Tax News

CCH (cch.taxgroup.com) reports:

  The IRS has released temporary and proposed regulations that provide guidance and clarification regarding methods under Code Sec. 482 to determine taxable income in connection with a cost sharing arrangement (CSA). The temporary regulations potentially affect controlled taxpayers, within the meaning of Code Sec. 482, that enter into CSAs.

  On August 29, 2005, 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 CSA were published in the Federal Register; a correction to such notices was filed on September 28, 2005. Substantial comments were received.

Background

 
Code Sec. 482 authorizes the IRS to allocate income, deductions and other tax items among related taxpayers in order to prevent the evasion of tax or to more clearly reflect income. Code Sec. 482 permits reallocation in any common control situation, including between two U.S. entities, but is largely employed in the international tax area, where there is incentive for multinational operations to use transfer pricing to take advantage of different tax systems and effective tax rates. In general, transfer pricing reallocates items of income and deductions among entities under common control to minimize the U.S. tax of foreign affiliates by permitting the IRS to challenge transfer prices pursuant to its broad authority to allocate gross income, deductions, credits or allowances between controlled taxpayers under Code Sec. 482.

  Proposed regulations under Code Sec. 482 issued in 2005 continued the arm's-length standard as the fundamental principle behind
Code Sec. 482 and the basis for transfer pricing adjustments. Under this standard, a controlled transaction meets the arm's-length standard if the results of the transaction are consistent with results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.

  Under a CSA, related parties agree to share the costs and risks of intangible development in proportion to their reasonable expectations of the extent to which they will benefit from their separate exploitation of the developed intangibles. The proposed regulations issued in 2005 provided rules governing CSAs consistent with the commensurate with income standard under the statute and the general arm's-length standard under the regulations.

Temporary Regulations

  In response to public comments received following the issuance of the 2005 proposed regulations, the temporary regulations make several significant changes to the proposed regulations. The temporary regulations generally provide guidance regarding the application of Code Sec. 482 and the arm's length method to CSAs, and provide further guidance on the evaluation of the arm's length results of cost sharing transactions (CSTs) and platform contribution transactions (PCTs). The regulations address the material functional and risk allocations in the context of a CSA, including the reasonably anticipated duration of the commitments, the intended scope of the intangible development, the degree and uncertainty of profit potential of the intangibles to be developed and the extent of platform and other contributions of resources, capabilities and rights to the development and exploitation of cost shared intangibles.

  The temporary regulations provide taxpayers with greater flexibility in designing certain aspects of CSAs and address the treatment of non-conforming intangible development arrangements. For example, the 2005 proposed regulations required the controlled participants in a CSA to receive non-overlapping territorial interests that entitled each controlled participant to the perpetual and exclusive right to the profits in its territory attributable cost shared intangibles. To provide taxpayers with more flexibility in designing qualifying divisional interests, the temporary regulations permit use of a new basis --the field of use division of interests --in addition to the territorial basis The temporary regulations also clarify the circumstances under which the IRS may treat an arrangement as a CSA even though there is a technical failure to meet the substantive requirements of a CSA. However, to prevent abuse and facilitate compliance, the temporary regulations address changes in participation which require arm's length consideration.

  The 2005 proposed regulations described external contributions for which compensation was due from other controlled participants, that is, preliminary or contemporaneous transactions; an "external contribution "generally consisted of the rights in the reference transaction (RT) in any resource or capability reasonably anticipated to contribute to developing cost shared intangibles. The temporary regulations replace the term "external contribution "with the term "platform contribution", replace the term "preliminary or contemporaneous transaction" with the term "platform contribution transaction", and do not employ the RT concept.

  The temporary regulation also clarify the "general principles" articulated in the 2005 proposed regulations applicable to any method to determine the arm's length charge in a PCT, clarifying that the principles are intended to provide supplementary guidance on the application of the best method rule to determine which method, or application of a method, provides the most reliable measure of an arm's length result in a CSA context. In that regard, the temporary regulations address the investor model that was a core principal of the 2005 proposed regulations and provide guidance on aggregation of transactions, discount rates, projections, and arm's length range. Additionally, the relevant considerations for purposes of evaluating whether a putative comparable controlled transaction reflects the most reliable measure of an arm's-length result are described, and the income method, acquisition price and market capitalization methods, residual profit split method and unspecified methods used for purposes of evaluating the arm's length charge in a PCT are addressed.

  The temporary regulations liberalize the form of payment (fixed or contingent) for post formation acquisitions; allowing controlled participants to chose the form of payment for PCTs regardless of whether the PCTs occur at the outset of the CSA or later, and also clarify the rules for contingent payments. Finally, the temporary regulations address the determination of periodic adjustments which implement the commensurate with income principle in the context of cost sharing and the administrative and transition rules as originally adopted in the 2005 proposed regulations for existing CSAs. The IRS and Treasury Department intend to issue a revenue procedure which will provide an exception to periodic adjustments in the context of an advanced pricing agreement entered into pursuant to Rev. Proc. 2006-9, 2006-1 C.B. 278.

  The text of the temporary regulations also serves as the text of the proposed regulations The temporary regulations are generally effective for CSAs commencing on or after January 5, 2009. There are transition rules for certain pre-exiting arrangements.

Hearing and Comments

  A public hearing on the proposed regulations is scheduled for April 21, 2009. Written or electronic comments must be received by the IRS by April 6, 2009. Outlines of topics to be discussed at the public hearing must be received by April 6, 2009.

T.D. 9441, 2009FED ¶47,011

Proposed Regulations, NPRM REG-144615-02, 2009FED ¶49,412

Other References:

 
Code Sec. 367

  CCH Reference - 2009FED ¶16,640A

  CCH Reference - 2009FED ¶16,640B

  CCH Reference - 2009FED ¶16,641

 
Code Sec. 482

  CCH Reference - 2009FED ¶22,282B

  CCH Reference - 2009FED ¶22,282CK

  CCH Reference - 2009FED ¶22,282D

  CCH Reference - 2009FED ¶22,282EK

  CCH Reference - 2009FED ¶22,282GA

  CCH Reference - 2009FED ¶22,282GE

  CCH Reference - 2009FED ¶22,282JG

  CCH Reference - 2009FED ¶22,282JK

  CCH Reference - 2009FED ¶22,282L

  CCH Reference - 2009FED ¶22,282Q

  CCH Reference - 2009FED ¶22,282QD

  CCH Reference - 2009FED ¶22,282R

  CCH Reference - 2009FED ¶22,282SG

  CCH Reference - 2009FED ¶22,282SH

  CCH Reference - 2009FED ¶22,282U

 
Code Sec. 861

  CCH Reference - 2009FED ¶27,149

 
Code Sec. 6662

  CCH Reference - 2009FED ¶39,653C

 
Code Sec. 7701

  CCH Reference - 2009FED ¶43,081

  Tax Research Consultant

  CCH Reference - TRC INTL: 15,152
CCH Reference - TRC INTL: 15,152.05
CCH Reference - TRC INTL: 15,152.10
CCH Reference - TRC INTL: 15,152.15
CCH Reference - TRC INTL: 15,152.20
CCH Reference - TRC INTL: 15,152.25