[Federal Register Volume 76, Number 247 (Friday, December 23, 2011)]
[Proposed Rules]
[Pages 80309-80310]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-32730]



[[Page 80309]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-145474-11]
RIN 1545-BK71


Use of Differential Income Stream as an Application of the Income 
Method and as a Consideration in Assessing the Best Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to temporary 
regulations and notice of proposed rulemaking.

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SUMMARY: In the Rules and Regulations section of this issue of the 
Federal Register, temporary regulations provide guidance on how an 
analysis of the differential income stream may provide a best method 
consideration for evaluating an application of the income method to 
determine taxable income in connection with a cost sharing arrangement. 
The text of those regulations also serves as the text of regulations 
that are proposed by cross-reference to the temporary regulations. This 
document also contains proposed regulations providing guidance on the 
use of the differential income stream as a specified application of the 
income method to determine taxable income in connection with a cost 
sharing arrangement.

DATES: Written or electronic comments and requests for a public hearing 
must be received by March 22, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-145474-11), Room 
5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
145474-11), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at www.regulations.gov (IRS REG-145474-11).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Joseph L. Tobin or Mumal R. Hemrajani, (202) 435-5265 (not a toll-free 
number); concerning submission of comments and/or requests for a 
hearing, [email protected].

SUPPLEMENTARY INFORMATION: 

Background

    A notice of proposed rulemaking and notice of public hearing 
regarding additional guidance to improve compliance with, and 
administration of, the rules in connection with a cost sharing 
arrangement (CSA) were published in the Federal Register (70 FR 51116) 
(REG-144615-02) on August 29, 2005 (2005 proposed regulations). A 
correction to the notice of proposed rulemaking and notice of public 
hearing was published in the Federal Register (70 FR 56611) on 
September 28, 2005. A public hearing was held on December 16, 2005.
    The Treasury Department and the IRS received numerous comments on a 
wide range of issues addressed in the 2005 proposed regulations. In 
response to these comments, temporary and proposed regulations were 
published in the Federal Register (74 FR 340-01 and 74 FR 236-01) (REG-
144615-02) on January 5, 2009 (2008 temporary regulations). Corrections 
to the 2008 temporary regulations were published in the Federal 
Register on February 27, 2009 (74 FR 8863-01), March 5, 2009 (74 FR 
9570-01, 74 FR 9570-02, and 74 FR 9577-01), and March 19, 2009 (74 FR 
11644-01). A public hearing was held on April 21, 2009.
    The Treasury Department and the IRS received comments on a range of 
issues addressed in the 2008 temporary regulations. Final regulations 
were issued in a previous issue of the Federal Register (REG-144615-02) 
(TD 9568) in December 2011 (final regulations). Certain guidance 
regarding discount rates was reserved in the final regulations because 
the Treasury Department and the IRS believe it is appropriate to 
solicit public comments on that subject matter.
    Temporary regulations (TD 9569) in the Rules and Regulations 
section of this issue of the Federal Register contain amendments to the 
final regulations and implement the use of the differential income 
stream as a consideration in assessing the best method in connection 
with a CSA. The text of those regulations also serves as the text of 
the regulations contained in this document that are proposed by cross-
reference to the temporary regulations (Sec.  1.482-7T(g)(2)(v)(B)(2) 
and (4)(vi)(F)(2)). This document also contains a proposed amendment to 
the regulations under section 482 that describes the specific 
application of the income method using the differential income stream 
(Sec.  1.482-7(g)(4)(v)).

Explanation of Provisions

    See the Explanation of Provisions for the temporary cost sharing 
regulations published in this issue of the Federal Register for an 
explanation of how proposed Sec.  1.482-7(g)(2)(v)(B)(2) and 
(4)(vi)(F)(2) build upon and augment Sec.  1.482-7(g)(4)(vi)(F)(1) 
(Reflection of similar risk profiles in cost sharing alternative and 
licensing alternative) of the final regulations.
    These proposed regulations also build upon and augment Sec.  1.482-
7(g)(4)(vi)(F)(1) of the final regulations by providing a new specified 
application of the income method. Section 1.482-7(g)(4)(v) of the 
proposed regulations provides that the determination of the arm's 
length charge for the PCT Payment can be derived by discounting the 
differential income stream at an appropriate rate. The differential 
income stream approach to determining PCT Payments depends on reliably 
determining the discount rate associated with the differential income 
stream. This, in turn, requires an understanding of the economic 
meaning of the differential income stream. For example, assume a CSA in 
which the PCT Payor does not contribute any platform or operating 
contributions, and undertakes only routine exploitation activities for 
which it anticipates a routine return. In such case, the total 
undiscounted anticipated profits (before PCT Payments) to the CSA in 
the PCT Payor's territory can be thought of as comprising the 
anticipated routine exploitation profits plus the anticipated 
development value of the cost shared intangibles in the PCT Payor's 
territory. Under the licensing alternative, on the other hand, the PCT 
Payor's total undiscounted anticipated profits consist solely of the 
anticipated routine exploitation profits. Thus, the differential income 
stream conceptually corresponds to the development value of the cost 
shared intangibles. For these reasons, an appropriate discount rate for 
the differential income stream might be determined based, for example, 
on the weighted average cost of capital of uncontrolled companies whose 
activities consist primarily of developing intangibles similar to the 
cost shared intangibles, and whose resources, capabilities, or rights 
are similar to the platform contributions and cost shared intangibles 
under the CSA. These proposed regulations also add Sec.  1.482-
7(g)(4)(viii) Example 9 to illustrate this newly specified application 
of the income method.

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Proposed Effective Dates

    Prop. Treas. Reg. Sec.  1.482-7(g)(2)(v)(B)(2), (4)(vi)(F)(2) and 
(viii), Example 8 are proposed to be applied to taxable years beginning 
on or after December 19, 2011.
    Prop. Treas. Reg. Sec.  1.482-7(g)(4)(v) and (viii), Example 9 are 
proposed to apply to taxable years beginning on or after the date of 
publication of a Treasury decision adopting such rules as final 
regulations in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to this regulation, and because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration (CCASBA) for comment on their impact 
on small businesses. CCASBA had no comments.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. Treasury and the IRS request comments on all aspects of the 
proposed rules. All comments will be available for public inspection 
and copying. A public hearing will be scheduled if requested in writing 
by any person that timely submits written comments. If a public hearing 
is scheduled, notice of the date, time, and place for the public 
hearing will be published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Joseph L. 
Tobin and Mumal R. Hemrajani, Office of the Associate Chief Counsel 
(International). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

    Par. 2. Section 1.482-7 is amended by adding paragraphs 
(g)(2)(v)(B)(2), (g)(4)(v), and (g)(4)(vi)(F)(2), and Examples 8 and 9 
to paragraph (g)(4)(viii).
    The additions read as follows:


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

* * * * *
    (g) * * *
    (2) * * *
    (v) * * *
    (B) * * *
    (2) [The text of the proposed amendment to Sec.  1.482-
7(g)(2)(v)(B)(2) is the same as the text of Sec.  1.482-
7T(g)(2)(v)(B)(2) published elsewhere in this issue of the Federal 
Register].
* * * * *
    (4) * * *
    (v) Application of income method using differential income stream. 
In some cases, the present value of an arm's length PCT Payment may be 
determined as the present value, discounted at the appropriate rate, of 
the PCT Payor's reasonably anticipated stream of additional positive or 
negative income over the duration of the CSA Activity that would result 
(before PCT Payments) from undertaking the cost sharing alternative 
rather than the licensing alternative (differential income stream). See 
Example 9 of paragraph (g)(4)(viii) of this section.
* * * * *
    (vi) * * *
    (F) * * *
    (2) [The text of the proposed amendment to Sec.  1.482-
7(g)(4)(vi)(F)(2) is the same as the text of Sec.  1.482-
7T(g)(4)(vi)(F)(2) published elsewhere in this issue of the Federal 
Register.]
* * * * *
    (viii) * * *

    Example 8. [The text of the proposed amendment to Sec.  1.482-
7(g)(4)(viii) (Example 8) is the same as the text of Sec.  1.482-
7T(g)(4)(viii) (Example 8) published elsewhere in this issue of the 
Federal Register.]

    Example 9. The facts are the same as in Example 1, except that 
additional data on discount rates are available that were not 
available in Example 1. The Commissioner determines the arm's length 
charge for the PCT Payment by discounting at an appropriate rate the 
differential income stream associated with the rights contributed by 
USP in the PCT (that is, the stream of income in column (11) of 
Example 1). Based on an analysis of a set of public companies whose 
resources, capabilities, and rights consist primarily of resources, 
capabilities, and rights similar to those contributed by USP in the 
PCT, the Commissioner determines that 15% to 17% is an appropriate 
range of discount rates to use to assess the value of the 
differential income stream associated with the rights contributed by 
USP in the PCT. The Commissioner determines that applying a discount 
rate of 17% to the differential income stream associated with the 
rights contributed by USP in the PCT yields a present value of $446 
million, while applying a discount rate of 15% to the differential 
income stream associated with the rights contributed by USP in the 
PCT yields a present value of $510 million. Because the taxpayer's 
result, $464 million, is within the interquartile range determined 
by the Commissioner, no adjustments are warranted. See paragraphs 
(g)(2)(v)(B)(2), (g)(4)(v), and (g)(4)(vi)(F)(1) of this section.
* * * * *
    (l) Effective/Applicability Dates. Treas. Reg. Sec.  1.482-
7(g)(2)(v)(B)(2), (g)(4)(vi)(F)(2) and (g)(4)(viii), Example 8 apply to 
taxable years beginning on or after December 19, 2011. Treas. Reg. 
Sec.  1.482-7(g)(4)(v) and (viii), Example 9 apply to taxable years 
beginning on or after the date of publication of a Treasury decision 
adopting these rules as final regulations in the Federal Register.
* * * * *

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-32730 Filed 12-19-11; 11:15 am]
BILLING CODE 4830-01-P