to the controlled services 
transaction are considered definitely related to the amounts so charged 
and are to be allocated to such amounts.
    (ii) Stewardship expenses attributable to dividends received. 
Stewardship expenses, which result from ``overseeing'' functions 
undertaken for a corporation's own benefit as an investor in a related 
corporation, shall be considered definitely related and allocable to 
dividends received, or to be received, from the related corporation. 
For purposes of this section, stewardship expenses of a corporation are 
those expenses resulting from ``duplicative activities'' (as defined in 
Sec.  1.482-9(l)(3)(iii)) or ``shareholder activities'' (as defined in 
Sec.  1.482-9(l)(3)(iv)) of the corporation with respect to the related 
corporation. Thus, for example, stewardship expenses include expenses 
of an activity the sole effect of which is either to protect the 
corporation's capital investment in the related corporation or to 
facilitate compliance by the corporation with reporting, legal, or 
regulatory requirements applicable specifically to the corporation, or 
both. If a corporation has a foreign or international department which 
exercises overseeing functions with respect to related foreign 
corporations and, in addition, the department performs other functions 
that generate other foreign-source income (such as fees for services 
rendered outside of the United States for the benefit of foreign 
related corporations, foreign-source royalties, and gross income of 
foreign branches), some part of the deductions with respect to that 
department are considered definitely related to the other foreign-
source income. In some instances, the operations of a foreign or 
international department will also generate United States source income 
(such as fees for services performed in the United States). Permissible 
methods of apportionment with respect to stewardship expenses include 
comparisons of time spent by employees weighted to take into account 
differences in compensation, or comparisons of each related 
corporation's gross receipts, gross income, or unit sales volume, 
assuming that stewardship activities are not substantially 
disproportionate to such factors. See paragraph (f)(5) of this section 
for the type of verification that may be required in this respect. See 
Sec.  1.482-9(l)(5) for examples that illustrate the principles of 
Sec.  1.482-9(l)(3). See Example 17 and Example 18 of paragraph (g) of 
this section for the allocation and apportionment of stewardship 
expenses. See paragraph (b)(3) of this section for the allocation and 
apportionment of deductions attributable to supportive functions other 
than stewardship expenses, such as expenses in the nature of day-to-day 
management, and paragraph (e)(5) of

[[Page 38873]]

this section generally for the allocation and apportionment of 
deductions attributable to legal and accounting fees and expenses.
* * * * *
    (f) * * *
    (4) Adjustments made under other provisions of the Code--(i) In 
general. If an adjustment which affects the taxpayer is made under 
section 482 or any other provision of the Code, it may be necessary to 
recompute the allocations and apportionments required by this section 
in order to reflect changes resulting from the adjustment. The 
recomputation made by the Commissioner shall be made using the same 
method of allocation and apportionment as was originally used by the 
taxpayer, provided such method as originally used conformed with 
paragraph (a)(2) of this section and, in light of the adjustment, such 
method does not result in a material distortion. In addition to 
adjustments which would be made aside from this section, adjustments to 
the taxpayer's income and deductions which would not otherwise be made 
may be required before applying this section in order to prevent a 
distortion in determining taxable income from a particular source of 
activity. For example, if an item included as a part of the cost of 
goods sold has been improperly attributed to specific sales, and, as a 
result, gross income under one of the operative sections referred to in 
paragraph (f)(1) of this section is improperly determined, it may be 
necessary for the Commissioner to make an adjustment to the cost of 
goods sold, consistent with the principles of this section, before 
applying this section. Similarly, if a domestic corporation transfers 
the stock in its foreign subsidiaries to a domestic subsidiary and the 
parent corporation continues to incur expenses in connection with 
protecting its capital investment in the foreign subsidiaries (see 
paragraph (e)(4) of this section), it may be necessary for the 
Commissioner to make an allocation under section 482 with respect to 
such expenses before making allocations and apportionments required by 
this section, even though the section 482 allocation might not 
otherwise be made.
* * * * *
    (g) * * *
    Example 17. Stewardship expenses (consolidation). (i) (A) Facts. 
X, a domestic corporation, wholly owns M, N, and O, also domestic 
corporations. X, M, N, and O file a consolidated income tax return. 
All the income of X and O is from sources within the United States, 
all of M's income is general category income from sources within 
South America, and all of N's income is general category income from 
sources within Africa. X receives no dividends from M, N, or O. 
During the taxable year, the consolidated group of corporations 
earned consolidated gross income of $550,000 and incurred total 
deductions of $370,000 as follows:

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

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

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

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

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

    (B) In addition, X incurs expenses of its supervision department 
of $1,500,000.
    (C) X's supervision department (the Department) is responsible 
for the supervision of its four subsidiaries and for rendering 
certain services to the subsidiaries, and this Department provides 
all the supportive functions necessary for X's foreign activities. 
The Department performs three principal types of activities. The 
first type consists of services for the direct benefit of U for 
which a fee is paid by U to X. The cost of the services for U is 
$900,000 (which results in a total charge to U of $1,000,000). The 
second type consists of activities described in Sec.  1.482-
9(l)(3)(iii) that are in the nature of shareholder oversight that 
duplicate functions performed by the subsidiaries' own employees and 
that do not provide an additional benefit to the subsidiaries. For 
example, a team of auditors from X's accounting department 
periodically audits the subsidiaries' books and prepares internal 
reports for use by X's management. Similarly, X's treasurer 
periodically reviews for the board of directors of X the 
subsidiaries' financial policies. These activities do not provide an 
additional benefit to the related corporations. The cost of the 
duplicative services and related supportive expenses is $540,000. 
The third type of activity consists of providing services which are 
ancillary to the license agreements which X maintains with 
subsidiaries T and U. The cost of the ancillary services is $60,000.
    (ii) Allocation. The Department's outlay of $900,000 for 
services rendered for the benefit of U is allocated to the 
$1,000,000 in fees paid by U. The remaining $600,000 in the 
Department's deductions are definitely related to the types of gross 
income to which they give rise, namely dividends from subsidiaries 
S, T, U, and V and royalties from T and U. However, $60,000 of the 
$600,000 in deductions are found to be attributable to the ancillary 
services and are definitely related (and therefore allocable) solely 
to royalties received from T and U, while the remaining $540,000 in 
deductions are

[[Page 38874]]

definitely related (and therefore allocable) to dividends received 
from all the subsidiaries.
    (iii) (A) Apportionment. For purposes of applying the foreign 
tax credit limitation, the statutory grouping is general category 
gross income from sources outside the United States and the residual 
grouping is gross income from sources within the United States. X's 
deduction of $540,000 for the Department's expenses and related 
supportive expenses which are allocable to dividends received from 
the subsidiaries must be apportioned between the statutory and 
residual groupings before the foreign tax credit limitation may be 
applied. In determining an appropriate method for apportioning the 
$540,000, a basis other than X's gross income must be used since the 
dividend payment policies of the subsidiaries bear no relationship 
either to the activities of the Department or to the amount of 
income earned by each subsidiary. This is evidenced by the fact that 
V paid no dividends during the year, whereas S, T, and U paid 
dividends of $1 million or more each. In the absence of facts that 
would indicate a material distortion resulting from the use of such 
method, the stewardship expenses ($540,000) may be apportioned on 
the basis of the gross receipts of each subsidiary.
    (B) The gross receipts of the subsidiaries were as follows:

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

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

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

* * * * *
    Example 30. Income taxes. (i)(A) Facts. As in Example 17 of this 
paragraph (g), X is a domestic corporation that wholly owns M, N, 
and O, also domestic corporations. X, M, N, and O file a 
consolidated income tax return. All the income of X and O is from 
sources within the United States, all of M's income is general 
category income from sources within South America, and all of N's 
income is general category income from sources within Africa. X 
receives no dividends from M, N, or O. During the taxable year, the 
consolidated group of corporations earned consolidated gross income 
of $550,000 and incurred total deductions of $370,000. X has gross 
income of $100,000 and deductions of $50,000, without regard to its 
deduction for state income tax. Of the $50,000 of deductions 
incurred by X, $15,000 relates to X's ownership of M; $10,000 
relates to X's ownership of N; $5,000 relates to X's ownership of O; 
and the entire $30,000 constitutes stewardship expenses. The 
remainder of X's $20,000 of deductions (which is assumed not to 
include state income tax) relates to production of U.S. source 
income from its plant in the United States. M has gross income of 
$250,000 and deductions of $100,000, which yield foreign-source 
general category taxable income of $150,000. N has gross income of 
$150,000 and deductions of $200,000, which yield a foreign-source 
general category loss of $50,000. O has gross income of $50,000 and 
deductions of $20,000, which yield U.S. source taxable income of 
$30,000.
    (B) Unlike Example 17 of this paragraph (g), however, X also has 
a deduction of $1,800 for state A income taxes. X's state A taxable 
income is computed by first making adjustments to the Federal 
taxable income of X to derive apportionable taxable income for state 
A tax purposes. An analysis of state A law indicates that state A 
law also includes in its definition of the taxable business income 
of X which is apportionable to X's state A activities, the taxable 
income of M, N, and O, which is related to X's business. As in 
Example 25 of this paragraph (g), the amount of apportionable 
taxable income attributable to business activities conducted in 
state A is determined by multiplying apportionable taxable income by 
a fraction (the ``state apportionment fraction'') that compares the 
relative amounts of payroll, property, and sales within state A with 
worldwide payroll, property, and sales. Assuming that X's 
apportionable taxable income equals $180,000, $100,000 of which is 
from sources without the United States, and $80,000 is from sources 
within the United States, and that the state apportionment fraction 
is equal to 10 percent, X has state A taxable income of $18,000. The 
state A income tax of $1,800 is then derived by applying the state A 
income tax rate of 10 percent to the $18,000 of state A taxable 
income.
    (ii) Allocation and apportionment. Assume that under Example 29 
of this paragraph (g), it is determined that X's deduction for state 
A income tax is definitely related to a class of gross income 
consisting of income from sources both within and without the United 
States, and that the state A tax is apportioned $1,000 to sources 
without the United States, and $800 to sources within the United 
States. Under Example 17 of this paragraph (g), without regard to 
the deduction for X's state A income tax, X has a separate loss of 
($25,000) from sources without the United States. After taking into 
account the deduction for state A income tax, X's separate loss from 
sources without the United States is increased by the $1,000 state A 
tax apportioned to sources without the United States, and equals a 
loss of ($26,000), for purposes of computing the numerator of the 
consolidated general category foreign tax credit limitation.
0
Par. 17. Section 1.861-8T is amended by revising paragraphs (a)(3), 
(a)(4), (a)(5), (b), (e)(3), (e)(4), (e)(5), (e)(6), (e)(7), (e)(8), 
(e)(9), (e)(10), (e)(11), (f)(1)(i), (f)(1)(iii), (f)(2), (f)(3), 
(f)(4), (f)(5), (g) Examples 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 
13,14, 15, 16, 17, 18, 19, 20, 21, 22, 22, 23, and 30, and (h) to read 
as follows:


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

* * * * *
    (a)(3) through (b) [Reserved]. For further guidance, see Sec.  
1.861-8(a)(3) through (b).
* * * * *
    (e) * * *
    (3) through (f)(1)(i) [Reserved]. For further guidance, see Sec.  
1.861-8(e)(3) through (f)(1)(i).
* * * * *
    (f)(1)(iii) through (g) Examples 1 through 23 [Reserved]. For 
further guidance, see Sec.  1.861-8(f)(1)(iii) through (g) Examples 1 
through 23.
* * * * *
    Example 30. [Reserved]. For further guidance, see Sec.  1.861-8(g) 
Example 30.
    (h) Effective/applicability date. (1) Paragraphs (f)(1)(vi)(E), 
(f)(1)(vi)(F), and (f)(1)(vi)(G) of this section apply to taxable years 
ending after April 9, 2008.
    (2) Paragraph (e)(4), the last sentence of paragraph (f)(4)(i), and 
paragraph (g), Examples 17, 18, and 30 of this section apply to taxable 
years beginning after July 31, 2009.
    (3) Also, see paragraph (e)(12)(iv) of this section and 1.861-
14(e)(6) for rules concerning the allocation and apportionment of 
deductions for charitable contributions.

0
Par. 18. Section 1.861-9T(k) is amended by adding new first and second 
sentences to read as follows:


Sec.  1.861-9T  Allocation and apportionment of interest expense 
(temporary).

* * * * *
    (k) * * * In general, the rules of this section apply for taxable 
years beginning after December 31, 1986. Paragraphs (b)(2) (concerning 
the treatment of certain foreign currency) and (d)(2) (concerning the 
treatment of interest incurred by nonresident aliens) of this section 
are applicable for taxable years commencing after December 31, 1988. * 
* *

[[Page 38875]]


0
Par. 19. Section 1.861-10T is amended by revising the section heading 
and adding new paragraph (f) to read as follows:


Sec.  1.861-10T  Special allocations of interest expense (temporary).

* * * * *
    (f) Effective/applicability date. (1) In general, the rules of this 
section apply for taxable years beginning after December 31, 1986.
    (2) Paragraphs (b)(3)(ii) (providing an operating costs test for 
purposes of the nonrecourse indebtedness exception) and (b)(6) 
(concerning excess collaterization of nonrecourse borrowings) of this 
section are applicable for taxable years commencing after December 31, 
1988.
    (3) Paragraph (e) (concerning the treatment of related controlled 
foreign corporation indebtedness) of this section is applicable for 
taxable years commencing after December 31, 1987. For rules for taxable 
years beginning before January 1, 1987, and for later years to the 
extent permitted by Sec.  1.861-13T, see Sec.  1.861-8 (revised as of 
April 1, 1986).

0
Par. 20. Section 1.861-11T is amended by revising the section heading 
and adding new paragraph (h) to read as follows:


Sec.  1.861-11T  Special rules for allocating and apportioning interest 
expense of an affiliated group of corporations (temporary).

* * * * *
    (h) Effective/applicability date. The rules of this section apply 
for taxable years beginning after December 31, 1986.

0
Par. 21. Section 1.861-12T is amended by revising the section heading 
and adding new paragraph (k) to read as follows:


Sec.  1.861-12T  Characterization rules and adjustments for certain 
assets (temporary).

* * * * *
    (k) Effective/applicability date. The rules of this section apply 
for taxable years beginning after December 31, 1986.

0
Par. 22. Section 1.861-14T is amended by adding new paragraph (k) to 
read as follows:


Sec.  1.861-14T  Special rules for allocating and apportioning certain 
expenses (other than interest expense) of an affiliated group of 
corporations (temporary).

* * * * *
    (k) Effective/applicability date. The rules of this section apply 
for taxable years beginning after December 31, 1986.


Sec.  1.6038A-1  [Amended]

0
Par. 23. Section 1.6038A-1 is amended by removing paragraph (n)(3) and 
redesignating paragraphs (n)(4), (n)(5), (n)(6) and (n)(7) as 
paragraphs (n)(3), (n)(4), (n)(5) and (n)(6), respectively.

0
Par. 24. Section 1.6038A-3 is amended by revising paragraphs (a)(3) 
Example 4, and (i) to read as follows:


Sec.  1.6038A-3  Record maintenance.

    (a) * * *
    (3) * * *

    Example 4. S, a U.S. reporting corporation, provides computer 
consulting services for its foreign parent, X. Based on the 
application of section 482 and the regulations, it is determined 
that the cost of services plus method, as described in Sec.  1.482-
9(e), will provide the most reliable measure of an arm's length 
result, based on the facts and circumstances of the controlled 
transaction between S and X. S is required to maintain records to 
permit verification upon audit of the comparable transactional costs 
(as described in Sec.  1.482-9(e)(2)(iii)) used to calculate the 
arm's length price. Based on the facts and circumstances, if it is 
determined that X's records are relevant to determine the correct 
U.S. tax treatment of the controlled transaction between S and X, 
the record maintenance requirements under section 6038A(a) and this 
section will be applicable to the records of X.
* * * * *
    (i) Effective/applicability date--(1) In general. This section is 
generally applicable on December 10, 1990. However, records described 
in this section in existence on or after March 20, 1990, must be 
maintained, without regard to when the taxable year to which the 
records relate began. Paragraph (a)(3) Example 4 of this section is 
generally applicable for taxable years beginning after July 31, 2009.
    (2) Election to apply regulation to earlier taxable years. A person 
may elect to apply the provisions of paragraph (a)(3) Example 4 of this 
section to earlier taxable years in accordance with the rules set forth 
in Sec.  1.482-9(n)(2).


Sec.  1.6038A-3T  [Removed]

0
Par. 25. Section 1.6038A-3T is removed.

0
Par. 26. Section 1.6662-6 is amended by revising paragraphs 
(d)(2)(ii)(B), (d)(2)(iii)(B)(4), (d)(2)(iii)(B)(6), and (g) to read as 
follows:


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

* * * * *
    (d) * * *
    (2) * * *
    (ii) * * *
    (B) Services cost method. A taxpayer's selection of the services 
cost method for certain services, described in Sec.  1.482-9(b), and 
its application of that method to a controlled services transaction 
will be considered reasonable for purposes of the specified method 
requirement only if the taxpayer reasonably allocated and apportioned 
costs in accordance with Sec.  1.482-9(k), and reasonably concluded 
that the controlled services transaction satisfies the requirements 
described in Sec.  1.482-9(b)(2). Whether the taxpayer's conclusion was 
reasonable must be determined from all the facts and circumstances. The 
factors relevant to this determination include those described in 
paragraph (d)(2)(ii)(A) of this section, to the extent applicable.
* * * * *
    (iii) * * *
    (B) * * *
    (4) A description of the method selected and an explanation of why 
that method was selected, including an evaluation of whether the 
regulatory conditions and requirements for application of that method, 
if any, were met;
* * * * *
    (6) A description of the controlled transactions (including the 
terms of sale) and any internal data used to analyze those 
transactions. For example, if a profit split method is applied, the 
documentation must include a schedule providing the total income, 
costs, and assets (with adjustments for different accounting practices 
and currencies) for each controlled taxpayer participating in the 
relevant business activity and detailing the allocations of such items 
to that activity. Similarly, if a cost-based method (such as the cost 
plus method, the services cost method for certain services, or a 
comparable profits method with a cost-based profit level indicator) is 
applied, the documentation must include a description of the manner in 
which relevant costs are determined and are allocated and apportioned 
to the relevant controlled transaction.
* * * * *
    (g) Effective/applicability date--(1) In general. This section is 
generally applicable on February 9, 1996. However, taxpayers may elect 
to apply this section to all open taxable years beginning after 
December 31, 1993.
    (2) Special rules. The provisions of paragraphs (d)(2)(ii)(B), 
(d)(2)(iii)(B)(4) and (d)(2)(iii)(B)(6) of this section are applicable 
for taxable years beginning after July 31, 2009. However, taxpayers may 
elect to apply the provisions of paragraphs (d)(2)(ii)(B), 
(d)(2)(iii)(B)(4) and (d)(2)(iii)(B)(6) of this section to

[[Page 38876]]

earlier taxable years in accordance with the rules set forth in Sec.  
1.482-9(n)(2).


Sec.  1.6662-6T  [Removed]

0
Par. 27. Section 1.6662-6T is removed.

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

0
Par. 28. The authority citation for part 31 continues to read in part 
as follows:

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

0
Par. 29. Section 31.3121(s)-1 is amended by revising paragraphs 
(c)(2)(iii) and (d) to read as follows:

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

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


Sec.  31.3121(s)-1T  [Removed]

0
Par. 30. Section 31.3121(s)-1T is removed.

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

0
Par. 31. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.
0
Par. 32. In Sec.  602.101, paragraph (b) is amended by adding an entry 
for ``Sec.  1.482-9(b)'' to the table to read follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described        control
                                                                number
------------------------------------------------------------------------
 
                                * * * * *
1.482-9(b).................................................    1545-2149
 
                                * * * * *
------------------------------------------------------------------------


    Approved: July 25, 2009.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
Michael Mundaca,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E9-18326 Filed 7-31-09; 8:45 am]
BILLING CODE 4830-01-P