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are confidential, as required by section
6103 of the Code.

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Background

26 CFR Parts 1, 301, and 602
[TD 9568]
RIN 1545–BI47

Section 482: Methods To Determine
Taxable Income in Connection With a
Cost Sharing Arrangement
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations and removal of
temporary regulations.
AGENCY:

This document contains final
regulations regarding methods to
determine taxable income in connection
with a cost sharing arrangement under
section 482 of the Internal Revenue
Code (Code). The final regulations
address issues that have arisen in
administering the current cost sharing
regulations. The final regulations affect
domestic and foreign entities that enter
into cost sharing arrangements
described in the final regulations.
DATES: Effective Date: These regulations
are effective on December 16, 2011.
Applicability Date: For dates of
applicability, see §§ 1.482–1(j)(6)(i),
1.482–2(f), 1.482–4(h), 1.482–7(l),
1.482–8(c), 1.482–9(n)(3), and 1.301–
7701–1(f).
FOR FURTHER INFORMATION CONTACT:
Joseph L. Tobin, (202) 435–5265 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
SUMMARY:

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Paperwork Reduction Act
The collection of information
contained in these final regulations has
been reviewed 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 1545–1364. The collections of
information in these final regulations
are in § 1.482–7(b)(2) and (k). Responses
to the collections of information are
required by the IRS to monitor
compliance of controlled taxpayers with
the provisions applicable to cost sharing
arrangements.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control
number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information

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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. These final regulations
make several changes to the 2008
temporary regulations in response to
these comments. In addition, a number
of editorial clarifications have been
made. These regulations adopt the
effective date and transition rules under
the 2008 temporary regulations so that
they are generally applicable for all
CSAs, with transition rules for certain
preexisting arrangements in existence
prior to January 5, 2009.
Explanation of Provisions
A. Overview—Economic Contributions
and Their Arm’s Length Compensation
in a CSA
These final regulations provide
guidance on the determination of and
compensation for all economic
contributions by all controlled
participants in connection with a CSA
in accordance with the arm’s length
standard.
The arm’s length analysis under
section 482 begins with the factual and
functional analysis of the actual
transaction or transactions among the
controlled taxpayers. In a CSA, the

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controlled participants make economic
contributions of two types, namely,
mutual commitments to prospectively
share intangible development costs in
proportion to their reasonably
anticipated benefits from exploitation of
the cost shared intangibles (cost
contributions) and to provide any
existing resources, capabilities, or rights
that are reasonably anticipated to
contribute to developing cost shared
intangibles (platform contributions).
CSAs may also involve economic
contributions by the controlled
participants of other existing resources,
capabilities, or rights related to the
exploitation of cost shared intangibles
(operating contributions). The concepts
of platform and operating contributions
are intended to encompass any existing
inputs that are reasonably anticipated to
facilitate developing or exploiting cost
shared intangibles at any time,
including resources, capabilities, or
rights, such as expertise in decisionmaking concerning research and
product development, manufacturing or
marketing intangibles or services, and
management oversight and direction.
Other prospective economic
contributions consist of costs incurred
to develop or acquire resources,
capabilities, and rights that facilitate the
exploitation of cost shared intangibles
(operating cost contributions). These
regulations provide guidance for
determining the arm’s length charge for
all such contributions to clearly reflect
the incomes of the controlled
participants.
The valuation guidance in the
regulations applies to determine the
most reliable measure of arm’s length
results for these economic contributions
over the duration of the activity of
developing and exploiting cost shared
intangibles (CSA Activity). The
combined effect of multiple
contributions, potentially including
controlled transactions outside of the
CSA (for example, make-or-sell licenses,
or intangible transfers governed by
section 367(d)), may need to be
evaluated on an aggregate basis, where
that approach provides the most reliable
measure of an arm’s length result. So,
for example, if a taxpayer transfers
intangibles in a transaction governed by
section 367(d) in connection with
contributions related to those same
intangibles in connection with a CSA,
then the pricing of the intangibles under
section 367(d) may need to be evaluated
along with the pricing of all
contributions in connection with the
CSA on an aggregate basis, where that
approach provides the most reliable
measure of an arm’s length result. Under

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the principles of the investor model, the
relative reliability of the analysis will
depend on the degree of consistency of
the valuation with the expectation that
each controlled participant’s net
investment attributable to cost
contributions, platform contributions,
operating contributions, and operating
cost contributions, is reasonably
anticipated to earn a rate of return
(which might be reflected in a discount
rate used in applying a method)
appropriate to the riskiness of the
controlled participant’s CSA Activity
over the entire period of the CSA
Activity. The duration of the CSA
Activity may, or may not, correspond to
the conventional concept of useful life
with respect to any of the underlying
economic contributions; it represents
the period over which the controlled
participants reasonably anticipate
returns from the CSA Activity.
For purposes of determining the best
method of measuring the arm’s length
results of a CSA, and any related
controlled transactions, these
regulations adopt the guidance included
in the 2008 temporary regulations on
assessing the potential applicability of
the comparable uncontrolled transaction
(CUT) method. The arm’s length
standard seeks to determine the results
that would obtain had uncontrolled
taxpayers engaged in the same
transaction under the same
circumstances. It is immaterial whether
the arrangement among uncontrolled
taxpayers is denominated as a ‘‘cost
sharing arrangement,’’ so long as the
arrangement involves the same
circumstances (or similar
circumstances, assuming that reliable
adjustments can be made to account for
any differences). Thus, long-term
licenses or research and development
services contracts may provide CUTs,
provided and to the extent they involve
the same or similar scope and
contractual terms, uncertainty of
outcomes, profit potential, allocation of
intangible development and
exploitation risks, including allocation
of the risks of existing contributions and
the risks of developing future
contributions, consistent with the actual
allocation of risks under the CSA and
through related controlled transactions.
A CSA may benefit from, and
contribute to, a controlled group’s
unique competitive advantages.
Therefore, there may be no uncontrolled
transactions that reliably reflect the
same contributions by the parties, over
a similar period of commitment, and
with the same risk profile and profit
potential. The arm’s length standard
requires application of the method that
most reliably reflects the results that

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would have been realized had
uncontrolled taxpayers engaged in the
same transaction. Where comparable
uncontrolled transactions are
unavailable, these regulations, like other
regulations under section 482, allow for
reference to the results the controlled
taxpayers could have realized by
choosing a realistic alternative. These
regulations adopt a specified income
method included in the 2008 temporary
regulations that represents an
application of the realistic alternatives
principle. These regulations adopt the
2008 temporary regulations’ provision
of a licensing alternative to the CSA that
closely aligns with the economics of the
CSA, but takes account of the licensor’s
commitment to bear the entire risk of
the intangible development that would
otherwise have been shared. The
realistic alternatives analysis effectively
constructs a comparable uncontrolled
transaction that, depending on the facts
and circumstances, may more reliably
reflect the economics of the actual
contributions to the CSA than can be
derived from third party transactions.
For cases where more than one
controlled participant makes significant
contributions to residual profits
(including platform or operating
contributions), these regulations adopt
the guidance included in the 2008
temporary regulations on a specified
residual profit split method (RPSM),
which is also an application of the
realistic alternatives principle.
These regulations also adopt guidance
on the application of two other specified
methods included in the 2008
temporary regulations—the acquisition
price method and the market
capitalization method. The guidance
regarding unspecified methods adopted
from the 2008 temporary regulations
reemphasizes that any such 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, and enter into a
particular transaction only if none of the
alternatives is clearly preferable to it.
These regulations resolve issues that
have been raised under the 1995
regulations. No inference is intended
regarding the appropriate resolution of
those issues under the 1995 regulations.
These regulations do not turn on
whether a given transaction in
connection with a CSA involves
intangible property within the meaning
of section 936(h)(3)(B), or whether such
item has been transferred, licensed, or
retained. Rather, if a controlled
participant devotes, in whole or part,
any existing resource, capability, or
right to intangible development for the

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benefit of another controlled
participant, whether by transfer or
license to the other controlled
participant, or by leveraging such
resource, capability, or right within the
context of the CSA, then the regulations
require an arm’s length charge for such
platform contribution, in addition to the
funding of intangible development
costs.
For example, the regulations require
an arm’s length charge for one
controlled participant’s platform
contribution commitment of a particular
research team’s experience and
expertise to intangible development
under a CSA, in addition to the
controlled participants’ sharing of the
ongoing intangible development costs of
the salaries of such researchers. To limit
the arm’s length charge in these
circumstances to sharing the ongoing
salary costs would ignore the value of
having the particular research team
already in place to undertake the
intangible development with the benefit
of its particular knowhow. See § 1.482–
7(c)(5), Example 2. As another example,
the contribution of core entrepreneurial
functions such as product selection,
market positioning, research strategy,
and risk determinations and
management requires an arm’s length
charge under these regulations. To omit
charges for these or any other significant
economic contributions one controlled
taxpayer makes for another’s benefit
would fail to clearly reflect the incomes
of such controlled taxpayers.
A unifying underpinning of the
section 482 regulations is that
controlled transactions reflecting similar
economics, regardless of the type of
transaction (such as transfer of
intangibles or provision of services),
should be valued in accordance with
similar principles and methods. See, for
example, § 1.482–1(b)(2)(iii). In
conjunction with finalizing § 1.482–7,
parallel rules are also finalized in
§§ 1.482–4(g) and 1.482–9(m)(3). Under
these provisions, the principles and
methods for valuing platform and
operating contributions under a CSA
may also apply for purposes of
determining the best method, which
may be an unspecified method, for
valuing similar contributions in
connection with controlled transfers of
intangibles or provisions of services.
B. Platform Contributions, Make-or-Sell
Rights Excluded—§ 1.482–7(c)(4)
A comment requested clarification of
the treatment of an item—e.g., a
program or tool to facilitate research
(research tools)—used under a CSA to
further the development of intangibles
targeted by the CSA, as within, or

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outside, the definition of make-or-sell
rights. The Treasury Department and the
IRS intend research tools to be treated
as platform contributions, and not as
excluded make-or-sell rights.
Accordingly, § 1.482–7(c)(4)(i) has been
modified and a new example added to
illustrate this concept.
C. Intangible Development Activity and
Costs—§ 1.482–7(d)(3)
The Treasury Department and the IRS
requested comments in Notice 2005–99,
2005–52 CB 1214, regarding the
valuation of stock options and other
stock-based compensation. Several
comments were received. The Treasury
Department and the IRS continue to
consider the matters described in Notice
2005–99, and intend to address these
issues in a subsequent regulations
project.

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D. Reasonably Anticipated Benefit
Shares—§ 1.482–7(e)(1)(i)
Several comments requested
clarification concerning how and when
to update reasonably anticipated benefit
(RAB) shares, and whether such updates
may be made retroactively or only
prospectively. In response to these
comments, the Treasury Department
and the IRS added several sentences to
§ 1.482–7(e)(1)(i) to clarify that RAB
shares determined for a particular
purpose should not be further updated
for that purpose based on information
not available at the time that
determination needed to be made. For
example, RAB shares determined in
order to determine intangible
development cost shares for a particular
taxable year should not be recomputed
based on information not available
during that particular taxable year, and
RAB shares determined for the purpose
of using a particular transfer pricing
method to evaluate the arm’s length
amount charged in a PCT should not be
recomputed based on information not
available on the date of that PCT. An
example is added to illustrate this
clarification. See § 1.482–7(e)(1)(iii),
Example 2. For readability, a portion of
the text of § 1.482–7T(e)(1)(i) was
redesignated as § 1.482–7(e)(1)(ii), and
§ 1.482–7T(e)(1)(ii) was redesignated as
§ 1.482–7(e)(1)(iii). The Treasury
Department and the IRS also observe in
these clarifications that nothing in
§ 1.482–7(e)(1) limits the
Commissioner’s use of subsequently
available information for purposes of its
allocation determinations in accordance
with the provisions of § 1.482–7(i)
(Allocations by the Commissioner in
connection with a CSA).

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E. Transfer Pricing Methods—§ 1.482–
7(g)
1. Supplemental Guidance on Methods
Applicable to PCTs—§ 1.482–7(g)(1)
One method for determining the arm’s
length charge for a contribution is to
calculate the total present value of the
stream of future economic benefits one
can expect in connection with such
contribution. In a CSA, the stream of
anticipated economic benefits to be
discounted will reflect the economic
benefits expected to arise from cost
shared intangibles to be developed
under the CSA. Consequently, the arm’s
length charge for a PCT can
appropriately be determined by taking
into account the economic benefits
anticipated to be produced in the future
by cost shared intangibles developed
under the CSA. Accordingly, a sentence
has been added to paragraph (g)(1) to
clarify that each method used for
evaluating the arm’s length amount
charged in a PCT must yield results
consistent with measuring the value of
a platform contribution by reference to
the future income anticipated to be
generated by the resulting cost shared
intangibles.
2. Best Method Analysis Considerations
and the Income Method—§ 1.482–7(g)(2)
and (4)
a. Discounting Operating Income—
§ 1.482–7(g)(2)(v)
The preamble to the 2008 temporary
regulations solicited comments on
whether and how the cost sharing rules
could reliably be administered on the
basis of cash flows instead of operating
income, and whether such a basis is
consistent with the second sentence of
section 482. No comments were
received that addressed this request,
though some comments did object to the
use of operating income, rather than
cash flows, in the cost sharing rules.
The Treasury Department and the IRS
believe that, while the use of cash flow
projections is permitted under the
regulations, detailed guidance on the
specific applications of the methods
should be based on discounting
operating income rather than cash flows
for a number of practical and
administrative reasons and, accordingly,
no changes were adopted to address this
issue.
b. Financial Projections and Discount
Rates—§ 1.482–7(g)(2)(v) and (vi)
Under the temporary regulations, the
specific applications of the income
method discussed in § 1.482–7(g)(4)
require a number of input parameters,
including financial projections and the
associated discount rate under the

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licensing alternative, and financial
projections and the associated discount
rate under the cost sharing alternative.
These regulations modify the 2008
temporary regulations in several
respects to clarify the interaction of
these input parameters in applying the
income method.
i. Financial Projections for the Licensing
and Cost Sharing Alternatives Are
Interrelated
These regulations provide that, under
the specific applications of the income
method, the financial projections
associated with the licensing and cost
sharing alternatives are the same except
for the licensing payments to be made
under the licensing alternative, and the
cost contributions and PCT Payments to
be made under the cost sharing
alternative. Thus, for example, if the
PCT Payor anticipates sales associated
with the cost shared intangibles to third
parties of $100 in the cost sharing
alternative, then it must anticipate sales
associated with the licensed intangible
to third parties of this same $100 under
the licensing alternative. Similarly, if
the PCT Payor’s anticipated selling costs
associated with those sales are $60 in
the cost sharing alternative, then its
anticipated selling costs are the same
$60 in the licensing alternative. The
financial projections associated with the
licensing alternative to the CSA are
closely associated with the financial
projections associated with the cost
sharing alternative, differing only in the
treatment of licensing payments, cost
contributions, and PCT Payments. As a
result, the income method, as in the
case of the more traditional discounted
cash flow methods, builds off of the
(single) probability-weighted financial
projections associated with the CSA
Activity.
ii. Discount Rates for the Licensing and
Cost Sharing Alternatives Are
Interrelated
The Treasury Department and the IRS
received several comments requesting
further guidance on the relationship
between the discount rate that is
appropriate for discounting the
operating income associated with the
cost sharing alternative and the discount
rate that is appropriate for discounting
the operating income associated with
the licensing alternative. In response to
these comments, and as a corollary to
the interrelationship of the financial
projections for the licensing and cost
sharing alternatives discussed in the
preceding paragraph, these regulations
provide further guidance on the
discount rates appropriate for these two
alternatives. Specifically, the difference,

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if any, in market-correlated risks
between the licensing and cost sharing
alternatives is due solely to the different
effects on risks of the PCT Payor making
licensing payments under the licensing
alternative, and the PCT Payor making
cost contributions and PCT Payments
under the cost sharing alternative. That
is, the difference in risk between the
two scenarios solely reflects (1) the
incremental risk, if any, associated with
the cost contributions taken on by the
PCT Payor in developing the cost shared
intangible under the cost sharing
alternative, and (2) the difference in
risk, if any, associated with the
particular payment forms of the
licensing payments and the PCT
Payments, in light of the fact that the
licensing payments in the licensing
alternative are partially replaced by cost
contributions and partially replaced by
PCT Payments in the cost sharing
alternative, each with its own payment
form.
c. Valuation Undertaken on a Pre-Tax
Basis—§ 1.482–7(g)(2)(x)
Several comments requested that the
final regulations clarify the term ‘‘tax
rate’’ for purposes of determining
amounts on a pre-tax basis. In response,
that term has been clarified in § 1.482–
7(j)(1) to mean the reasonably
anticipated effective tax rate with
respect to the pre-tax income to which
the rate of tax is being applied. For
example, under the income method, this
rate would be the reasonably anticipated
effective tax rate of the PCT Payor or
PCT Payee under the cost sharing
alternative or licensing alternative, as
appropriate. See § 1.482–7(g)(4)(i)(G).
Several comments also requested
clarification on the guidance concerning
the determination of pre-tax PCT
Payments under the income method.
While PCT Payments must be
determined on a pre-tax basis, in
general, the financial projections and
discount rates used to apply the income
method are post-tax measures.
Comments suggested that this
discrepancy makes such a
determination difficult and raises
concerns about valuation principles to
derive a pre-tax PCT Payment based on
post-tax data.
The Treasury Department and the IRS
believe that the requirement that PCT
Payments be determined on a pre-tax
basis is fundamental to the
determination of an arm’s length result,
and, while no changes were made to the
regulations in this regard, examples
were added to illustrate this concept.
Under the income method, the operative
rule in all cases is to derive the pre-tax
PCT Payments that set the post-tax

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present value of the cost sharing
alternative equal to the post-tax present
value of the licensing alternative. The
operative rule can be satisfied in a
number of ways. For example, annual
pre-tax PCT Payments can be directly
determined such that, when
incorporated into the PCT Payor’s
financial projections (which should
reflect the deductibility of the pre-tax
PCT Payments), the post-tax net present
values of the licensing and cost sharing
alternatives are equated. See § 1.482–
7(g)(4)(viii), Example 4. Alternatively,
the present value of post-tax PCT
Payments can be directly determined by
subtracting the present value of the
post-tax income associated with the
licensing alternative from the present
value of the post-tax income associated
with the cost sharing alternative
(exclusive of the PCT Payment). This
difference, which reflects the post-tax
present value of the PCT Payment, must
be grossed up to derive the pre-tax PCT
Payment. See § 1.482–7(g)(4)(viii),
Example 5. Another alternative, in
certain situations (for example, when
financial projections are based on
income, rather than cash flows, and
when a controlled participant’s tax rate
is not materially affected by whether it
enters into the cost sharing or licensing
alternative), is for the present value of
pre-tax PCT Payments to be directly
determined by subtracting the present
value of the pre-tax income associated
with the licensing alternative from the
present value of the pre-tax income
associated with the cost sharing
alternative (exclusive of the PCT
Payment), both discounted at post-tax
discount rates. That is, under certain
conditions the pre-tax PCT Payments
that equate the pre-tax present values of
the two alternatives will also equate the
post-tax present values of the two
alternatives (which satisfies the
operative rule). This last method does
not reflect a violation of valuation
theory, but merely a method that applies
under certain conditions to derive the
pre-tax PCT Payment more directly,
rather than deriving the post-tax PCT
Payment under the operative rule and
grossing it up. Discounting pre-tax
income with post-tax discount rates
conceptually provides a measure of pretax income. Discounting pre-tax income
with pre-tax discount rates, on the other
hand, conceptually provides a measure
of post-tax income. See § 1.482–
7(g)(4)(viii), Example 6. The specific
applications of the income method
described in paragraphs (g)(4)(ii)
through (iv) and the examples set forth
in paragraph (g)(4)(viii) of these final
regulations assume that such

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circumstances apply, but the regulations
do not exclude other applications.
3. Acquisition Price and Market
Capitalization Methods—§ 1.482–7(g)(5)
and (6)
The acquisition price method as
specified in § 1.482–7(g)(5) typically
may be considered for determining PCT
Payments with respect to platform
contributions as a result of asset or stock
acquisitions. Comments were received
that, with some acquisitions, there may
be benefits to the controlled group
whose scope extends beyond the
development of cost shared intangibles.
The Treasury Department and the IRS
agree that these facts and circumstances
should be taken into account in the
appropriate application of the
acquisition price method and any other
methods for purposes of determining
the best method, but believe that this is
adequately addressed by other
provisions of the section 482
regulations. See, for example, §§ 1.482–
1(c) (Best method rule) and (d)
(Comparability), and 1.482–7(g)(2)(iv)
(Aggregation of transactions).
Several comments requested that the
final regulations provide more guidance
on what types of tax adjustments may be
needed with respect to PCT Payments
determined under the acquisition price
or market capitalization method. The
Treasury Department and the IRS
believe that the determination as to
whether to make such adjustments
should be based on facts and
circumstances of each case and thus are
best addressed under the general
comparability guidance in Treas. Reg.
§ 1.482–1(d) (Comparability). Therefore,
the specific references to tax
adjustments under those methods were
removed.
4. Residual Profit Split Method—
§ 1.482–7(g)(7)
The residual profit split method
under § 1.482–7(g)(7) allocates a PCT
Payor’s nonroutine residual divisional
profit or loss according to the controlled
participants’ relative nonroutine
contributions. The calculation of
nonroutine residual divisional profit or
loss includes a subtraction of market
returns for routine contributions. See
§ 1.482–7(g)(7)(iii)(B). These regulations
clarify that market returns for operating
cost contributions are included in, and
market returns for cost contributions are
excluded from, that subtraction. Market
returns are not assigned to cost
contributions because, under this
method, resources, capabilities, and
rights that benefit the development of
cost shared intangibles (and thus make
such development more valuable than

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its cost) are compensated as platform
contributions.
F. Form of Payment—§ 1.482–7(h)
1. Consistency of Form of Payment With
Arm’s Length Charge
Under the section 482 regulations,
controlled taxpayers have flexibility to
choose a form of payment with respect
to an arm’s length charge, provided that
the form of payment may be reasonably
expected to yield a value consistent
with such arm’s length charge
determined as of the date of the PCT.
Thus, a taxpayer must not only
determine an arm’s length charge
correctly under § 1.482–7(g) but also
designate a form of payment that is
consistent with that arm’s length charge
determined as of the date of the PCT.
This dual concept of the flexibility in
selecting the form of payment as well as
the obligation to preserve the arm’s
length charge through determining the
form of payment as of the date of the
PCT is clarified by a new sentence
added to § 1.482–7(h)(2)(i).
2. Services Markup Form of Payment
Several comments suggested that the
final regulations should expressly
permit the use of methods in § 1.482–9,
particularly the cost of services plus
method, for valuing and determining the
form of payment of PCT Payments for
services provided as, for example, by a
research team. As noted in the
preceding paragraph, these regulations
clarify the flexibility taxpayers enjoy to
adopt a form of payment consistent with
the arm’s length charge determined for
a PCT. In theory, therefore, the arm’s
length charge for a platform
contribution of services of a research
team might be converted into a cost-ofservices-plus form of payment, provided
that, among other conditions, the
method and form of payment treating
the platform value of such research team
separately from the arm’s length charge
for any other platform contributions
provide the most reliable measures of
the arm’s length charges. The
experience of the IRS, however, is that
the arm’s length charges for platform
contributions of the services of a
research team along with other platform
contributions (e.g., of a base technology)
are most often most reliably determined
in the aggregate.
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G. Periodic Adjustments—§ 1.482–7(i)
1. Determination of Periodic
Adjustments—§ 1.482–7(i)(6)(v) and (vi)
a. In General—§ 1.482–7(i)(6)(i)
The temporary regulations provided
detailed guidance for the calculation of
periodic adjustments in situations

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where there is a single adjustment with
respect to a single controlled
participant. The Treasury Department
and the IRS intended that the principles
of that detailed guidance should also be
applied in cases involving multiple
periodic adjustments (whether with
respect to one or multiple controlled
participants, or with respect to one or
multiple PCT Payments) and,
accordingly, § 1.482–7T(i)(6)(i) provided
that the Commissioner may make
periodic adjustments with respect to all
PCT Payments between all PCT Payors
and PCT Payees for the Adjustment Year
and all subsequent years for the
duration of the CSA Activity. In
response to these comments, a new
example in § 1.482–7(i)(6)(vii) illustrates
the application of § 1.482–7(i)(6)(i)
when more than one periodic
adjustment is required.
b. Adjusted RPSM—§ 1.482–7(i)(6)(v)(B)
One comment suggested that the
requirement that an adjusted RPSM be
used for determining periodic
adjustments is inconsistent with the
arm’s length standard because the arm’s
length standard requires that the best
method rule be applied in all
circumstances, and the adjusted RPSM
will not be the best method in every
circumstance. The Treasury Department
and the IRS believe that this is
sufficiently addressed by the 2008
temporary regulations, which provide
for periodic adjustments to be
administered consistent with the arm’s
length standard. Specifically, § 1.482–
7(i)(6)(i) provides that, in determining
whether to make periodic adjustments,
the Commissioner may consider
whether the outcome as adjusted more
reliably reflects an arm’s length result
under all the relevant facts and
circumstances.
c. Exceptions to Periodic Adjustments—
§ 1.482–7(i)(6)(vi)
Several comments suggested that the
definition of ‘‘divisional profits or
losses’’ is too broad and includes too
much value in the concept of the
actually experienced return ratio
(AERR), thereby making the numerator
in the Periodic Trigger too large relative
to the denominator, and thus too easily
triggered. In response to this comment,
the exception to periodic adjustments in
§ 1.482–7T(i)(6)(vi)(A)(3) is expanded to
take into account the PCT Payor’s
routine platform contributions. The
language is further clarified to provide
that, in addition to the exclusion of
certain profits or losses, the PCT Payor’s
divisional profits or losses are
calculated by taking into account the
expenses on account of operating cost

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contributions and routine platform
contributions.
d. Contractual CWI Provisions—§ 1.482–
1(d)(3)(ii)(C), Examples 3 Through 7
The IRS has encountered a number of
contracts that contain price terms for
transactions that are subject to section
482, including buy-ins and PCTs, that
provide for contingent terms based on
subsequent actual income experience.
Some such terms specify a charge for
the transaction and then further provide
for adjustments to that charge based
generally on the actual income results.
Certain of these terms are specifically
tied to the mechanics of the CWI
regulations (for example, a price
adjustment is required if the income is
less than 80 percent or greater than 120
percent of the price charged). See
§§ 1.482–4(f)(2)(ii)(B)(6) and (C)(4) and
1.482–7T(i)(6)(i) and (ii).
Controlled participants have
flexibility in agreeing to contingent
payment terms and, thus, in allocating
upside or downside risk among the
parties. In so doing, the parties can tie
their prices to the income actually
earned with respect to the subject of the
buy-in or PCT. Such price terms must be
determined on an upfront basis and
must be coordinated and consistent
with the arm’s length charge. The IRS
has experience, however, with taxpayers
failing to provide for arm’s length
compensation for the allocation of risk,
as well as failing to provide price terms
that are sufficiently clear so as to
constitute an upfront allocation of risk
that has economic substance.
Accordingly, several examples have
been added to § 1.482–7(h)(2)(iii)(C) to
illustrate the treatment of certain types
of contingent price terms under these
regulations, and apply the principles set
forth in §§ 1.482–7(h)(2)(iii)(B) and
(k)(1)(iv) and 1.482–1(d)(3)(ii)(B)(1) and
(iii)(B).
2. Advance Pricing Agreement
As stated in the Preamble to the 2008
temporary regulations, the Treasury
Department and the IRS are considering
issuing a revenue procedure providing
an exception to periodic adjustments,
similar to exceptions provided in
§ 1.482–7(i)(6)(vi), in the context of an
advance pricing agreement (APA)
entered into pursuant to Rev. Proc.
2006–9, 2006–1 CB 278. Accordingly,
no periodic adjustments would be made
in any year based on a Trigger PCT that
is a covered transaction under the APA.
See § 601.601(d)(2)(ii)(b).

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H. Administrative Requirements—
§ 1.482–7(k)

Department participated in their
development.

1. CSA Statements, mailing to Ogden
Campus—§ 1.482–7(k)(4)(iii)
A number of comments requested that
the regulations provide a specific
address for mailing CSA Statements to
the Ogden Campus. In response to these
comments, a specific mailing address
for CSA Statements has been added to
the regulations.

List of Subjects

2. Advance Pricing Agreements
One comment requested that
taxpayers with CSAs covered by APAs
be relieved from the administrative
requirements in § 1.482–7(k)(2) through
(4). The Treasury Department and the
IRS are considering guidance addressing
this issue, and solicit further comments
concerning the extent to which
compliance with the APA procedures
should be deemed to satisfy any of the
administrative requirements under
§ 1.482–7(k)(2) through (4). These
comments should address the impact of
any such change on the ability of the
IRS to properly examine CSA-related
transactions.

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Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
has also been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations. It is hereby
certified that the collections of
information in these regulations will not
have a significant economic impact on
a substantial number of small entities.
This certification is based on the fact
that this rule applies to U.S. businesses
and foreign affiliates that enter into cost
sharing arrangements. Few small
entities are expected to enter into cost
sharing agreements, as defined by these
regulations. 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 Code, these
regulations were submitted to the Chief
Counsel for Advocacy of the Small
Business Administration (CCASBA) for
comment on their impact on small
businesses. CCASBA did not have any
comments.
Drafting Information
The principal author of these
regulations is Joseph L. Tobin of the
Office of Associate Chief Counsel
(International). However, other
personnel from the IRS and the Treasury

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26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes,
Excise taxes, Gift taxes, Income taxes,
Penalties, Reporting and recordkeeping
requirements.

80087

1. The entries for § 1.482–1(b)(2)(i)
and (iii) are revised.
■ 2. The entries for § 1.482–2(e) and (f)
are revised.
■ 3. The entries for § 1.482–4(f)(3)(i)(B),
(g) and (h) are revised.
■ 4. The entry for § 1.482–7 is revised.
■ 5. The entries for § 1.482–9(m)(3) and
(n) are revised.
The additions and revisions read as
follows:
■

§ 1.482–0 Outline of regulations under
section 482.

26 CFR Part 602

*

Reporting and recordkeeping
requirements.

§ 1.482–1 Allocation of income and
deductions among taxpayers.

Amendment to the Regulations
Accordingly, 26 CFR parts 1, 301, and
602 are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an entry
in numerical order to read as follows:

■

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

Par 2. Section 1.367(a)–1 is amended
by revising paragraph (d)(3) to read as
follows:

■

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

*

*
*
*
*
(d) * * *
(3) Transfer. For purposes of section
367 and regulations thereunder, the
term ‘‘transfer’’ means any transaction
that constitutes a transfer for purposes
of section 332, 351, 354, 355, 356, or
361, as applicable. A person’s entering
into a cost sharing arrangement under
§ 1.482–7 or acquiring rights to
intangible property under such an
arrangement shall not be considered a
transfer of property described in section
367(a)(1). See § 1.6038B–1T(b)(4) for the
date on which the transfer is considered
to be made.
*
*
*
*
*
■ Par. 3. Section 1.367(a)–1T is
amended by revising paragraph (d)(3) to
read as follows:
§ 1.367(a)–1T Transfers to foreign
corporations subject to section 367(a): In
general (temporary).

*

*
*
*
*
(d) * * *
(3) [Reserved]. For further guidance,
see § 1.367(a)–1(d)(3).
*
*
*
*
*
Par. 4. Section 1.482–0 is amended as
follows:

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*

*

*

*

*

*
*
*
*
(b) * * *
(2) * * *
(i) Methods.
*
*
*
*
*
(iii) Coordination of methods
applicable to certain intangible
development arrangements.
*
*
*
*
*
§ 1.482–2 Determination of taxable income
in specific situations.

*

*
*
*
*
(e) Cost sharing arrangement.
(f) Effective/applicability Date.
(1) In general.
(2) Election to apply paragraph (b) to
earlier taxable years.
*
*
*
*
*
§ 1.482–4 Methods to determine taxable
income in connection with a transfer of
intangible property.

*

*
*
*
*
(f) * * *
(3) * * *
(i) * * *
(B) Cost sharing arrangements.
*
*
*
*
*
(g) Coordination with rules governing
cost sharing arrangements.
(h) Effective/applicability date.
(1) In general.
(2) Election to apply regulation to
earlier taxable years.
*
*
*
*
*
§ 1.482–7 Methods to determine taxable
income in connection with a cost sharing
arrangement.

(a) In general.
(1) RAB share method for cost sharing
transactions (CSTs).
(2) Methods for platform contribution
transactions (PCTs).
(3) Methods for other controlled
transactions.
(i) Contribution to a CSA by a
controlled taxpayer that is not a
controlled participant.
(ii) Transfer of interest in a cost
shared intangible.

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations

(iii) Other controlled transactions in
connection with a CSA.
(iv) Controlled transactions in the
absence of a CSA.
(4) Coordination with the arm’s length
standard.
(b) Cost sharing arrangement.
(1) Substantive requirements.
(i) CSTs.
(ii) PCTs.
(iii) Divisional interests.
(iv) Examples.
(2) Administrative requirements.
(3) Date of a PCT.
(4) Divisional interests.
(i) In general.
(ii) Territorial based divisional
interests.
(iii) Field of use based divisional
interests.
(iv) Other divisional bases.
(v) Examples.
(5) Treatment of certain arrangements
as CSAs.
(i) Situation in which Commissioner
must treat arrangement as a CSA.
(ii) Situation in which Commissioner
may treat arrangement as a CSA.
(iii) Examples.
(6) Entity classification of CSAs.
(c) Platform contributions.
(1) In general.
(2) Terms of platform contributions.
(i) Presumed to be exclusive.
(ii) Rebuttal of Exclusivity.
(iii) Proration of PCT Payments to the
extent allocable to other business
activities.
(A) In general.
(B) Determining the proration of PCT
Payments.
(3) Categorization of the PCT.
(4) Certain make-or-sell rights
excluded.
(i) In general.
(ii) Examples.
(5) Examples.
(d) Intangible development costs.
(1) Determining whether costs are
IDCs.
(i) Definition and scope of the IDA.
(ii) Reasonably anticipated cost
shared intangible.
(iii) Costs included in IDCs.
(iv) Examples.
(2) Allocation of costs.
(3) Stock-based compensation.
(i) In general.
(ii) Identification of stock-based
compensation with the IDA.
(iii) Measurement and timing of stockbased compensation IDC.
(A) In general.
(1) Transfers to which section 421
applies.
(2) Deductions of foreign controlled
participants.
(3) Modification of stock option.
(4) Expiration or termination of CSA.

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(B) Election with respect to options on
publicly traded stock.
(1) In general.
(2) Publicly traded stock.
(3) Generally accepted accounting
principles.
(4) Time and manner of making the
election.
(C) Consistency.
(4) IDC share.
(5) Examples.
(e) Reasonably anticipated benefits
share.
(1) Definition.
(i) In general.
(ii) Reliability.
(iii) Examples.
(2) Measure of benefits.
(i) In general.
(ii) Indirect bases for measuring
anticipated benefits.
(A) Units used, produced, or sold.
(B) Sales.
(C) Operating profit.
(D) Other bases for measuring
anticipated benefits.
(E) Examples.
(iii) Projections used to estimate
benefits.
(A) In general.
(B) Examples.
(f) Changes in participation under a
CSA.
(1) In general.
(2) Controlled transfer of interests.
(3) Capability variation.
(4) Arm’s length consideration for a
change in participation.
(5) Examples.
(g) Supplemental guidance on
methods applicable to PCTs.
(1) In general.
(2) Best method analysis applicable
for evaluation of a PCT pursuant to a
CSA.
(i) In general.
(ii) Consistency with upfront
contractual terms and risk allocation—
the investor model.
(A) In general.
(B) Example.
(iii) Consistency of evaluation with
realistic alternatives.
(A) In general.
(B) Examples.
(iv) Aggregation of transactions.
(v) Discount rate.
(A) In general.
(B) Considerations in best method
analysis of discount rate.
(1) Discount rate variation between
realistic alternatives.
(2) [Reserved].
(3) Discount rate variation between
forms of payment.
(4) Post-tax rate.
(C) Example.
(vi) Financial projections.
(vii) Accounting principles.

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(A) In general.
(B) Examples.
(viii) Valuations of subsequent PCTs.
(A) Date of subsequent PCT.
(B) Best method analysis for
subsequent PCT.
(ix) Arm’s length range.
(A) In general.
(B) Methods based on two or more
input parameters.
(C) Variable input parameters.
(D) Determination of arm’s length PCT
Payment.
(1) No variable input parameters.
(2) One variable input parameter.
(3) More than one variable input
parameter.
(E) Adjustments.
(x) Valuation undertaken on a pre-tax
basis.
(3) Comparable uncontrolled
transaction method.
(4) Income method.
(i) In general.
(A) Equating cost sharing and
licensing alternatives.
(B) Cost sharing alternative.
(C) Licensing alternative.
(D) Only one controlled participant
with nonroutine platform contributions.
(E) Income method payment forms.
(F) Discount rates appropriate to cost
sharing and licensing alternatives.
(G) The effect of taxation on
determining the arm’s length amount.
(ii) Evaluation of PCT Payor’s cost
sharing alternative.
(iii) Evaluation of PCT Payor’s
licensing alternative.
(A) Evaluation based on CUT.
(B) Evaluation based on CPM.
(iv) Lump sum payment form.
(v) [Reserved].
(vi) Best method analysis
considerations.
(A) Coordination with § 1.482–1(c).
(B) Assumptions Concerning Tax
Rates.
(C) Coordination with § 1.482–4(c)(2).
(D) Coordination with § 1.482–5(c).
(E) Certain Circumstances Concerning
PCT Payor.
(F) Discount rates.
(1) Reflection of similar risk profiles
of cost sharing alternative and licensing
alternative.
(2) [Reserved].
(vii) Routine platform and operating
contributions.
(viii) Examples.
(5) Acquisition Price Method.
(i) In general.
(ii) Determination of arm’s length
charge.
(iii) Adjusted acquisition price.
(iv) Best method analysis
considerations.
(v) Example.
(6) Market capitalization method.

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
(i) In general.
(ii) Determination of arm’s length
charge.
(iii) Average market capitalization.
(iv) Adjusted average market
capitalization.
(v) Best method analysis
considerations.
(vi) Examples.
(7) Residual profit split method.
(i) In general.
(ii) Appropriate share of profits and
losses.
(iii) Profit split.
(A) In general.
(B) Determine nonroutine residual
divisional profit or loss.
(C) Allocate nonroutine residual
divisional profit or loss.
(1) In general.
(2) Relative value determination.
(3) Determination of PCT Payments.
(4) Routine platform and operating
contributions.
(iv) Best method analysis
considerations.
(A) In general.
(B) Comparability.
(C) Data and assumptions.
(D) Other factors affecting reliability.
(v) Examples.
(8) Unspecified methods.
(h) Form of payment rules.
(1) CST Payments.
(2) PCT Payments.
(i) In general.
(ii) No PCT Payor stock.
(iii) Specified form of payment.
(A) In general.
(B) Contingent payments.
(C) Examples.
(iv) Conversion from fixed to
contingent form of payment.
(3) Coordination of best method rule
and form of payment.
(i) Allocations by the Commissioner
in connection with a CSA.
(1) In general.
(2) CST allocations.
(i) In general.
(ii) Adjustments to improve the
reliability of projections used to
estimate RAB shares.
(A) Unreliable projections.
(B) Foreign-to-foreign adjustments.
(C) Correlative adjustments to PCTs.
(D) Examples.
(iii) Timing of CST allocations.
(3) PCT allocations.
(4) Allocations regarding changes in
participation under a CSA.
(5) Allocations when CSTs are
consistently and materially
disproportionate to RAB shares.
(6) Periodic adjustments.
(i) In general.
(ii) PRRR.
(iii) AERR.
(A) In general.

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(B) PVTP.
(C) PVI.
(iv) ADR.
(A) In general.
(B) Publicly traded companies.
(C) Publicly traded.
(D) PCT Payor WACC.
(E) Generally accepted accounting
principles.
(v) Determination of periodic
adjustments.
(A) In general.
(B) Adjusted RPSM as of
Determination Date.
(vi) Exceptions to periodic
adjustments.
(A) Controlled participants establish
periodic adjustment not warranted.
(1) Transactions involving the same
platform contribution as in the Trigger
PCT.
(2) Results not reasonably anticipated.
(3) Reduced AERR does not cause
Periodic Trigger.
(4) Increased AERR does not cause
Periodic Trigger.
(B) Circumstances in which Periodic
Trigger deemed not to occur.
(1) 10-year period.
(2) 5-year period.
(vii) Examples.
(j) Definitions and special rules.
(1) Definitions.
(i) In general.
(ii) Examples.
(2) Special rules.
(i) Consolidated group.
(ii) Trade or business.
(iii) Partnership.
(3) Character.
(i) CST Payments.
(ii) PCT Payments.
(iii) Examples.
(k) CSA administrative requirements.
(1) CSA contractual requirements.
(i) In general.
(ii) Contractual provisions.
(iii) Meaning of contemporaneous.
(A) In general.
(B) Example.
(iv) Interpretation of contractual
provisions.
(A) In general.
(B) Examples.
(2) CSA documentation requirements.
(i) In general.
(ii) Additional CSA documentation
requirements.
(iii) Coordination rules and
production of documents.
(A) Coordination with penalty
regulations.
(B) Production of documentation.
(3) CSA accounting requirements.
(i) In general.
(ii) Reliance on financial accounting.
(4) CSA reporting requirements.
(i) CSA Statement.
(ii) Content of CSA Statement.

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80089

(iii) Time for filing CSA Statement.
(A) 90-day rule.
(B) Annual return requirement.
(1) In general.
(2) Special filing rule for annual
return requirement.
(iv) Examples.
(l) Effective/applicability date.
(m) Transition rule.
(1) In general.
(2) Transitional modification of
applicable provisions.
(3) Special rule for certain periodic
adjustments.
*
*
*
*
*
§ 1.482–9 Methods to determine taxable
income in connection with a controlled
services transaction.

*

*
*
*
*
(m) * * *
(3) Coordination with rules governing
cost sharing arrangements.
*
*
*
*
*
(n) Effective/applicability dates.
§ 1.482–0T

[Removed]

Par. 5. Section 1.482–0T is removed.
■ Par. 6. Section 1.482–1 is amended
by:
■ 1. Revising paragraph (b)(2)(i) and the
last sentence in paragraph (c)(1).
■ 2. Adding a new paragraph (b)(2)(iii).
■ 3. Adding a new sentence to the end
of paragraph (j)(6)(i).
The additions and revisions read as
follows:
■

§ 1.482–1 Allocation of income and
deductions among taxpayers.

*

*
*
*
*
(b) * * *
(2) Arm’s length methods—(i)
Methods. Sections 1.482–2 through
1.482–6, 1.482–7, and 1.482–9 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. Section 1.482–1 and this section
provide general principles applicable in
determining arm’s length results of such
controlled transactions, but do not
provide methods, for which reference
must be made to those other sections in
accordance with paragraphs (b)(2)(ii)
and (iii) of this section. Section 1.482–
7 provides the specific methods to be
used to evaluate whether a cost sharing
arrangement as defined in § 1.482–7
produces results consistent with an
arm’s length result.
*
*
*
*
*
(iii) Coordination of methods
applicable to certain intangible
development arrangements. Section
1.482–7 provides the specific methods
to be used to determine arm’s length

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results of controlled transactions in
connection with a cost sharing
arrangement as defined in § 1.482–7.
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
intangibles, other than a cost sharing
arrangement covered by § 1.482–7. See
also §§ 1.482–4(g) (Coordination with
rules governing cost sharing
arrangements) and 1.482–9(m)(3)
(Coordination with rules governing cost
sharing arrangements).
*
*
*
*
*
(c) * * *
(1) * * * See § 1.482–7 for the
applicable methods in the case of a cost
sharing arrangement.
*
*
*
*
*
(j) * * *
(6) * * *
(i) * * * The provision of paragraph
(b)(2)(iii) of this section is generally
applicable on January 5, 2009.
*
*
*
*
*
§ 1.482–1T

[Removed]

Par. 7. Section 1.482–1T is removed.
Par. 8. Section 1.482–2 is amended by
revising paragraphs (e) and (f) to read as
follows:

■
■

§ 1.482–2 Determination of taxable income
in specific situations.

*

*
*
*
*
(e) Cost sharing arrangement. For
rules governing allocations under
section 482 to reflect an arm’s length
consideration for controlled transactions
involving a cost sharing arrangement,
see § 1.482–7.
(f) Effective/applicability date—(1) In
general. The provision of paragraph (b)
of this section is generally applicable for
taxable years beginning after December
31, 2006. The provision of paragraph (e)
of this section is generally applicable on
January 5, 2009.
(2) Election to apply paragraph (b) to
earlier taxable years. A person may elect
to apply the provisions of paragraph (b)
of this section to earlier taxable years in
accordance with the rules set forth in
§ 1.482–9(n)(2).

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§ 1.482–2T

[Removed]

Par. 9. Section 1.482–2T is removed.
Par. 10. Section 1.482–4 is amended
as follows
■ 1. Paragraphs (f)(3)(i)(B), (g) and (h)
are revised.
■ 2. Paragraph (f)(7) is removed.
The revisions read as follows:
■
■

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

*

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

[Removed].

Par. 11. Section 1.482–4T is removed.
■ Par. 12. Section 1.482–5 is amended
by revising the last sentence of
paragraph (c)(2)(iv) to read as follows:
■

§ 1.482–5

Comparable profits method.

*

*
*
*
*
(c) * * *
(2) * * *
(iv) * * * As another example, it may
be appropriate to adjust the operating
profit of a party to account for material

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differences in the utilization of or
accounting for stock-based
compensation (as defined by § 1.482–
7(d)(3)(i)) among the tested party and
comparable parties.
*
*
*
*
*
■ Par. 13. Section 1.482–7 is added to
read as follows:
§ 1.482–7 Methods to determine taxable
income in connection with a cost sharing
arrangement.

(a) In general. The arm’s length
amount charged in a controlled
transaction reasonably anticipated to
contribute to developing intangibles
pursuant to a cost sharing arrangement
(CSA), as described in paragraph (b) of
this section, must be determined under
a method described in this section. Each
method must be applied in accordance
with the provisions of § 1.482–1, except
as those provisions are modified in this
section.
(1) RAB share method for cost sharing
transactions (CSTs). See paragraph
(b)(1)(i) of this section regarding the
requirement that controlled
participants, as defined in section
(j)(1)(i) of this section, share intangible
development costs (IDCs) in proportion
to their shares of reasonably anticipated
benefits (RAB shares) by entering into
cost sharing transactions (CSTs).
(2) Methods for platform contribution
transactions (PCTs). The arm’s length
amount charged in a platform
contribution transaction (PCT)
described in paragraph (b)(1)(ii) of this
section must be determined under the
method or methods applicable under
the other section or sections of the
section 482 regulations, as
supplemented by paragraph (g) of this
section. See § 1.482–1(b)(2)(ii)
(Selection of category of method
applicable to transaction), § 1.482–
1(b)(2)(iii) (Coordination of methods
applicable to certain intangible
development arrangements), and
paragraph (g) of this section
(Supplemental guidance on methods
applicable to PCTs).
(3) Methods for other controlled
transactions—(i) Contribution to a CSA
by a controlled taxpayer that is not a
controlled participant. If a controlled
taxpayer that is not a controlled
participant contributes to developing a
cost shared intangible, as defined in
section (j)(1)(i) of this section, it must
receive consideration from the
controlled participants under the rules
of § 1.482–4(f)(4) (Contribution to the
value of an intangible owned by
another). Such consideration will be
treated as an intangible development
cost for purposes of paragraph (d) of this
section.

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(ii) Transfer of interest in a cost
shared intangible. If at any time (during
the term, or upon or after the
termination, of a CSA) a controlled
participant transfers an interest in a cost
shared intangible to another controlled
taxpayer, the controlled participant
must receive an arm’s length amount of
consideration from the transferee under
the rules of §§ 1.482–4 through 1.482–6
as supplemented by paragraph (f)(4) of
this section regarding arm’s length
consideration for a change in
participation. For this purpose, a
capability variation described in
paragraph (f)(3) of this section is
considered to be a controlled transfer of
interests in cost shared intangibles.
(iii) Other controlled transactions in
connection with a CSA. Controlled
transactions between controlled
participants that are not PCTs or CSTs
and are not described in paragraph
(a)(3)(ii) of this section (for example,
provision of a cross operating
contribution, as defined in paragraph
(j)(1)(i) of this section, or make-or-sell
rights, as defined in paragraph (c)(4) of
this section) require arm’s length
consideration under the rules of
§§ 1.482–1 through 1.482–6, and 1.482–
9 as supplemented by paragraph
(g)(2)(iv) of this section.
(iv) Controlled transactions in the
absence of a CSA. If a controlled
transaction is reasonably anticipated to
contribute to developing intangibles
pursuant to an arrangement that is not
a CSA described in paragraph (b)(1) or
(5) of this section, whether the results of
any such controlled transaction are
consistent with an arm’s length result
must be determined under the
applicable rules of the other sections of
the regulations under section 482. For
example, an arrangement for developing
intangibles in which one controlled
taxpayer’s costs of developing the
intangibles significantly exceeds its
share of reasonably anticipated benefits
from exploiting the developed
intangibles would not in substance be a
CSA, as described in paragraphs (b)(1)(i)
through (iii) of this section or paragraph
(b)(5)(i) of this section. In such a case,
unless the rules of this section are
applicable by reason of paragraph (b)(5)
of this section, the arrangement must be
analyzed under other applicable
sections of regulations under section
482 to determine whether it achieves
arm’s length results, and if not, to
determine any allocations by the
Commissioner that are consistent with
such other regulations under section
482. See § 1.482–1(b)(2)(ii) (Selection of
category of method applicable to
transaction) and (iii) (Coordination of

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methods applicable to certain intangible
development arrangements).
(4) Coordination with the arm’s length
standard. A CSA produces results that
are consistent with an arm’s length
result within the meaning of § 1.482–
1(b)(1) if, and only if, each controlled
participant’s IDC share (as determined
under paragraph (d)(4) of this section)
equals its RAB share, each controlled
participant compensates its RAB share
of the value of all platform contributions
by other controlled participants, and all
other requirements of this section are
satisfied.
(b) Cost sharing arrangement. A cost
sharing arrangement is an arrangement
by which controlled participants share
the costs and risks of developing cost
shared intangibles in proportion to their
RAB shares. An arrangement is a CSA
if and only if the requirements of
paragraphs (b)(1) through (4) of this
section are met.
(1) Substantive requirements–(i)
CSTs. All controlled participants must
commit to, and in fact, engage in cost
sharing transactions. In CSTs, the
controlled participants make payments
to each other (CST Payments) as
appropriate, so that in each taxable year
each controlled participant’s IDC share
is in proportion to its respective RAB
share.
(ii) PCTs. All controlled participants
must commit to, and in fact, engage in
platform contributions transactions to
the extent that there are platform
contributions pursuant to paragraph (c)
of this section. In a PCT, each other
controlled participant (PCT Payor) is
obligated to, and must in fact, make
arm’s length payments (PCT Payments)
to each controlled participant (PCT
Payee) that provides a platform
contribution. For guidance on
determining such arm’s length
obligation, see paragraph (g) of this
section.
(iii) Divisional interests. Each
controlled participant must receive a
non-overlapping interest in the cost
shared intangibles without further
obligation to compensate another
controlled participant for such interest.
(iv) Examples. The following
examples illustrate the principles of this
paragraph (b)(1):
Example 1. Company A and Company B,
who are members of the same controlled
group, execute an agreement to jointly
develop vaccine X and own the exclusive
rights to commercially exploit vaccine X in
their respective territories, which together
comprise the whole world. The agreement
provides that they will share some, but not
all, of the costs for developing Vaccine X in
proportion to RAB share. Such agreement is
not a CSA because Company A and Company

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80091

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

(2) Administrative requirements. The
CSA must meet the requirements of
paragraph (k) of this section.
(3) Date of a PCT. The controlled
participants must enter into a PCT as of
the earliest date on or after the CSA is
entered into on which a platform
contribution is reasonably anticipated to
contribute to developing cost shared
intangibles.
(4) Divisional interests—(i) In general.
Pursuant to paragraph (b)(1)(iii) of this
section, each controlled participant
must receive a non-overlapping interest
in the cost shared intangibles without
further obligation to compensate
another controlled participant for such
interest. Each controlled participant
must be entitled to the perpetual and
exclusive right to the profits from

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transactions of any member of the
controlled group that includes the
controlled participant with uncontrolled
taxpayers to the extent that such profits
are attributable to such interest in the
cost shared intangibles.
(ii) Territorial based divisional
interests. The CSA may divide all
interests in cost shared intangibles on a
territorial basis as follows. The entire
world must be divided into two or more
non-overlapping geographic territories.
Each controlled participant must receive
at least one such territory, and in the
aggregate all the participants must
receive all such territories. Each
controlled participant will be assigned
the perpetual and exclusive right to
exploit the cost shared intangibles
through the use, consumption, or
disposition of property or services in its
territories. Thus, compensation will be
required if other members of the
controlled group exploit the cost shared
intangibles in such territory.
(iii) Field of use based divisional
interests. The CSA may divide all
interests in cost shared intangibles on
the basis of all uses (whether or not
known at the time of the division) to
which cost shared intangibles are to be
put as follows. All anticipated uses of
cost shared intangibles must be
identified. Each controlled participant
must be assigned at least one such
anticipated use, and in the aggregate all
the participants must be assigned all
such anticipated uses. Each controlled
participant will be assigned the
perpetual and exclusive right to exploit
the cost shared intangibles through the
use or uses assigned to it and one
controlled participant must be assigned
the exclusive and perpetual right to
exploit cost shared intangibles through
any unanticipated uses.
(iv) Other divisional bases. (A) In the
event that the CSA does not divide
interests in the cost shared intangibles
on the basis of exclusive territories or
fields of use as described in paragraphs
(b)(4)(ii) and (iii) of this section, the
CSA may adopt some other basis on
which to divide all interests in the cost
shared intangibles among the controlled
participants, provided that each of the
following criteria is met:
(1) The basis clearly and
unambiguously divides all interests in
cost shared intangibles among the
controlled participants.
(2) The consistent use of such basis
for the division of all interests in the
cost shared intangibles can be
dependably verified from the records
maintained by the controlled
participants.
(3) The rights of the controlled
participants to exploit cost shared

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intangibles are non-overlapping,
exclusive, and perpetual.
(4) The resulting benefits associated
with each controlled participant’s
interest in cost shared intangibles are
predictable with reasonable reliability.
(B) See paragraph (f)(3) of this section
for rules regarding the requirement of
arm’s length consideration for changes
in participation in CSAs involving
divisions of interest described in this
paragraph (b)(4)(iv).
(v) Examples. The following examples
illustrate the principles of this
paragraph (b)(4):
Example 1. Companies P and S, both
members of the same controlled group, enter
into a CSA to develop product Z. Under the
CSA, P receives the interest in product Z in
the United States and S receives the interest
in product Z in the rest of the world, as
described in paragraph (b)(4)(ii) of this
section. Both P and S have plants for
manufacturing product Z located in their
respective geographic territories. However,
for commercial reasons, product Z is
nevertheless manufactured by P in the
United States for sale to customers in certain
locations just outside the United States in
close proximity to P’s U.S. manufacturing
plant. Because S owns the territorial rights
outside the United States, P must compensate
S to ensure that S realizes all the cost shared
intangible profits from P’s sales of product Z
in S’s territory. The pricing of such
compensation must also ensure that P
realizes an appropriate return for its
manufacturing efforts. Benefits projected
with respect to such sales will be included
for purposes of estimating S’s, but not P’s,
RAB share.
Example 2. The facts are the same as in
Example 1 except that P and S agree to divide
their interest in product Z based on site of
manufacturing. P will have exclusive and
perpetual rights in product Z manufactured
in facilities owned by P. S will have
exclusive and perpetual rights to product Z
manufactured in facilities owned by S. P and
S agree that neither will license
manufacturing rights in product Z to any
related or unrelated party. Both P and S
maintain books and records that allow
production at all sites to be verified. Both
own facilities that will manufacture product
Z and the relative capacities of these sites are
known. All facilities are currently operating
at near capacity and are expected to continue
to operate at near capacity when product Z
enters production so that it will not be
feasible to shift production between P’s and
S’s facilities. P and S have no plans to build
new facilities and the lead time required to
plan and build a manufacturing facility
precludes the possibility that P or S will
build a new facility during the period for
which sales of Product Z are expected. Based
on these facts, this basis for the division of
interests in Product Z is a division described
in paragraph (b)(4)(iv) of this section. The
basis for the division of interest is
unambiguous and clearly defined and its use
can be dependably verified. P and S both
have non-overlapping, exclusive and

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perpetual rights in Product Z. The division
of interest results in the participant’s relative
benefits being predictable with reasonable
reliability.
Example 3. The facts are the same as in
Example 2 except that P’s and S’s
manufacturing facilities are not expected to
operate at full capacity when product Z
enters production. Production of Product Z
can be shifted at any time between sites
owned by P and sites owned by S, although
neither P nor S intends to shift production
as a result of the agreement. The division of
interests in Product Z between P and S based
on manufacturing site is not a division
described in paragraph (b)(4)(iv) of this
section because their relative shares of
benefits are not predictable with reasonable
reliability. The fact that neither P nor S
intends to shift production is irrelevant.

(5) Treatment of certain arrangements
as CSAs—(i) Situation in which
Commissioner must treat arrangement
as a CSA. The Commissioner must
apply the rules of this section to an
arrangement among controlled
taxpayers if the administrative
requirements of paragraph (b)(2) of this
section are met with respect to such
arrangement and the controlled
taxpayers reasonably concluded that
such arrangement was a CSA meeting
the requirements of paragraphs (b)(1),
(3), and (4) of this section.
(ii) Situation in which Commissioner
may treat arrangement as a CSA. For
arrangements among controlled
taxpayers not described in paragraph
(b)(5)(i) of this section, the
Commissioner may apply the provisions
of this section if the Commissioner
concludes that the administrative
requirements of paragraph (b)(2) of this
section are met, and, notwithstanding
technical failure to meet the substantive
requirements of paragraph (b)(1), (3), or
(4) of this section, the rules of this
section will provide the most reliable
measure of an arm’s length result. See
§ 1.482–1(c)(1) (the best method rule).
For purposes of applying this paragraph
(b)(5)(ii), any such arrangement shall be
interpreted by reference to paragraph
(k)(1)(iv) of this section.
(iii) Examples. The following
examples illustrate the principles of this
paragraph (b)(5). In the examples,
assume that Companies P and S are both
members of the same controlled group.
Example 1. (i) P owns the patent on a
formula for a capsulated pain reliever, P-Cap.
P reasonably anticipates, pending further
research and experimentation, that the P-Cap
formula could form the platform for a
formula for P-Ves, an effervescent version of
P-Cap. P also owns proprietary software that
it reasonably anticipates to be critical to the
research efforts. P and S execute a contract
that purports to be a CSA by which they
agree to proportionally share the costs and
risks of developing a formula for P-Ves. The

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agreement reflects the various contractual
requirements described in paragraph (k)(1) of
this section and P and S comply with the
documentation, accounting, and reporting
requirements of paragraphs (k)(2) through (4)
of this section. Both the patent rights for PCap and the software are reasonably
anticipated to contribute to the development
of P-Ves and therefore are platform
contributions for which compensation is due
from S as part of PCTs. Though P and S enter
into and implement a PCT for the P-Cap
patent rights that satisfies the arm’s length
standard, they fail to enter into a PCT for the
software.
(ii) In this case, P and S have substantially
complied with the contractual requirements
of paragraph (k)(1) of this section and the
documentation, accounting, and reporting
requirements of paragraphs (k)(2) through (4)
of this section and therefore have met the
administrative requirements of paragraph
(b)(2) of this section. However, because they
did not enter into a PCT, as required under
paragraphs (b)(1)(ii) and (b)(3) of this section,
for the software that was reasonably
anticipated to contribute to the development
of P-Ves (see paragraph (c) of this section),
they cannot reasonably conclude that their
arrangement was a CSA. Accordingly, the
Commissioner is not required under
paragraph (b)(5)(i) of this section to apply the
rules of this section to their arrangement.
(iii) Nevertheless, the arrangement between
P and S closely resembles a CSA. If the
Commissioner concludes that the rules of
this section provide the most reliable
measure of an arm’s length result for such
arrangement, then pursuant to paragraph
(b)(5)(ii) of this section, the Commissioner
may apply the rules of this section and treat
P and S as entering into a PCT for the
software in accordance with the requirements
of paragraph (b)(1)(ii) of this section, and
make any appropriate allocations under
paragraph (i) of this section. Alternatively,
the Commissioner may conclude that the
rules of this section do not provide the most
reliable measure of an arm’s length result. In
such case, the arrangement would be
analyzed under the methods under other
sections of the 482 regulations to determine
whether the arrangement reaches an arm’s
length result.
Example 2. The facts are the same as in
Example 1 except that P and S do enter into
and implement a PCT for the software as
required under this paragraph (b). The
Commissioner determines that the PCT
Payments for the software were not arm’s
length; nevertheless, under the facts and
circumstances at the time they entered into
the CSA and PCTs, P and S reasonably
concluded their arrangement to be a CSA.
Because P and S have met the requirements
of paragraph (b)(2) of this section and
reasonably concluded their arrangement is a
CSA, pursuant to paragraph (b)(5)(i) of this
section, the Commissioner must apply the
rules of this section to their arrangement.
Accordingly, the Commissioner treats the
arrangement as a CSA and makes
adjustments to the PCT Payments as
appropriate under this section to achieve an
arm’s length result for the PCT for the
software.

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Example 3. (i) The facts are the same as in
Example 1 except that P and S do enter into
a PCT for the software as required under this
paragraph (b). The agreement entered into by
P and S provides for a fixed consideration of
$50 million per year for four years, payable
at the end of each year. This agreement
satisfies the arm’s length standard. However,
S actually pays P consideration at the end of
each year in the form of four annual royalties
equal to two percent of sales. While such
royalties at the time of the PCT were
expected to be $50 million per year, actual
sales during the first year were less than
anticipated and the first royalty payment was
only $25 million.
(ii) In this case, P and S failed to
implement the terms of their agreement.
Under these circumstances, P and S could
not reasonably conclude that their
arrangement was a CSA, as described in
paragraph (b)(1) of this section. Accordingly,
the Commissioner is not required under
paragraph (b)(5)(i) of this section to apply the
rules of this section to their arrangement.
(iii) Nevertheless, the arrangement between
P and S closely resembles a CSA. If the
Commissioner concludes that the rules of
this section provide the most reliable
measure of an arm’s length result for such
arrangement, then pursuant to paragraph
(b)(5)(ii) of this section, the Commissioner
may apply the rules of this section and make
any appropriate allocations under paragraph
(i) of this section. Alternatively, the
Commissioner may conclude that the rules of
this section do not provide the most reliable
measure of an arm’s length result. In such
case, the arrangement would be analyzed
under the methods under other sections of
the 482 regulations to determine whether the
arrangement reaches an arm’s length result.
Example 4. (i) The facts are the same as in
Example 1 except that P does not own
proprietary software and P and S use a
method for determining the arm’s length
amount of the PCT Payment for the P-Cap
patent rights different from the method used
in Example 1.
(ii) P and S determine that the arm’s length
amount of the PCT Payments for the P-Cap
patent is $10 million. However, the
Commissioner determines the best method
for determining the arm’s length amount of
the PCT Payments for the P-Cap patent rights
and under such method the arm’s length
amount is $100 million. To determine this
$10 million present value, P and S assumed
a useful life of eight years for the platform
contribution, because the P-Cap patent rights
will expire after eight years. However, the PCap patent rights are expected to lead to
benefits attributable to exploitation of the
cost shared intangibles extending many years
beyond the expiration of the P-Cap patent,
because use of the P-Cap patent rights will
let P and S bring P-Ves to market before the
competition, and because P and S expect to
apply for additional patents covering P-Ves,
which would bar competitors from selling
that product for many future years. The
assumption by P and S of a useful life for the
platform contribution that is less than the
anticipated period of exploitation of the cost
shared intangibles is contrary to paragraph
(g)(2)(ii) of this section, and reduces the
reliability of the method used by P and S.

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(iii) The method used by P and S employs
a declining royalty. The royalty starts at 8%
of sales, based on an application of the CUT
method in which the purported CUTs all
involve licenses to manufacture and sell the
current generation of P-Cap, and declines to
0% over eight years, declining by 1% each
year. Such make-or-sell rights are
fundamentally different from use of the PCap patent rights to generate a new product.
This difference raises the issue of whether
the make-or-sell rights are sufficiently
comparable to the rights that are the subject
of the PCT Payment. See § 1.482–4(c). While
a royalty rate for make-or-sell rights can form
the basis for a reliable determination of an
arm’s length PCT Payment in the CUT-based
implementation of the income method
described in paragraph (g)(4) of this section,
under that method such royalty rate does not
decline to zero. Therefore, the use of a
declining royalty rate based on an initial rate
for make-or-sell rights further reduces the
reliability of the method used by P and S.
(iv) Sales of the next-generation product
are not anticipated until after seven years, at
which point the royalty rate will have
declined to 1%. The temporal mismatch
between the period of the royalty rate decline
and the period of exploitation raises further
concerns about the method’s reliability.
(v) For the reasons given in paragraphs (ii)
through (iv) of this Example 4, the method
used by P and S is so unreliable and so
contrary to provisions of this section that P
and S could not reasonably conclude that
they had contracted to make arm’s length
PCT Payments as required by paragraphs
(b)(1)(ii) and (b)(3) of this section, and thus
could not reasonably conclude that their
arrangement was a CSA. Accordingly, the
Commissioner is not required under
paragraph (b)(5)(i) of this section to apply the
rules of this section to their arrangement.
(vi) Nevertheless, the arrangement between
P and S closely resembles a CSA. If the
Commissioner concludes that the rules of
this section provide the most reliable
measure of an arm’s length result for such
arrangement, then pursuant to paragraph
(b)(5)(ii) of this section, the Commissioner
may apply the rules of this section and make
any appropriate allocations under paragraph
(i) of this section. Alternatively, the
Commissioner may conclude that the rules of
this section do not provide the most reliable
measure of an arm’s length result. In such
case, the arrangement would be analyzed
under the methods under other section 482
regulations to determine whether the
arrangement reaches an arm’s length result.

(6) Entity classification of CSAs. See
§ 301.7701–1(c) of this chapter for the
classification of CSAs for purposes of
the Internal Revenue Code.
(c) Platform contributions—(1) In
general. A platform contribution is any
resource, capability, or right that a
controlled participant has developed,
maintained, or acquired externally to
the intangible development activity
(whether prior to or during the course
of the CSA) that is reasonably
anticipated to contribute to developing

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

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

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being any of such types of transaction.
If the controlled participants fail to
make such designation in their
documentation, the Commissioner may
make a designation consistent with the
principles of paragraph (k)(1)(iv) of this
section.
(4) Certain make-or-sell rights
excluded—(i) In general. Any right to
exploit an existing resource, capability,
or right without further development of
such item, such as the right to make,
replicate, license, or sell existing
products, does not constitute a platform
contribution to a CSA (and the arm’s
length compensation for such rights
(make-or-sell rights) does not satisfy the
compensation obligation under a PCT)
unless exploitation without further
development of such item is reasonably
anticipated to contribute to developing
or further developing a cost shared
intangible.
(ii) Examples. The following
examples illustrate the principles of this
paragraph (c)(4):
Example 1. P and S, which are members of
the same controlled group, execute a CSA.
Under the CSA, P and S will bear their RAB
shares of IDCs for developing the second
generation of ABC, a computer software
program. Prior to that arrangement, P had
incurred substantial costs and risks to
develop ABC. Concurrent with entering into
the arrangement, P (as the licensor) executes
a license with S (as the licensee) by which
S may make and sell copies of the existing
ABC. Such make-or-sell rights do not
constitute a platform contribution to the
CSA. The rules of §§ 1.482–1 and 1.482–4
through 1.482–6 must be applied to
determine the arm’s length consideration in
connection with the make-or-sell licensing
arrangement. In certain circumstances, this
determination of the arm’s length
consideration may be done on an aggregate
basis with the evaluation of compensation
obligations pursuant to the PCTs entered into
by P and S in connection with the CSA. See
paragraph (g)(2)(iv) of this section.
Example 2. (i) P, a software company, has
developed and currently exploits software
program ABC. P and S enter into a CSA to
develop future generations of ABC. The ABC
source code is the platform on which future
generations of ABC will be built and is
therefore a platform contribution of P for
which compensation is due from S pursuant
to a PCT. Concurrent with entering into the
CSA, P licenses to S the make-or-sell rights
for the current version of ABC. P has entered
into similar licenses with uncontrolled
parties calling for sales-based royalty
payments at a rate of 20%. The current
version of ABC has an expected product life
of three years. P and S enter into a contingent
payment agreement to cover both the PCT
Payments due from S for P’s platform
contribution and payments due from S for
the make-or-sell license. Based on the
uncontrolled make-or-sell licenses, P and S
agree on a sales-based royalty rate of 20% in

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Year 1 that declines on a straight line basis
to 0% over the 3 year product life of ABC.
(ii) The make-or-sell rights for the current
version of ABC are not platform
contributions, though paragraph (g)(2)(iv) of
this section provides for the possibility that
the most reliable determination of an arm’s
length charge for the platform contribution
and the make-or-sell license may be one that
values the two transactions in the aggregate.
A contingent payment schedule based on the
uncontrolled make-or-sell licenses may
provide an arm’s length charge for the
separate make-or-sell license between P and
S, provided the royalty rates in the
uncontrolled licenses similarly decline, but
as a measure of the aggregate PCT and
licensing payments it does not account for
the arm’s length value of P’s platform
contributions which include the rights in the
source code and future development rights in
ABC.
Example 3. S is a controlled participant
that owns Patent Q, which protects S’s use
of a research tool that is helpful in
developing and testing new pharmaceutical
compounds. The research tool, which is not
itself such a compound, is used in the CSA
Activity to develop such compounds.
However, the CSA Activity is not anticipated
to result in the further development of the
research tool or in patents based on Patent Q.
Although the right to use Patent Q is not
anticipated to result in the further
development of Patent Q or the technology
that it protects, that right constitutes a
platform contribution (as opposed to makeor-sell rights) because it is anticipated to
contribute to the research activity to develop
cost shared intangibles relating to
pharmaceutical compounds covered by the
CSA.

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(5) Examples. The following examples
illustrate the principles of this
paragraph (c). In each example,
Companies P and S are members of the
same controlled group, and execute a
CSA providing that each will have the
exclusive right to exploit cost shared
intangibles in its own territory. See
paragraph (b)(4)(ii) of this section
(Territorial based divisional interests).
Example 1. Company P has developed and
currently markets version 1.0 of a new
software application XYZ. Company P and
Company S execute a CSA under which they
will share the IDCs for developing future
versions of XYZ. Version 1.0 is reasonably
anticipated to contribute to the development
of future versions of XYZ and therefore
Company P’s rights in version 1.0 constitute
a platform contribution from Company P that
must be compensated by Company S
pursuant to a PCT. Pursuant to paragraph
(c)(3) of this section, the controlled
participants designate the platform
contribution as a transfer of intangibles that
would otherwise be governed by § 1.482–4, if
entered into by controlled parties.
Accordingly, pursuant to paragraph (a)(2) of
this section, the applicable method for
determining the arm’s length value of the
compensation obligation under the PCT
between Company P and Company S will be

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governed by § 1.482–4 as supplemented by
paragraph (g) of this section. Absent a
showing to the contrary by P and S, the
platform contribution in this case is
presumed to be the exclusive provision of the
benefit of all rights in version 1.0, other than
the rights described in paragraph (c)(4) of this
section (Certain make-or-sell rights
excluded). This includes the right to use
version 1.0 for purposes of research and the
exclusive right in S’s territory to exploit any
future products that incorporated the
technology of version 1.0, and would cover
a term extending as long as the controlled
participants were to exploit future versions of
XYZ or any other product based on the
version 1.0 platform. The compensation
obligation of Company S pursuant to the PCT
will reflect the full value of the platform
contribution, as limited by Company S’s RAB
share.
Example 2. Company P and Company S
execute a CSA under which they will share
the IDCs for developing Vaccine Z. Company
P will commit to the project its research team
that has successfully developed a number of
other vaccines. The expertise and existing
integration of the research team is a unique
resource or capability of Company P which
is reasonably anticipated to contribute to the
development of Vaccine Z. Therefore, P’s
provision of the capabilities of the research
team constitute a platform contribution for
which compensation is due from Company S
as part of a PCT. Pursuant to paragraph (c)(3)
of this section, the controlled parties
designate the platform contribution as a
provision of services that would otherwise be
governed by § 1.482–9(a) if entered into by
controlled parties. Accordingly, pursuant to
paragraph (a)(2) of this section, the
applicable method for determining the arm’s
length value of the compensation obligation
under the PCT between Company P and
Company S will be governed by § 1.482–9(a)
as supplemented by paragraph (g) of this
section. Absent a showing to the contrary by
P and S, the platform contribution in this
case is presumed to be the exclusive
provision of the benefits by Company P of its
research team to the development of Vaccine
Z. Because the IDCs include the ongoing
compensation of the researchers, the
compensation obligation under the PCT is
only for the value of the commitment of the
research team by Company P to the CSA’s
development efforts net of such researcher
compensation. The value of the
compensation obligation of Company S for
the PCT will reflect the full value of the
provision of services, as limited by Company
S’s RAB share.

(d) Intangible development costs—(1)
Determining whether costs are IDCs.
Costs included in IDCs are determined
by reference to the scope of the
intangible development activity (IDA).
(i) Definition and scope of the IDA.
For purposes of this section, the IDA
means the activity under the CSA of
developing or attempting to develop
reasonably anticipated cost shared
intangibles. The scope of the IDA
includes all of the controlled

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participants’ activities that could
reasonably be anticipated to contribute
to developing the reasonably anticipated
cost shared intangibles. The IDA cannot
be described merely by a list of
particular resources, capabilities, or
rights that will be used in the CSA,
because such a list would not identify
reasonably anticipated cost shared
intangibles. Also, the scope of the IDA
may change as the nature or identity of
the reasonably anticipated cost shared
intangibles changes or the nature of the
activities necessary for their
development become clearer. For
example, the relevance of certain
ongoing work to developing reasonably
anticipated cost shared intangibles or
the need for additional work may only
become clear over time.
(ii) Reasonably anticipated cost
shared intangible. For purposes of this
section, reasonably anticipated cost
shared intangible means any intangible,
within the meaning of § 1.482–4(b), that,
at the applicable point in time, the
controlled participants intend to
develop under the CSA. Reasonably
anticipated cost shared intangibles may
change over the course of the CSA. The
controlled participants may at any time
change the reasonably anticipated cost
shared intangibles but must document
any such change pursuant to paragraph
(k)(2)(ii)(A)(1) of this section. Removal
of reasonably anticipated cost shared
intangibles does not affect the
controlled participants’ interests in cost
shared intangibles already developed
under the CSA. In addition, the
reasonably anticipated cost shared
intangibles automatically expand to
include the intended result of any
further development of a cost shared
intangible already developed under the
CSA, or applications of such an
intangible. However, the controlled
participants may override this automatic
expansion in a particular case if they
separately remove specified further
development of such intangible (or
specified applications of such
intangible) from the IDA, and document
such separate removal pursuant to
paragraph (k)(2)(ii)(A)(3) of this section.
(iii) Costs included in IDCs. For
purposes of this section, IDCs mean all
costs, in cash or in kind (including
stock-based compensation, as described
in paragraph (d)(3) of this section), but
excluding acquisition costs for land or
depreciable property, in the ordinary
course of business after the formation of
a CSA that, based on analysis of the
facts and circumstances, are directly
identified with, or are reasonably
allocable to, the IDA. Thus, IDCs
include costs incurred in attempting to
develop reasonably anticipated cost

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shared intangibles regardless of whether
such costs ultimately lead to
development of those intangibles, other
intangibles developed unexpectedly, or
no intangibles. IDCs shall also include
the arm’s length rental charge for the
use of any land or depreciable tangible
property (as determined under § 1.482–
2(c) (Use of tangible property)) directly
identified with, or reasonably allocable
to, the IDA. Reference to generally
accepted accounting principles or
Federal income tax accounting rules
may provide a useful starting point but
will not be conclusive regarding
inclusion of costs in IDCs. IDCs do not
include interest expense, foreign income
taxes (as defined in § 1.901–2(a)), or
domestic income taxes.
(iv) Examples. The following
examples illustrate the principles of this
paragraph (d)(1):

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

(2) Allocation of costs. If a particular
cost is directly identified with, or
reasonably allocable to, a function the
results of which will benefit both the
IDA and other business activities, the
cost must be allocated on a reasonable
basis between the IDA and such other
business activities in proportion to the
relative economic value that the IDA
and such other business activities are
anticipated to derive from such results.
(3) Stock-based compensation—(i) In
general. As used in this section, the
term stock-based compensation means

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any compensation provided by a
controlled participant to an employee or
independent contractor in the form of
equity instruments, options to acquire
stock (stock options), or rights with
respect to (or determined by reference
to) equity instruments or stock options,
including but not limited to property to
which section 83 applies and stock
options to which section 421 applies,
regardless of whether ultimately settled
in the form of cash, stock, or other
property.
(ii) Identification of stock-based
compensation with the IDA. The
determination of whether stock-based
compensation is directly identified
with, or reasonably allocable to, the IDA
is made as of the date that the stockbased compensation is granted.
Accordingly, all stock-based
compensation that is granted during the
term of the CSA and, at date of grant,
is directly identified with, or reasonably
allocable to, the IDA is included as an
IDC under paragraph (d)(1) of this
section. In the case of a repricing or
other modification of a stock option, the
determination of whether the repricing
or other modification constitutes the
grant of a new stock option for purposes
of this paragraph (d)(3)(ii) will be made
in accordance with the rules of section
424(h) and related regulations.
(iii) Measurement and timing of stockbased compensation IDC—(A) In
general. Except as otherwise provided
in this paragraph (d)(3)(iii), the cost
attributable to stock-based
compensation is equal to the amount
allowable to the controlled participant
as a deduction for federal income tax
purposes with respect to that stockbased compensation (for example, under
section 83(h)) and is taken into account
as an IDC under this section for the
taxable year for which the deduction is
allowable.
(1) Transfers to which section 421
applies. Solely for purposes of this
paragraph (d)(3)(iii)(A), section 421 does
not apply to the transfer of stock
pursuant to the exercise of an option
that meets the requirements of section
422(a) or 423(a).
(2) Deductions of foreign controlled
participants. Solely for purposes of this
paragraph (d)(3)(iii)(A), an amount is
treated as an allowable deduction of a
foreign controlled participant to the
extent that a deduction would be
allowable to a United States taxpayer.
(3) Modification of stock option.
Solely for purposes of this paragraph
(d)(3)(iii)(A), if the repricing or other
modification of a stock option is
determined, under paragraph (d)(3)(ii)
of this section, to constitute the grant of
a new stock option not identified with,

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or reasonably allocable to, the IDA, the
stock option that is repriced or
otherwise modified will be treated as
being exercised immediately before the
modification, provided that the stock
option is then exercisable and the fair
market value of the underlying stock
then exceeds the price at which the
stock option is exercisable. Accordingly,
the amount of the deduction that would
be allowable (or treated as allowable
under this paragraph (d)(3)(iii)(A)) to
the controlled participant upon exercise
of the stock option immediately before
the modification must be taken into
account as an IDC as of the date of the
modification.
(4) Expiration or termination of CSA.
Solely for purposes of this paragraph
(d)(3)(iii)(A), if an item of stock-based
compensation identified with, or
reasonably allocable to, the IDA is not
exercised during the term of a CSA, that
item of stock-based compensation will
be treated as being exercised
immediately before the expiration or
termination of the CSA, provided that
the stock-based compensation is then
exercisable and the fair market value of
the underlying stock then exceeds the
price at which the stock-based
compensation is exercisable.
Accordingly, the amount of the
deduction that would be allowable (or
treated as allowable under this
paragraph (d)(3)(iii)(A)) to the
controlled participant upon exercise of
the stock-based compensation must be
taken into account as an IDC as of the
date of the expiration or termination of
the CSA.
(B) Election with respect to options on
publicly traded stock—(1) In general.
With respect to stock-based
compensation in the form of options on
publicly traded stock, the controlled
participants in a CSA may elect to take
into account all IDCs attributable to
those stock options in the same amount,
and as of the same time, as the fair value
of the stock options reflected as a charge
against income in audited financial
statements or disclosed in footnotes to
such financial statements, provided that
such statements are prepared in
accordance with United States generally
accepted accounting principles by or on
behalf of the company issuing the
publicly traded stock.
(2) Publicly traded stock. As used in
this paragraph (d)(3)(iii)(B), the term
publicly traded stock means stock that
is regularly traded on an established
United States securities market and is
issued by a company whose financial
statements are prepared in accordance
with United States generally accepted
accounting principles for the taxable
year.

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(3) Generally accepted accounting
principles. For purposes of this
paragraph (d)(3)(iii)(B), a financial
statement prepared in accordance with
a comprehensive body of generally
accepted accounting principles other
than United States generally accepted
accounting principles is considered to
be prepared in accordance with United
States generally accepted accounting
principles provided that either—
(i) The fair value of the stock options
under consideration is reflected in the
reconciliation between such other
accounting principles and United States
generally accepted accounting
principles required to be incorporated
into the financial statement by the
securities laws governing companies
whose stock is regularly traded on
United States securities markets; or
(ii) In the absence of a reconciliation
between such other accounting
principles and United States generally
accepted accounting principles that
reflects the fair value of the stock
options under consideration, such other
accounting principles require that the
fair value of the stock options under
consideration be reflected as a charge
against income in audited financial
statements or disclosed in footnotes to
such statements.
(4) Time and manner of making the
election. The election described in this
paragraph (d)(3)(iii)(B) is made by an
explicit reference to the election in the
written contract required by paragraph
(k)(1) of this section or in a written
amendment to the CSA entered into
with the consent of the Commissioner
pursuant to paragraph (d)(3)(iii)(C) of
this section. In the case of a CSA in
existence on August 26, 2003, the
election by written amendment to the
CSA may be made without the consent
of the Commissioner if such amendment
is entered into not later than the latest
due date (with regard to extensions) of
a federal income tax return of any
controlled participant for the first
taxable year beginning after August 26,
2003.
(C) Consistency. Generally, all
controlled participants in a CSA taking
options on publicly traded stock into
account under paragraph (d)(3)(ii),
(d)(3)(iii)(A), or (d)(3)(iii)(B) of this
section must use that same method of
identification, measurement and timing
for all options on publicly traded stock
with respect to that CSA. Controlled
participants may change their method
only with the consent of the
Commissioner and only with respect to
stock options granted during taxable
years subsequent to the taxable year in
which the Commissioner’s consent is
obtained. All controlled participants in

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the CSA must join in requests for the
Commissioner’s consent under this
paragraph (d)(3)(iii)(C). Thus, for
example, if the controlled participants
make the election described in
paragraph (d)(3)(iii)(B) of this section
upon the formation of the CSA, the
election may be revoked only with the
consent of the Commissioner, and the
consent will apply only to stock options
granted in taxable years subsequent to
the taxable year in which consent is
obtained. Similarly, if controlled
participants already have granted stock
options that have been or will be taken
into account under the general rule of
paragraph (d)(3)(iii)(A) of this section,
then except in cases specified in the last
sentence of paragraph (d)(3)(iii)(B)(4) of
this section, the controlled participants
may make the election described in
paragraph (d)(3)(iii)(B) of this section
only with the consent of the
Commissioner, and the consent will
apply only to stock options granted in
taxable years subsequent to the taxable
year in which consent is obtained.
(4) IDC share. A controlled
participant’s IDC share for a taxable year
is equal to the controlled participant’s
cost contribution for the taxable year,
divided by the sum of all IDCs for the
taxable year. A controlled participant’s
cost contribution for a taxable year
means all of the IDCs initially borne by
the controlled participant, plus all of the
CST Payments that the participant
makes to other controlled participants,
minus all of the CST Payments that the
participant receives from other
controlled participants.
(5) Examples. The following examples
illustrate this paragraph (d):
Example 1. Foreign parent (FP) and its U.S.
subsidiary (USS) enter into a CSA to develop
a better mousetrap. USS and FP share the
costs of FP’s R&D facility that will be
exclusively dedicated to this research, the
salaries of the researchers at the facility, and
overhead costs attributable to the project.
They also share the cost of a conference
facility that is at the disposal of the senior
executive management of each company.
Based on the facts and circumstances, the
cost of the conference facility cannot be
directly identified with, and is not
reasonably allocable to, the IDA. In this case,
the cost of the conference facility must be
excluded from the amount of IDCs.
Example 2. U.S. parent (USP) and its
foreign subsidiary (FS) enter into a CSA to
develop intangibles for producing a new
device. USP and FS share the costs of an R&D
facility, the salaries of the facility’s
researchers, and overhead costs attributable
to the project. Although USP also incurs
costs related to field testing of the device,
USP does not include those costs in the IDCs
that USP and FS will share under the CSA.
The Commissioner may determine, based on
the facts and circumstances, that the costs of

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field testing are IDCs that the controlled
participants must share.
Example 3. U.S. parent (USP) and its
foreign subsidiary (FS) enter into a CSA to
develop a new process patent. USP assigns
certain employees to perform solely R&D to
develop a new mathematical algorithm to
perform certain calculations. That algorithm
will be used both to develop the new process
patent and to develop a new design patent
the development of which is outside the
scope of the CSA. During years covered by
the CSA, USP compensates such employees
with cash salaries, stock-based
compensation, or a combination of both. USP
and FS anticipate that the economic value
attributable to the R&D will be derived from
the process patent and the design patent in
a relative proportion of 75% and 25%,
respectively. Applying the principles of
paragraph (d)(2) of this section, 75% of the
compensation of such employees must be
allocated to the development of the new
process patent and, thus, treated as IDCs.
With respect to the cash salary
compensation, the IDC is 75% of the face
value of the cash. With respect to the stockbased compensation, the IDC is 75% of the
value of the stock-based compensation as
determined under paragraph (d)(3)(iii) of this
section.
Example 4. Foreign parent (FP) and its U.S.
subsidiary (USS) enter into a CSA to develop
a new computer source code. FP has an
executive officer who oversees a research
facility and employees dedicated solely to
the IDA. The executive officer also oversees
other research facilities and employees
unrelated to the IDA, and performs certain
corporate overhead functions. The full
amount of the costs of the research facility
and employees dedicated solely to the IDA
can be directly identified with the IDA and,
therefore, are IDCs. In addition, based on the
executive officer’s records of time worked on
various matters, the controlled participants
reasonably allocate 20% of the executive
officer’s compensation to supervision of the
facility and employees dedicated to the IDA,
50% of the executive officer’s compensation
to supervision of the facilities and employees
unrelated to the IDA, and 30% of the
executive officer’s compensation to corporate
overhead functions. The controlled
participants also reasonably determine that
the results of the executive officer’s corporate
overhead functions yield equal economic
benefit to the IDA and the other business
activities of FP. Applying the principles of
paragraph (d)(1) of this section, the executive
officer’s compensation allocated to
supervising the facility and employees
dedicated to the IDA (amounting to 20% of
the executive officer’s total compensation)
must be treated as IDCs. Applying the
principles of paragraph (d)(2) of this section,
half of the executive officer’s compensation
allocated to corporate overhead functions
(that is, half of 30% of the executive officer’s
total compensation), must be treated as IDCs.
Therefore, a total of 35% (20% plus 15%) of
the executive officer’s total compensation
must be treated as IDCs.

(e) Reasonably anticipated benefits
share—(1) Definition—(i) In general. A
controlled participant’s share of

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reasonably anticipated benefits is equal
to its reasonably anticipated benefits
divided by the sum of the reasonably
anticipated benefits, as defined in
paragraph (j)(1)(i) of this section, of all
the controlled participants. RAB shares
must be updated to account for changes
in economic conditions, the business
operations and practices of the
participants, and the ongoing
development of intangibles under the
CSA. For purposes of determining RAB
shares at any given time, reasonably
anticipated benefits must be estimated
over the entire period, past and future,
of exploitation of the cost shared
intangibles, and must reflect appropriate
updates to take into account the most
reliable data regarding past and
projected future results available at such
time. RAB shares determined for a
particular purpose shall not be further
updated for that purpose based on
information not available at the time
that determination needed to be made.
For example, RAB shares determined in
order to determine IDC shares for a
particular taxable year (as set forth in
paragraphs (b)(1)(i) and (d)(4) of this
section) shall not be recomputed based
on information not available at that
time. Similarly, RAB shares determined
for the purpose of using a particular
method such as the acquisition price
method (as set forth in paragraph
(g)(5)(ii) of this section) to evaluate the
arm’s length amount charged in a PCT
shall not be recomputed based on
information not available at the date of
that PCT. However, nothing in this
paragraph (e)(1)(i) shall limit the
Commissioner’s use of subsequently
available information for purposes of its
allocation determinations in accordance
with the provisions of paragraph (i)
(Allocations by the Commissioner in
connection with a CSA) of this section.
(ii) Reliability. A controlled
participant’s RAB share must be
determined by using the most reliable
estimate. In determining which of two
or more available estimates is most
reliable, the quality of the data and
assumptions used in the analysis must
be taken into account, consistent with
§ 1.482–1(c)(2)(ii) (Data and
assumptions). Thus, the reliability of an
estimate will depend largely on the
completeness and accuracy of the data,
the soundness of the assumptions, and
the relative effects of particular
deficiencies in data or assumptions on
different estimates. If two estimates are
equally reliable, no adjustment should
be made based on differences between
the estimates. The following factors will
be particularly relevant in determining

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the reliability of an estimate of RAB
shares:
(A) The basis used for measuring
benefits, as described in paragraph
(e)(2)(ii) of this section.
(B) The projections used to estimate
benefits, as described in paragraph
(e)(2)(iii) of this section.
(iii) Examples. The following
examples illustrate the principles of this
paragraph (e)(1):
Example 1. (i) USP and FS plan to conduct
research to develop Product Lines A and B.
USP and FS reasonably anticipate respective
benefits from Product Line A of 100X and
200X and respective benefits from Product
Line B, respectively, of 300X and 400X. USP
and FS thus reasonably anticipate combined
benefits from Product Lines A and B of 400X
and 600X, respectively.
(ii) USP and FS could enter into a separate
CSA to develop Product Line A with
respective RAB shares of 331⁄3 percent and
662⁄3 percent (reflecting a ratio of 100X to
200X), and into a separate CSA to develop
Product Line B with respective RAB shares
of 426⁄7 percent and 571⁄7 percent (reflecting
a ratio of 300X to 400X). Alternatively, USP
and FS could enter into a single CSA to
develop both Product Lines A and B with
respective RAB shares of 40 percent and 60
percent (in the ratio of 400X to 600X). If the
separate CSAs are chosen, then any costs for
activities that contribute to developing both
Product Line A and Product Line B will
constitute IDCs of the respective CSAs as
required by paragraphs (d)(1) and (2) of this
section.
Example 2. (i) USP, a US company, wholly
owns foreign subsidiary, FS. USP and FS
enter into a CSA at the start of Year 1. The
CSA’s total IDCs are $100,000 in each year
for Years 1 through 4. In Year 1, USP
correctly estimates its RAB share as 50%,
based on information available at the time,
and therefore correctly computes $50,000 as
its cost contribution for Year 1.
(ii) In Year 4, USP correctly estimates its
RAB share to be 70%, based on information
available at the time and, therefore, correctly
computes $70,000 as its cost contribution for
Year 4.
(iii) In Year 4, USP also files an amended
return for Year 1 in which USP deducts a
cost contribution of $70,000, asserting that,
for this purpose, it should revise its Year 1
estimated RAB share to 70% based on the
information that is now available to it in Year
4. The Commissioner determines that USP is
incorrect for two reasons. First, a RAB share
determined for a particular purpose (here, to
determine USP’s IDC shares and thus USP’s
cost contributions in Year 1) should not be
revised based on information not available to
USP until Year 4. See paragraph (e)(1)(i) of
this section. Second, more generally, USP is
not permitted to file an amended return for
this purpose under § 1.482–1(a)(3). Therefore,
for both of these reasons, Commissioner
adjusts USP’s amended return for Year 1 by
disallowing $20,000 of the $70,000
deduction.

(2) Measure of benefits—(i) In general.
In order to estimate a controlled

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participant’s RAB share, the amount of
each controlled participant’s reasonably
anticipated benefits must be measured
on a basis that is consistent for all such
participants. See paragraph (e)(2)(ii)(E)
Example 9 of this section. If a controlled
participant transfers a cost shared
intangible to another controlled
taxpayer, other than by way of a transfer
described in paragraph (f) of this
section, that controlled participant’s
benefits from the transferred intangible
must be measured by reference to the
transferee’s benefits, disregarding any
consideration paid by the transferee to
the controlled participant (such as a
royalty pursuant to a license agreement).
Reasonably anticipated benefits are
measured either on a direct basis, by
reference to estimated benefits to be
generated by the use of cost shared
intangibles (generally based on
additional revenues plus cost savings
less any additional costs incurred), or
on an indirect basis, by reference to
certain measurements that reasonably
can be assumed to relate to benefits to
be generated. Such indirect bases of
measurement of anticipated benefits are
described in paragraph (e)(2)(ii) of this
section. A controlled participant’s
reasonably anticipated benefits must be
measured on the basis, whether direct or
indirect, that most reliably determines
RAB shares. In determining which of
two bases of measurement is most
reliable, the factors set forth in § 1.482–
1(c)(2)(ii) (Data and assumptions) must
be taken into account. It normally will
be expected that the basis that provided
the most reliable estimate for a
particular year will continue to provide
the most reliable estimate in subsequent
years, absent a material change in the
factors that affect the reliability of the
estimate. Regardless of whether a direct
or indirect basis of measurement is
used, adjustments may be required to
account for material differences in the
activities that controlled participants
undertake to exploit their interests in
cost shared intangibles. See Examples 4
and 7 of paragraph (e)(2)(ii)(E) of this
section.
(ii) Indirect bases for measuring
anticipated benefits. Indirect bases for
measuring anticipated benefits from
participation in a CSA include the
following:
(A) Units used, produced, or sold.
Units of items used, produced, or sold
by each controlled participant in the
business activities in which cost shared
intangibles are exploited may be used as
an indirect basis for measuring its
anticipated benefits. This basis of
measurement will more reliably
determine RAB shares to the extent that
each controlled participant is expected

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to have a similar increase in net profit
or decrease in net loss attributable to the
cost shared intangibles per unit of the
item or items used, produced, or sold.
This circumstance is most likely to arise
when the cost shared intangibles are
exploited by the controlled participants
in the use, production, or sale of
substantially uniform items under
similar economic conditions.
(B) Sales. Sales by each controlled
participant in the business activities in
which cost shared intangibles are
exploited may be used as an indirect
basis for measuring its anticipated
benefits. This basis of measurement will
more reliably determine RAB shares to
the extent that each controlled
participant is expected to have a similar
increase in net profit or decrease in net
loss attributable to cost shared
intangibles per dollar of sales. This
circumstance is most likely to arise if
the costs of exploiting cost shared
intangibles are not substantial relative to
the revenues generated, or if the
principal effect of using cost shared
intangibles is to increase the controlled
participants’ revenues (for example,
through a price premium on the
products they sell) without affecting
their costs substantially. Sales by each
controlled participant are unlikely to
provide a reliable basis for measuring
RAB shares unless each controlled
participant operates at the same market
level (for example, manufacturing,
distribution, etc.).
(C) Operating profit. Operating profit
of each controlled participant from the
activities in which cost shared
intangibles are exploited, as determined
before any expense (including
amortization) on account of IDCs, may
be used as an indirect basis for
measuring anticipated benefits. This
basis of measurement will more reliably
determine RAB shares to the extent that
such profit is largely attributable to the
use of cost shared intangibles, or if the
share of profits attributable to the use of
cost shared intangibles is expected to be
similar for each controlled participant.
This circumstance is most likely to arise
when cost shared intangibles are closely
associated with the activity that
generates the profit and the activity
could not be carried on or would
generate little profit without use of
those intangibles.
(D) Other bases for measuring
anticipated benefits. Other bases for
measuring anticipated benefits may in
some circumstances be appropriate, but
only to the extent that there is expected
to be a reasonably identifiable
relationship between the basis of
measurement used and additional
revenue generated or net costs saved by

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the use of cost shared intangibles. For
example, a division of costs based on
employee compensation would be
considered unreliable unless there were
a relationship between the amount of
compensation and the expected
additional revenue generated or net
costs saved by the controlled
participants from using the cost shared
intangibles.
(E) Examples. The following examples
illustrates this paragraph (e)(2)(ii):
Example 1. Controlled parties A and B
enter into a CSA to develop product and
process intangibles for already existing
Product P. Without such intangibles, A and
B would each reasonably anticipate revenue,
in present value terms, of $100M from sales
of Product P until it becomes obsolete. With
the intangibles, A and B each reasonably
anticipate selling the same number of units
each year, but reasonably anticipate that the
price will be higher. Because the particular
product intangible is more highly regarded in
A’s market, A reasonably anticipates an
increase of $20M in present value revenue
from the product intangible, while B
reasonably anticipates an increase of only
$10M in present value from the product
intangible. Further, A and B each reasonably
anticipate spending an additional amount
equal to $5M in present value in production
costs to include the feature embodying the
product intangible. Finally, A and B each
reasonably anticipate saving an amount equal
to $2M in present value in production costs
by using the process intangible. A and B
reasonably anticipate no other economic
effects from exploiting the cost shared
intangibles. A’s reasonably anticipated
benefits from exploiting the cost shared
intangibles equal its reasonably anticipated
increase in revenue ($20M) plus its
reasonably anticipated cost savings ($2M)
less its reasonably anticipated increased costs
($5M), which equals $17M. Similarly, B’s
reasonably anticipated benefits from
exploiting the cost shared intangibles equal
its reasonably anticipated increase in revenue
($10M) plus its reasonably anticipated cost
savings ($2M) less its reasonably anticipated
increased costs ($5M), which equals $7M.
Thus A’s reasonably anticipated benefits are
$17M and B’s reasonably anticipated benefits
are $7M.
Example 2. Foreign Parent (FP) and U.S.
Subsidiary (USS) both produce a feedstock
for the manufacture of various highperformance plastic products. Producing the
feedstock requires large amounts of
electricity, which accounts for a significant
portion of its production cost. FP and USS
enter into a CSA to develop a new process
that will reduce the amount of electricity
required to produce a unit of the feedstock.
FP and USS currently both incur an
electricity cost of $2 per unit of feedstock
produced and rates for each are expected to
remain similar in the future. The new
process, if it is successful, will reduce the
amount of electricity required by each
company to produce a unit of the feedstock
by 50%. Switching to the new process would
not require FP or USS to incur significant

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investment or other costs. Therefore, the cost
savings each company is expected to achieve
after implementing the new process are $1
per unit of feedstock produced. Under the
CSA, FP and USS divide the costs of
developing the new process based on the
units of the feedstock each is anticipated to
produce in the future. In this case, units
produced is the most reliable basis for
measuring RAB shares and dividing the IDCs
because each controlled participant is
expected to have a similar $1 (50% of current
charge of $2) decrease in costs per unit of the
feedstock produced.
Example 3. The facts are the same as in
Example 2, except that currently USS pays
$3 per unit of feedstock produced for
electricity while FP pays $6 per unit of
feedstock produced. In this case, units
produced is not the most reliable basis for
measuring RAB shares and dividing the IDCs
because the participants do not expect to
have a similar decrease in costs per unit of
the feedstock produced. The Commissioner
determines that the most reliable measure of
RAB shares may be based on units of the
feedstock produced if FP’s units are weighted
relative to USS’s units by a factor of 2. This
reflects the fact that FP pays twice as much
as USS for electricity and, therefore, FP’s
savings of $3 per unit of the feedstock (50%
reduction of current charge of $6) would be
twice USS’s savings of $1.50 per unit of
feedstock (50% reduction of current charge of
$3) from any new process eventually
developed.
Example 4. The facts are the same as in
Example 3, except that to supply the
particular needs of the U.S. market USS
manufactures the feedstock with somewhat
different properties than FP’s feedstock. This
requires USS to employ a somewhat different
production process than does FP. Because of
this difference, USS would incur significant
construction costs in order to adopt any new
process that may be developed under the cost
sharing agreement. In this case, units
produced is not the most reliable basis for
measuring RAB shares. In order to reliably
determine RAB shares, the Commissioner
measures the reasonably anticipated benefits
of USS and FP on a direct basis. USS’s
reasonably anticipated benefits are its
reasonably anticipated total savings in
electricity costs, less its reasonably
anticipated costs of adopting the new
process. FS’s reasonably anticipated benefits
are its reasonably anticipated total savings in
electricity costs.
Example 5. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a CSA to develop
new anesthetic drugs. USP obtains the right
to market any resulting drugs in the United
States and FS obtains the right to market any
resulting drugs in the rest of the world. USP
and FS determine RAB shares on the basis of
their respective total anticipated operating
profit from all drugs under development.
USP anticipates that it will receive a much
higher profit than FS per unit sold because
the price of the drugs is not regulated in the
United States, whereas the price of the drugs
is regulated in many non-U.S. jurisdictions.
In both controlled participants’ territories,
the anticipated operating profits are almost
entirely attributable to the use of the cost

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shared intangibles. In this case, the
controlled participants’ basis for measuring
RAB shares is the most reliable.
Example 6. (i) Foreign Parent (FP) and U.S.
Subsidiary (USS) manufacture and sell
fertilizers. They enter into a CSA to develop
a new pellet form of a common agricultural
fertilizer that is currently available only in
powder form. Under the CSA, USS obtains
the rights to produce and sell the new form
of fertilizer for the U.S. market while FP
obtains the rights to produce and sell the new
form of fertilizer in the rest of the world. The
costs of developing the new form of fertilizer
are divided on the basis of the anticipated
sales of fertilizer in the controlled
participants’ respective markets.
(ii) If the research and development is
successful, the pellet form will deliver the
fertilizer more efficiently to crops and less
fertilizer will be required to achieve the same
effect on crop growth. The pellet form of
fertilizer can be expected to sell at a price
premium over the powder form of fertilizer
based on the savings in the amount of
fertilizer that needs to be used. This price
premium will be a similar premium per
dollar of sales in each territory. If the
research and development is successful, the
costs of producing pellet fertilizer are
expected to be approximately the same as the
costs of producing powder fertilizer and the
same for both FP and USS. Both FP and USS
operate at approximately the same market
levels, selling their fertilizers largely to
independent distributors.
(iii) In this case, the controlled
participants’ basis for measuring RAB shares
is the most reliable.
Example 7. The facts are the same as in
Example 6, except that FP distributes its
fertilizers directly while USS sells to
independent distributors. In this case, sales
of USS and FP are not the most reliable basis
for measuring RAB shares unless adjustments
are made to account for the difference in
market levels at which the sales occur.
Example 8. Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a CSA to develop
materials that will be used to train all new
entry-level employees. FP and USS
determine that the new materials will save
approximately ten hours of training time per
employee. Because their entry-level
employees are paid on differing wage scales,
FP and USS decide that they should not
measure benefits based on the number of
entry-level employees hired by each. Rather,
they measure benefits based on
compensation paid to the entry-level
employees hired by each. In this case, the
basis used for measuring RAB shares is the
most reliable because there is a direct
relationship between compensation paid to
new entry-level employees and costs saved
by FP and USS from the use of the new
training materials.
Example 9. U.S. Parent (USP), Foreign
Subsidiary 1 (FS1), and Foreign Subsidiary 2
(FS2) enter into a CSA to develop computer
software that each will market and install on
customers’ computer systems. The controlled
participants measure benefits on the basis of
projected sales by USP, FS1, and FS2 of the
software in their respective geographic areas.
However, FS1 plans not only to sell but also

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to license the software to unrelated
customers, and FS1’s licensing income
(which is a percentage of the licensees’ sales)
is not counted in the projected benefits. In
this case, the basis used for measuring the
benefits of each controlled participant is not
the most reliable because all of the benefits
received by controlled participants are not
taken into account. In order to reliably
determine RAB shares, FS1’s projected
benefits from licensing must be included in
the measurement on a basis that is the same
as that used to measure its own and the other
controlled participants’ projected benefits
from sales (for example, all controlled
participants might measure their benefits on
the basis of operating profit).

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

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Example 1. (i) Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a CSA to develop
a new car model. The controlled participants
plan to spend four years developing the new
model and four years producing and selling
the new model. USS and FP project total
sales of $4 billion and $2 billion,
respectively, over the planned four years of
exploitation of the new model. The
controlled participants determine RAB shares
for each year of 662⁄3% for USS and 331⁄3%
for FP, based on projected total sales.
(ii) USS typically begins producing and
selling new car models a year after FP begins
producing and selling new car models. In
order to reflect USS’s one-year lag in
introducing new car models, a more reliable
projection of each participant’s RAB share
would be based on a projection of all four
years of sales for each participant, discounted
to present value.
Example 2. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a CSA to develop
new and improved household cleaning
products. Both controlled participants have
sold household cleaning products for many
years and have stable worldwide market
shares. The products under development are
unlikely to produce unusual profits for either
controlled participant. The controlled
participants determine RAB shares on the
basis of each controlled participant’s current
sales of household cleaning products. In this
case, the controlled participants’ RAB shares
are reliably projected by current sales of
cleaning products.
Example 3. The facts are the same as in
Example 2, except that FS’s market share is
rapidly expanding because of the business
failure of a competitor in its geographic area.
The controlled participants’ RAB shares are
not reliably projected by current sales of
cleaning products. FS’s benefit projections
should take into account its growth in market
share.
Example 4. Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a CSA to develop
synthetic fertilizers and insecticides. FP and
USS share costs on the basis of each
controlled participant’s current sales of
fertilizers and insecticides. The market
shares of the controlled participants have
been stable for fertilizers, but FP’s market
share for insecticides has been expanding.
The controlled participants’ projections of
RAB shares are reliable with regard to
fertilizers, but not reliable with regard to
insecticides; a more reliable projection of
RAB shares would take into account the
expanding market share for insecticides.

(f) Changes in participation under a
CSA—(1) In general. A change in
participation under a CSA occurs when
there is either a controlled transfer of
interests or a capability variation. A
change in participation requires arm’s
length consideration under paragraph
(a)(3)(ii) of this section, and as more
fully described in this paragraph (f).
(2) Controlled transfer of interests. A
controlled transfer of interests occurs
when a participant in a CSA transfers all
or part of its interests in cost shared
intangibles under the CSA in a

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controlled transaction, and the
transferee assumes the associated
obligations under the CSA. For example,
a change in the territorial based
divisional interests or field of use based
divisional interests, as described in
paragraph (b)(4), is a controlled transfer
of interests. After the controlled transfer
of interests occurs, the CSA will still
exist if at least two controlled
participants still have interests in the
cost shared intangibles. In such a case,
the transferee will be treated as
succeeding to the transferor’s prior
history under the CSA as pertains to the
transferred interests, including the
transferor’s cost contributions, benefits
derived, and PCT Payments attributable
to such rights or obligations. A transfer
that would otherwise constitute a
controlled transfer of interests for
purposes of this paragraph (f)(2) shall
not constitute a controlled transfer of
interests if it also constitutes a
capability variation for purposes of
paragraph (f)(3) of this section.
(3) Capability variation. A capability
variation occurs when, in a CSA in
which interests in cost shared
intangibles are divided as described in
paragraph (b)(4)(iv) of this section, the
controlled participants’ division of
interests or their relative capabilities or
capacities to benefit from the cost
shared intangibles are materially
altered. For purposes of paragraph
(a)(3)(ii) of this section, a capability
variation is considered to be a
controlled transfer of interests in cost
shared intangibles, in which any
controlled participant whose RAB share
decreases as a result of the capability
variation is a transferor, and any
controlled participant whose RAB share
thus increases is the transferee of the
interests in cost shared intangibles.
(4) Arm’s length consideration for a
change in participation. In the event of
a change in participation, the arm’s
length amount of consideration from the
transferee, under the rules of §§ 1.482–
1 and 1.482–4 through 1.482–6 and
paragraph (a)(3)(ii) of this section, will
be determined consistent with the
reasonably anticipated incremental
change in the returns to the transferee
and transferor resulting from such
change in participation. Such changes
in returns will themselves depend on
the reasonably anticipated incremental
changes in the benefits from exploiting
the cost shared intangibles, IDCs borne,
and PCT Payments (if any). However,
any arm’s length consideration required
under this paragraph (f)(4) with respect
to a capability variation shall be
reduced as necessary to prevent
duplication of an adjustment already
performed under paragraph (i)(2)(ii)(A)

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of this section that resulted from the
same capability variation. If an
adjustment has been performed already
under this paragraph (f)(4) with respect
to a capability variation, then for
purposes of any adjustment to be
performed under paragraph (i)(2)(ii)(A)
of this section, the controlled
participants’ projected benefit shares
referred to in paragraph (i)(2)(ii)(A) of
this section shall be considered to be the
controlled participants’ respective RAB
shares after the capability variation
occurred.
(5) Examples. The following examples
illustrate the principles of this
paragraph (f):

precludes the possibility that P or S will
build a new facility during the period for
which sales of Product Z are expected. When
the CSA is formed, P has a platform
contribution T. Under the PCT for T, S is
obligated to pay P sales-based royalties
according to a certain formula. Aside from T,
there are no other platform contributions.
Two years after the formation of the CSA,
owing to a change in plans not reasonably
foreseeable at the time the CSA was entered
into, S acquires additional facilities F for the
manufacture of Product Z. Such acquisition
constitutes a capability variation described in
paragraph (f)(3) of this section. Under this
capability variation, S’s RAB share increases
from 50% to 60%. Accordingly, there is a
compensable change in participation under
paragraph (f)(3) of this section.

Example 1. X, Y, and Z are the only
controlled participants in a CSA. The CSA
divides interests in cost shared intangibles on
a territorial basis as described in paragraph
(b)(4)(ii) of this section. X is assigned the
territories of the Americas, Y is assigned the
territory of the UK and Australia, and Z is
assigned the rest of the world. When the CSA
is formed, X has a platform contribution T.
Under the PCTs for T, Y and Z are each
obligated to pay X royalties equal to five
percent of their respective sales. Aside from
T, there are no platform contributions. Two
years after the formation of the CSA, Y
transfers to Z its interest in cost shared
intangibles relating to the UK territory, and
the associated obligations, in a controlled
transfer of interests described in paragraph
(f)(2) of this section. At that time the
reasonably anticipated benefits from
exploiting cost shared intangibles in the UK
have a present value of $11M, the reasonably
anticipated IDCs to be borne relating to the
UK territory have a present value of $3M, and
the reasonably anticipated PCT Payments to
be made to X relating to sales in the UK
territory have a present value of $2M. As
arm’s length consideration for the change in
participation due to the controlled transfer of
interests, Z must pay Y compensation with
an anticipated present value of $11M, less
$3M, less $2M, which equals $6M.
Example 2. As in Example 2 of paragraph
(b)(4)(v) of this section, companies P and S,
both members of the same controlled group,
enter into a CSA to develop product Z. P and
S agree to divide their interest in product Z
based on site of manufacturing. P will have
exclusive and perpetual rights in product Z
manufactured in facilities owned by P. S will
have exclusive and perpetual rights to
product Z manufactured in facilities owned
by S. P and S agree that neither will license
manufacturing rights in product Z to any
related or unrelated party. Both P and S
maintain books and records that allow
production at all sites to be verified. Both
own facilities that will manufacture product
Z and the relative capacities of these sites are
known. All facilities are currently operating
at near capacity and are expected to continue
to operate at near capacity when product Z
enters production so that it will not be
feasible to shift production between P’s and
S’s facilities. P and S have no plans to build
new facilities and the lead time required to
plan and build a manufacturing facility

(g) Supplemental guidance on
methods applicable to PCTs—(1) In
general. This paragraph (g) provides
supplemental guidance on applying the
methods listed in this paragraph (g)(1)
for purposes of evaluating the arm’s
length amount charged in a PCT. Each
method will yield a value for the
compensation obligation of each PCT
Payor consistent with the product of the
combined pre-tax value to all controlled
participants of the platform contribution
that is the subject of the PCT and the
PCT Payor’s RAB share. Each method
must yield results consistent with
measuring the value of a platform
contribution by reference to the future
income anticipated to be generated by
the resulting cost shared intangibles.
The methods are—
(i) The comparable uncontrolled
transaction method described in
§ 1.482–4(c), or the comparable
uncontrolled services price method
described in § 1.482–9(c), as further
described in paragraph (g)(3) of this
section;
(ii) The income method, described in
paragraph (g)(4) of this section;
(iii) The acquisition price method,
described in paragraph (g)(5) of this
section;
(iv) The market capitalization method,
described in paragraph (g)(6) of this
section;
(v) The residual profit split method,
described in paragraph (g)(7) of this
section; and
(vi) Unspecified methods, described
in paragraph (g)(8) of this section.
(2) Best method analysis applicable
for evaluation of a PCT pursuant to a
CSA—(i) In general. Each method must
be applied in accordance with the
provisions of § 1.482–1, including the
best method rule of § 1.482–1(c), the
comparability analysis of § 1.482–1(d),
and the arm’s length range of § 1.482–
1(e), except as those provisions are
modified in this paragraph (g).
(ii) Consistency with upfront
contractual terms and risk allocation—

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the investor model—(A) In general.
Although all of the factors entering into
a best method analysis described in
§ 1.482–1(c) and (d) must be considered,
specific factors may be particularly
relevant in the context of a CSA. In
particular, the relative reliability of an
application of any method depends on
the degree of consistency of the analysis
with the applicable contractual terms
and allocation of risk under the CSA
and this section among the controlled
participants as of the date of the PCT,
unless a change in such terms or
allocation has been made in return for
arm’s length consideration. In this
regard, a CSA involves an upfront
division of the risks as to both
reasonably anticipated obligations and
reasonably anticipated benefits over the
reasonably anticipated term of the CSA
Activity. Accordingly, the relative
reliability of an application of a method
also depends on the degree of
consistency of the analysis with the
assumption that, as of the date of the
PCT, each controlled participant’s
aggregate net investment in the CSA
Activity (including platform
contributions, operating contributions,
as such term is defined in paragraph
(j)(1)(i) of this section, operating cost
contributions, as such term is defined in
paragraph (j)(1)(i) of this section, and
cost contributions) is reasonably
anticipated to earn a rate of return
(which might be reflected in a discount
rate used in applying a method)
appropriate to the riskiness of the
controlled participant’s CSA Activity
over the entire period of such CSA
Activity. If the cost shared intangibles
themselves are reasonably anticipated to
contribute to developing other
intangibles, then the period described in
the preceding sentence includes the
period, reasonably anticipated as of the
date of the PCT, of developing and
exploiting such indirectly benefited
intangibles.
(B) Example. The following example
illustrates the principles of this
paragraph (g)(2)(ii):
Example. (i) P, a U.S. corporation, has
developed a software program, DEF, which
applies certain algorithms to reconstruct
complete DNA sequences from partiallyobserved DNA sequences. S is a whollyowned foreign subsidiary of P. On the first
day of Year 1, P and S enter into a CSA to
develop a new generation of genetic tests,
GHI, based in part on the use of DEF. DEF
is therefore a platform contribution of P for
which compensation is due from S pursuant
to a PCT. S makes no platform contributions
to the CSA. Sales of GHI are projected to
commence two years after the inception of
the CSA and then to continue for eight more
years. Based on industry experience, P and
S are confident that GHI will be replaced by

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a new type of genetic testing based on
technology unrelated to DEF or GHI and that,
at that point, GHI will have no further value.
P and S project that that replacement will
occur at the end of Year 10.
(ii) For purposes of valuing the PCT for P’s
platform contribution of DEF to the CSA, P
and S apply a type of residual profit split
method that is not described in paragraph
(g)(7) of this section and which, accordingly,
constitutes an unspecified method. See
paragraph (g)(7)(i) (last sentence) of this
section. The principles of this paragraph
(g)(2) apply to any method for valuing a PCT,
including the unspecified method used by P
and S.
(iii) Under the method employed by P and
S, in each year, a portion of the income from
sales of GHI in S’s territory is allocated to
certain routine contributions made by S. The
residual of the profit or loss from GHI sales
in S’s territory after the routine allocation
step is divided between P and S pro rata to
their capital stocks allocable to S’s territory.
Each controlled participant’s capital stock is
computed by capitalizing, applying a capital
growth factor to, and amortizing its historical
expenditures regarding DEF allocable to S’s
territory (in the case of P), or its ongoing cost
contributions towards developing GHI (in the
case of S). The amortization of the capital
stocks is effected on a straight-line basis over
an assumed four-year life for the relevant
expenditures. The capital stocks are grown
using an assumed growth factor that P and
S consider to be appropriate.
(iv) The assumption that all expenditures
amortize on a straight-line basis over four
years does not appropriately reflect the
principle that as of the date of the PCT
regarding DEF, every contribution to the
development of GHI, including DEF, is
reasonably anticipated to have value
throughout the entire period of exploitation
of GHI which is projected to continue
through Year 10. Under this method as
applied by P and S, the share of the residual
profit in S’s territory that is allocated to P as
a PCT Payment from S will decrease every
year. After Year 4, P’s capital stock in DEF
will necessarily be $0, so that P will receive
none of the residual profit or loss from GHI
sales in S’s territory after Year 4 as a PCT
Payment.
(v) As a result of this limitation of the PCT
Payments to be made by S, the anticipated
return to S’s aggregate investment in the
CSA, over the whole period of S’s CSA
Activity, is at a rate that is significantly
higher than the appropriate rate of return for
S’s CSA Activity (as determined by a reliable
method). This discrepancy is not consistent
with the investor model principle that S
should anticipate a rate of return to its
aggregate investment in the CSA, over the
whole period of its CSA Activity, appropriate
for the riskiness of its CSA Activity. The
inconsistency of the method with the
investor model materially lessens its
reliability for purposes of a best method
analysis. See § 1.482–1(c)(2)(ii)(B).

(iii) Consistency of evaluation with
realistic alternatives—(A) In general.
The relative reliability of an application
of a method also depends on the degree

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of consistency of the analysis with the
assumption that uncontrolled taxpayers
dealing at arm’s length would have
evaluated the terms of the transaction,
and only entered into such transaction,
if no alternative is preferable. This
condition is not met, therefore, where
for any controlled participant the total
anticipated present value of its income
attributable to its entering into the CSA,
as of the date of the PCT, is less than
the total anticipated present value of its
income that could be achieved through
an alternative arrangement realistically
available to that controlled participant.
In principle, this comparison is made on
a post-tax basis but, in many cases, a
comparison made on a pre-tax basis will
yield equivalent results. See also
paragraph (g)(2)(v)(B)(1) of this section
(Discount rate variation between
realistic alternatives).
(B) Examples. The following
examples illustrate the principles of this
paragraph (g)(2)(iii):
Example 1. (i) P, a corporation, and S, a
wholly-owned subsidiary of P, enter into a
CSA to develop a personal transportation
device (the product). Under the arrangement,
P will undertake all of the R&D, and
manufacture and market the product in
Country X. S will make CST Payments to P
for its appropriate share of P’s R&D costs, and
manufacture and market the product in the
rest of the world. P owns existing patents and
trade secrets that are reasonably anticipated
to contribute to the development of the
product. Therefore the rights in the patents
and trade secrets are platform contributions
for which compensation is due from S as part
of a PCT.
(ii) S’s manufacturing and distribution
activities under the CSA will be routine in
nature, and identical to the activities it
would undertake if it alternatively licensed
the product from P.
(iii) Reasonably reliable estimates indicate
that P could develop the product without
assistance from S and license the product
outside of Country X for a royalty of 20% of
sales. Based on reliable financial projections
that include all future development costs and
licensing revenue that are allocable to the
non-Country X market, and using a discount
rate appropriate for the riskiness of P’s role
as a licensor (see paragraph (g)(2)(v) of this
section), the post-tax present value of this
licensing alternative to P for the non-Country
X market (measured as of the date of the PCT)
would be $500 million. Thus, based on this
realistic alternative, the anticipated post-tax
present value under the CSA to P in the nonCountry X market (measured as of the date
of the PCT), taking into account anticipated
development costs allocable to the nonCountry X market, and anticipated CST
Payments and PCT Payments from S, and
using a discount rate appropriate for the
riskiness of P’s role as a participant in the
CSA, should not be less than $500 million.
Example 2. (i) The facts are the same as in
Example 1, except that there are no reliable
estimates of the value to P from the licensing

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alternative to the CSA. Further, reasonably
reliable estimates indicate that an arm’s
length return for S’s routine manufacturing
and distribution activities is a 10% mark-up
on total costs of goods sold plus operating
expenses related to those activities. Finally,
the Commissioner determines that the
respective activities undertaken by P and S
(other than licensing payments, cost
contributions, and PCT Payments) would be
identical regardless of whether the
arrangement was undertaken as a CSA (cost
sharing alternative) or as a long-term
licensing arrangement (licensing alternative).
In particular, in both alternatives, P would
perform all research activities and S would
undertake routine manufacturing and
distribution activities associated with its
territory.
(ii) P undertakes an economic analysis that
derives S’s cost contributions under the CSA,
based on reliable financial projections. Based
on this and further economic analysis, P
determines S’s PCT Payment as a certain
lump sum amount to be paid as of the date
of the PCT (Date D).
(iii) Based on reliable financial projections
that include S’s cost contributions and that
incorporate S’s PCT Payment, as computed
by P, and using a discount rate appropriate
for the riskiness of S’s role as a CSA
participant (see paragraphs (g)(2)(v) and
(4)(vi)(F) of this section), the anticipated
post-tax net present value to S in the cost
sharing alternative (measured as of Date D) is
$800 million. Further, based on these same
reliable projections (but incorporating S’s
licensing payments instead of S’s cost
contributions and PCT Payment), and using
a discount rate appropriate for the riskiness
of S’s role as a long-term licensee, the
anticipated post-tax net present value to S in
the licensing alternative (measured as of Date
D) is $100 million. Thus, S’s anticipated
post-tax net present value is $700 million
greater in the cost sharing alternative than in
the licensing alternative. This result suggests
that P’s anticipated post-tax present value
must be significantly less under the cost
sharing alternative than under the licensing
alternative. This means that the reliability of
P’s analysis as described in paragraph (ii) of
this Example 2 is reduced, because P would
not be expected to enter into a CSA if its
alternative of being a long-term licensor is
preferable.
Example 3. (i) The facts are the same as in
paragraphs (i) and (ii) of Example 2. In
addition, based on reliable financial
projections that include S’s cost
contributions and S’s PCT Payment, and
using a discount rate appropriate for the
riskiness of S’s role as a CSA participant, the
anticipated post-tax net present value to S
under the CSA (measured as of the date of
the PCT) is $50 million. Also, instead of
entering the CSA, S has the realistic
alternative of manufacturing and distributing
product Z unrelated to the personal
transportation device, with the same
anticipated 10% mark-up on total costs that
it would anticipate for its routine activities
in Example 2. Under its realistic alternative,
at a discount rate appropriate for the
riskiness of S’s role with respect to product
Z, S anticipates a present value of $100
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(ii) Because the lump sum PCT Payment
made by S results in S having a considerably
lower anticipated net present value than S
could achieve through an alternative
arrangement realistically available to it, the
reliability of P’s calculation of the lump sum
PCT Payment is reduced.

(iv) Aggregation of transactions. The
combined effect of multiple
contemporaneous transactions,
consisting either of multiple PCTs, or of
one or more PCT and one or more other
transactions in connection with a CSA
that are not governed by this section
(such as transactions involving cross
operating contributions or make-or-sell
rights), may require evaluation in
accordance with the principles of
aggregation described in § 1.482–
1(f)(2)(i). In such cases, it may be that
the multiple transactions are reasonably
anticipated, as of the date of the PCT(s),
to be so interrelated that the method
that provides the most reliable measure
of an arm’s length charge is a method
under this section applied on an
aggregate basis for the PCT(s) and other
transactions. A section 482 adjustment
may be made by comparing the
aggregate arm’s length charge so
determined to the aggregate payments
actually made for the multiple
transactions. In such a case, it generally
will not be necessary to allocate
separately the aggregate arm’s length
charge as between various PCTs or as
between PCTs and such other
transactions. However, such an
allocation may be necessary for other
purposes, such as applying paragraph
(i)(6) (Periodic adjustments) of this
section. An aggregate determination of
the arm’s length charge for multiple
transactions will often yield a payment
for a controlled participant that is equal
to the aggregate value of the platform
contributions and other resources,
capabilities, and rights covered by the
multiple transactions multiplied by that
controlled participant’s RAB share.
Because RAB shares only include
benefits from cost shared intangibles,
the reliability of an aggregate
determination of payments for multiple
transactions may be reduced to the
extent that it includes transactions
covering resources, capabilities, and
rights for which the controlled
participants’ expected benefit shares
differ substantially from their RAB
shares.
(v) Discount rate—(A) In general. The
best method analysis in connection with
certain methods or forms of payment
may depend on a rate or rates of return
used to convert projected results of
transactions to present value, or to
otherwise convert monetary amounts at
one or more points in time to equivalent

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amounts at a different point or points in
time. For this purpose, a discount rate
or rates should be used that most
reliably reflect the market-correlated
risks of activities or transactions and
should be applied to the best estimates
of the relevant projected results, based
on all the information potentially
available at the time for which the
present value calculation is to be
performed. Depending on the particular
facts and circumstances, the marketcorrelated risk involved and thus, the
discount rate, may differ among a
company’s various activities or
transactions. Normally, discount rates
are most reliably determined by
reference to market information.
(B) Considerations in best method
analysis of discount rate—(1) Discount
rate variation between realistic
alternatives. Realistic alternatives may
involve varying risk exposure and, thus,
may be more reliably evaluated using
different discount rates. See paragraphs
(g)(4)(i)(F) and (vi)(F) of this section. In
some circumstances, a party may have
less risk as a licensee of intangibles
needed in its operations, and so require
a lower discount rate, than it would
have by entering into a CSA to develop
such intangibles, which may involve the
party’s assumption of additional risk in
funding its cost contributions to the
IDA. Similarly, self-development of
intangibles and licensing out may be
riskier for the licensor, and so require a
higher discount rate, than entering into
a CSA to develop such intangibles,
which would relieve the licensor of the
obligation to fund a portion of the IDCs
of the IDA.
(2) [Reserved].
(3) Discount rate variation between
forms of payment. Certain forms of
payment may involve different risks
than others. For example, ordinarily a
royalty computed on a profits base
would be more volatile, and so require
a higher discount rate to discount
projected payments to present value,
than a royalty computed on a sales base.
(4) Post-tax rate. In general, discount
rate estimates that may be inferred from
the operations of the capital markets are
post-tax discount rates. Therefore, an
analysis would in principle apply posttax discount rates to income net of
expense items including taxes (post-tax
income). However, in certain
circumstances the result of applying a
post-tax discount rate to post-tax
income is equivalent to the product of
the result of applying a post-tax
discount rate to income net of expense
items other than taxes (pre-tax income),
and the difference of one minus the tax
rate (as defined in paragraph (j)(1)(i) of
this section). Therefore, in such

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circumstances, calculation of pre-tax
income, rather than post-tax income,
may be sufficient. See, for example,
paragraph (g)(4)(i)(G) of this section.
(C) Example. The following example
illustrates the principles of this
paragraph (g)(2)(v):

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

(vi) Financial projections. The
reliability of an estimate of the value of
a platform or operating contribution in
connection with a PCT will often
depend upon the reliability of
projections used in making the estimate.
Such projections should reflect the best
estimates of the items projected
(normally reflecting a probability
weighted average of possible outcomes
and thus also reflecting non-marketcorrelated risk). Projections necessary
for this purpose may include a
projection of sales, IDCs, costs of
developing operating contributions,
routine operating expenses, and costs of
sales. Some method applications
directly estimate projections of items
attributable to separate development
and exploitation by the controlled
participants within their respective

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divisions. Other method applications
indirectly estimate projections of items
from the perspective of the controlled
group as a whole, rather than from the
perspective of a particular participant,
and then apportion the items so
estimated on some assumed basis. For
example, in some applications, sales
might be directly projected by division,
but worldwide projections of other
items such as operating expenses might
be apportioned among divisions in the
same ratio as the divisions’ respective
sales. Which approach is more reliable
depends on which provides the most
reliable measure of an arm’s length
result, considering the competing
perspectives under the facts and
circumstances in light of the
completeness and accuracy of the
underlying data, the reliability of the
assumptions, and the sensitivity of the
results to possible deficiencies in the
data and assumptions. For these
purposes, projections that have been
prepared for non-tax purposes are
generally more reliable than projections
that have been prepared solely for
purposes of meeting the requirements in
this paragraph (g).
(vii) Accounting principles—(A) In
general. Allocations or other valuations
done for accounting purposes may
provide a useful starting point but will
not be conclusive for purposes of the
best method analysis in evaluating the
arm’s length charge in a PCT,
particularly where the accounting
treatment of an asset is inconsistent
with its economic value.
(B) Examples. The following
examples illustrate the principles of this
paragraph (g)(2)(vii):
Example 1. (i) USP, a U.S. corporation and
FSub, a wholly-owned foreign subsidiary of
USP, enter into a CSA in Year 1 to develop
software programs with application in the
medical field. Company X is an uncontrolled
software company located in the United
States that is engaged in developing software
programs that could significantly enhance
the programs being developed by USP and
FSub. Company X is still in a startup phase,
so it has no currently exploitable products or
marketing intangibles and its workforce
consists of a team of software developers.
Company X has negligible liabilities and
tangible property. In Year 2, USP purchases
Company X as part of an uncontrolled
transaction in order to acquire its in-process
technology and workforce for purposes of the
development activities of the CSA. USP files
a consolidated return that includes Company
X. For accounting purposes, $50 million of
the $100 million acquisition price is
allocated to the in-process technology and
workforce, and the residual $50 million is
allocated to goodwill.
(ii) The in-process technology and
workforce of Company X acquired by USP
are reasonably anticipated to contribute to

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developing cost shared intangibles and
therefore the rights in the in-process
technology and workforce of Company X are
platform contributions for which FSub must
compensate USP as part of a PCT. In
determining whether to apply the acquisition
price or another method for purposes of
evaluating the arm’s length charge in the
PCT, relevant best method analysis
considerations must be weighed in light of
the general principles of paragraph (g)(2) of
this section. The allocation for accounting
purposes raises an issue as to the reliability
of using the acquisition price method in this
case because it suggests that a significant
portion of the value of Company X’s
nonroutine contributions to USP’s business
activities is allocable to goodwill, which is
often difficult to value reliably and which,
depending on the facts and circumstances,
might not be attributable to platform
contributions that are to be compensated by
PCTs. See paragraph (g)(5)(iv)(A) of this
section.
(iii) Paragraph (g)(2)(vii)(A) of this section
provides that accounting treatment may be a
starting point, but is not determinative for
purposes of assessing or applying methods to
evaluate the arm’s length charge in a PCT.
The facts here reveal that Company X has
nothing of economic value aside from its inprocess technology and assembled workforce.
The $50 million of the acquisition price
allocated to goodwill for accounting
purposes, therefore, is economically
attributable to either of, or both, the inprocess technology and the workforce. That
moots the potential issue under the
acquisition price method of the reliability of
valuation of assets not to be compensated by
PCTs, since there are no such assets.
Assuming the acquisition price method is
otherwise the most reliable method, the
aggregate value of Company X’s in-process
technology and workforce is the full
acquisition price of $100 million.
Accordingly, the aggregate value of the arm’s
length PCT Payments due from FSub to USP
for the platform contributions consisting of
the rights in Company X’s in-process
technology and workforce will equal $100
million multiplied by FSub’s RAB share.
Example 2. (i) The facts are the same as
in Example 1, except that Company X is a
mature software business in the United States
with a successful current generation of
software that it markets under a recognized
trademark, in addition to having the research
team and new generation software in process
that could significantly enhance the
programs being developed under USP’s and
FSub’s CSA. USP continues Company X’s
existing business and integrates the research
team and the in-process technology into the
efforts under its CSA with FSub. For
accounting purposes, the $100 million price
for acquiring Company X is allocated $50
million to existing software and trademark,
$25 million to in-process technology and
research workforce, and the residual $25
million to goodwill and going concern value.
(ii) In this case an analysis of the facts
indicates a likelihood that, consistent with
the allocation under the accounting treatment
(although not necessarily in the same
amount), a significant amount of the

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nonroutine contributions to the USP’s
business activities consist of goodwill and
going concern value economically
attributable to the existing U.S. software
business rather than to the platform
contributions consisting of the rights in the
in-process technology and research
workforce. In addition, an analysis of the
facts indicates that a significant amount of
the nonroutine contributions to USP’s
business activities consist of the make-or-sell
rights under the existing software and
trademark, which are not platform
contributions and might be difficult to value.
Accordingly, further consideration must be
given to the extent to which these
circumstances reduce the relative reliability
of the acquisition price method in
comparison to other potentially applicable
methods for evaluating the PCT Payment.
Example 3. (i) USP, a U.S. corporation,
and FSub, a wholly-owned foreign subsidiary
of USP, enter into a CSA in Year 1 to develop
Product A. Company Y is an uncontrolled
corporation that owns Technology X, which
is critical to the development of Product A.
Company Y currently markets Product B,
which is dependent on Technology X. USP
is solely interested in acquiring Technology
X, but is only able to do so through the
acquisition of Company Y in its entirety for
$200 million in an uncontrolled transaction
in Year 2. For accounting purposes, the
acquisition price is allocated as follows: $120
million to Product B and the underlying
Technology X, $30 million to trademark and
other marketing intangibles, and the residual
$50 million to goodwill and going concern
value. After the acquisition of Company Y,
Technology X is used to develop Product A.
No other part of Company Y is used in any
manner. Immediately after the acquisition,
product B is discontinued, and, therefore, the
accompanying marketing intangibles become
worthless. None of the previous employees of
Company Y is retained.
(ii) The Technology X of Company Y
acquired by USP is reasonably anticipated to
contribute to developing cost shared
intangibles and is therefore a platform
contribution for which FSub must
compensate USP as part of a PCT. Although
for accounting purposes a significant portion
of the acquisition price of Company Y was
allocated to items other than Technology X,
the facts demonstrate that USP had no
intention of using and therefore placed no
economic value on any part of Company Y
other than Technology X. If USP was willing
to pay $200 million for Company Y solely for
purposes of acquiring Technology X, then
assuming the acquisition price method is
otherwise the most reliable method, the value
of Technology X is the full $200 million
acquisition price. Accordingly, the value of
the arm’s length PCT Payment due from FSub
to USP for the platform contribution
consisting of the rights in Technology X will
equal the product of $200 million and FSub’s
RAB share.

(viii) Valuations of subsequent
PCTs—(A) Date of subsequent PCT. The
date of a PCT may occur subsequent to
the inception of the CSA. For example,
an intangible initially developed outside

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the IDA may only subsequently become
a platform contribution because that
later time is the earliest date on which
it is reasonably anticipated to contribute
to developing cost shared intangibles
within the IDA. In such case, the date
of the PCT, and the analysis of the arm’s
length amount charged in the
subsequent PCT, is as of such later time.
(B) Best method analysis for
subsequent PCT. In cases where PCTs
occur on different dates, the
determination of the arm’s length
amount charged, respectively, in the
prior and subsequent PCTs must be
coordinated in a manner that provides
the most reliable measure of an arm’s
length result. In some circumstances, a
subsequent PCT may be reliably
evaluated independently of other PCTs,
as may be possible for example, under
the acquisition price method. In other
circumstances, the results of prior and
subsequent PCTs may be interrelated
and so a subsequent PCT may be most
reliably evaluated under the residual
profit split method of paragraph (g)(7) of
this section. In those cases, for purposes
of allocating the present value of
nonroutine residual divisional profit or
loss, and so determining the present
value of the subsequent PCT Payments,
in accordance with paragraph
(g)(7)(iii)(C) of this section, the PCT
Payor’s interest in cost shared
intangibles, both already developed and
in process, are treated as additional PCT
Payor operating contributions as of the
date of the subsequent PCT.
(ix) Arm’s length range–(A) In
general. The guidance in § 1.482–1(e)
regarding determination of an arm’s
length range, as modified by this
section, applies in evaluating the arm’s
length amount charged in a PCT under
a transfer pricing method provided in
this section (applicable method).
Section 1.482–1(e)(2)(i) provides that
the arm’s length range is ordinarily
determined by applying a single pricing
method selected under the best method
rule to two or more uncontrolled
transactions of similar comparability
and reliability although use of more
than one method may be appropriate for
the purposes described in § 1.482–
1(c)(2)(iii). The rules provided in
§ 1.482–1(e) and this section for
determining an arm’s length range shall
not override the rules provided in
paragraph (i)(6) of this section for
periodic adjustments by the
Commissioner. The provisions in
paragraphs (g)(2)(ix)(C) and (D) of this
section apply only to applicable
methods that are based on two or more
input parameters as described in
paragraph (g)(2)(ix)(B) of this section.
For an example of how the rules of this

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section for determining an arm’s length
range of PCT Payments are applied, see
paragraph (g)(4)(viii) of this section.
(B) Methods based on two or more
input parameters. An applicable
method may determine PCT Payments
based on calculations involving two or
more parameters whose values depend
on the facts and circumstances of the
case (input parameters). For some input
parameters (market-based input
parameters), the value is most reliably
determined by reference to data that
derives from uncontrolled transactions
(market data). For example, the value of
the return to a controlled participant’s
routine contributions, as such term is
defined in paragraph (j)(1)(i) of this
section, to the CSA Activity (which
value is used as an input parameter in
the income method described in
paragraph (g)(4) of this section) may in
some cases be most reliably determined
by reference to the profit level of a
company with rights, resources, and
capabilities comparable to those routine
contributions. See § 1.482–5. As another
example, the value for the discount rate
that reflects the riskiness of a controlled
participant’s role in the CSA (which
value is used as an input parameter in
the income method described in
paragraph (g)(4) of this section) may in
some cases be most reliably determined
by reference to the stock beta of a
company whose overall risk is
comparable to the riskiness of the
controlled participant’s role in the CSA.
(C) Variable input parameters. For
some market-based input parameters
(variable input parameters), the
parameter’s value is most reliably
determined by considering two or more
observations of market data that have, or
with adjustment can be brought to, a
similar reliability and comparability, as
described in § 1.482–1(e)(2)(ii) (for
example, profit levels or stock betas of
two or more companies). See paragraph
(g)(2)(ix)(B) of this section.
(D) Determination of arm’s length PCT
Payment. For purposes of applying this
paragraph (g)(2)(ix), each input
parameter is assigned a single most
reliable value, unless it is a variable
input parameter as described in
paragraph (g)(2)(ix)(C) of this section.
The determination of the arm’s length
payment depends on the number of
variable input parameters.
(1) No variable input parameters. If
there are no variable input parameters,
the arm’s length PCT Payment is a
single value determined by using the
single most reliable value determined
for each input parameter.
(2) One variable input parameter. If
there is exactly one variable input
parameter, then under the applicable

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method, the arm’s length range of PCT
Payments is the interquartile range, as
described in § 1.482–1(e)(2)(iii)(C), of
the set of PCT Payment values
calculated by selecting—
(i) Iteratively, the value of the variable
input parameter that is based on each
observation as described in paragraph
(g)(2)(ix)(C) of this section; and
(ii) The single most reliable values for
each other input parameter.
(3) More than one variable input
parameter. If there are two or more
variable input parameters, then under
the applicable method, the arm’s length
range of PCT Payments is the
interquartile range, as described in
§ 1.482–1(e)(2)(iii)(C), of the set of PCT
Payment values calculated iteratively
using every possible combination of
permitted choices of values for the input
parameters. For input parameters other
than a variable input parameter, the
only such permitted choice is the single
most reliable value. For variable input
parameters, such permitted choices
include any value that is—
(i) Based on one of the observations
described in paragraph (g)(2)(ix)(C) of
this section; and
(ii) Within the interquartile range (as
described in § 1.482–1(e)(2)(iii)(C)) of
the set of all values so based.
(E) Adjustments. Section 1.482–
1(e)(3), applied as modified by this
paragraph (g)(2)(ix), determines when
the Commissioner may make an
adjustment to a PCT Payment due to the
taxpayer’s results being outside the
arm’s length range. Adjustment will be
to the median, as defined in § 1.482–
1(e)(3). Thus, the Commissioner is not
required to establish an arm’s length
range prior to making an allocation
under section 482.
(x) Valuation undertaken on a pre-tax
basis. PCT Payments in general may
increase the PCT Payee’s tax liability
and decrease the PCT Payor’s tax
liability. The arm’s length amount of a
PCT Payment determined under the
methods in this paragraph (g) is the
value of the PCT Payment itself, without
regard to such tax effects. Therefore, the
methods under this section must be
applied, with suitable adjustments if
needed, to determine the PCT Payments
on a pre-tax basis. See paragraphs
(g)(2)(v)(B) and (4)(i)(G) of this section.
(3) Comparable uncontrolled
transaction method. The comparable
uncontrolled transaction (CUT) method
described in § 1.482–4(c), and the
comparable uncontrolled services price
(CUSP) method described in § 1.482–
9(c), may be applied to evaluate whether
the amount charged in a PCT is arm’s
length by reference to the amount
charged in a comparable uncontrolled

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transaction. Although all of the factors
entering into a best method analysis
described in § 1.482–1(c) and (d) must
be considered, comparability and
reliability under this method are
particularly dependent on similarity of
contractual terms, degree to which
allocation of risks is proportional to
reasonably anticipated benefits from
exploiting the results of intangible
development, similar period of
commitment as to the sharing of
intangible development risks, and
similar scope, uncertainty, and profit
potential of the subject intangible
development, including a similar
allocation of the risks of any existing
resources, capabilities, or rights, as well
as of the risks of developing other
resources, capabilities, or rights that
would be reasonably anticipated to
contribute to exploitation within the
parties’ divisions, that is consistent with
the actual allocation of risks between
the controlled participants as provided
in the CSA in accordance with this
section. When applied in the manner
described in § 1.482–4(c) or 1.482–9(c),
the CUT or CUSP method will typically
yield an arm’s length total value for the
platform contribution that is the subject
of the PCT. That value must then be
multiplied by each PCT Payor’s
respective RAB share in order to
determine the arm’s length PCT
Payment due from each PCT Payor. The
reliability of a CUT or CUSP that yields
a value for the platform contribution
only in the PCT Payor’s division will be
reduced to the extent that value is not
consistent with the total worldwide
value of the platform contribution
multiplied by the PCT Payor’s RAB
share.
(4) Income method—(i) In general—
(A) Equating cost sharing and licensing
alternatives. The income method
evaluates whether the amount charged
in a PCT is arm’s length by reference to
a controlled participant’s best realistic
alternative to entering into a CSA.
Under this method, the arm’s length
charge for a PCT Payment will be an
amount such that a controlled
participant’s present value, as of the
date of the PCT, of its cost sharing
alternative of entering into a CSA equals
the present value of its best realistic
alternative. In general, the best realistic
alternative of the PCT Payor to entering
into the CSA would be to license
intangibles to be developed by an
uncontrolled licensor that undertakes
the commitment to bear the entire risk
of intangible development that would
otherwise have been shared under the
CSA. Similarly, the best realistic
alternative of the PCT Payee to entering

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into the CSA would be to undertake the
commitment to bear the entire risk of
intangible development that would
otherwise have been shared under the
CSA and license the resulting
intangibles to an uncontrolled licensee.
Paragraphs (g)(4)(i)(B) through (vi) of
this section describe specific
applications of the income method, but
do not exclude other possible
applications of this method.
(B) Cost sharing alternative. The PCT
Payor’s cost sharing alternative
corresponds to the actual CSA in
accordance with this section, with the
PCT Payor’s obligation to make the PCT
Payments to be determined and its
commitment for the duration of the IDA
to bear cost contributions.
(C) Licensing alternative. The
licensing alternative is derived on the
basis of a functional and risk analysis of
the cost sharing alternative, but with a
shift of the risk of cost contributions to
the licensor. Accordingly, the PCT
Payor’s licensing alternative consists of
entering into a license with an
uncontrolled party, for a term extending
for what would be the duration of the
CSA Activity, to license the make-or-sell
rights in to-be-developed resources,
capabilities, or rights of the licensor.
Under such license, the licensor would
undertake the commitment to bear the
entire risk of intangible development
that would otherwise have been shared
under the CSA. Apart from any
difference in the allocation of the risks
of the IDA, the licensing alternative
should assume contractual provisions
with regard to non-overlapping
divisional intangible interests, and with
regard to allocations of other risks, that
are consistent with the actual CSA in
accordance with this section. For
example, the analysis under the
licensing alternative should assume a
similar allocation of the risks of any
existing resources, capabilities, or
rights, as well as of the risks of
developing other resources, capabilities,
or rights that would be reasonably
anticipated to contribute to exploitation
within the parties’ divisions, that is
consistent with the actual allocation of
risks between the controlled
participants as provided in the CSA in
accordance with this section.
Accordingly, the financial projections
associated with the licensing and cost
sharing alternatives are necessarily the
same except for the licensing payments
to be made under the licensing
alternative and the cost contributions
and PCT Payments to be made under the
CSA.
(D) Only one controlled participant
with nonroutine platform contributions.
This method involves only one of the

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controlled participants providing
nonroutine platform contributions as
the PCT Payee. For a method under
which more than one controlled
participant may be a PCT Payee, see the
application of the residual profit
method pursuant to paragraph (g)(7) of
this section.
(E) Income method payment forms.
The income method may be applied to
determine PCT Payments in any form of
payment (for example, lump sum,
royalty on sales, or royalty on divisional
profit). For converting to another form
of payment, see generally paragraph (h)
(Form of payment rules) of this section.
(F) Discount rates appropriate to cost
sharing and licensing alternatives. The
present value of the cost sharing and
licensing alternatives, respectively,
should be determined using the
appropriate discount rates in
accordance with paragraphs (g)(2)(v)
and (g)(4)(vi)(F) of this section. See, for
example, § 1.482–7(g)(2)(v)(B)(1)
(Discount rate variation between
realistic alternatives). In circumstances
where the market-correlated risks as
between the cost sharing and licensing
alternatives are not materially different,
a reliable analysis may be possible by
using the same discount rate with
respect to both alternatives.
(G) The effect of taxation on
determining the arm’s length amount.
(1) In principle, the present values of
the cost sharing and licensing
alternatives should be determined by
applying post-tax discount rates to posttax income (including the post-tax value
to the controlled participant of the PCT
Payments). If such approach is adopted,
then the post-tax value of the PCT
Payments must be appropriately
adjusted in order to determine the arm’s
length amount of the PCT Payments on
a pre-tax basis. See paragraph (g)(2)(x) of
this section.
(2) In certain circumstances, post-tax
income may be derived as the product
of the result of applying a post-tax
discount rate to pre-tax income, and a
factor equal to one minus the tax rate (as
defined in (j)(1)(i)). See paragraph
(g)(2)(v)(B) of this section.
(3) To the extent that a controlled
participant’s tax rate is not materially
affected by whether it enters into the
cost sharing or licensing alternative (or
reliable adjustments may be made for
varying tax rates), the factor (that is, one
minus the tax rate) may be cancelled
from both sides of the equation of the
cost sharing and licensing alternative
present values. Accordingly, in such
circumstance it is sufficient to apply
post-tax discount rates to projections of
pre-tax income for the purpose of
equating the cost sharing and licensing

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alternatives. The specific applications of
the income method described in
paragraphs (g)(4)(ii) through (iv) of this
section and the examples set forth in
paragraph (g)(4)(viii) of this section
assume that a controlled participant’s
tax rate is not materially affected by
whether it enters into the cost sharing
or licensing alternative.
(ii) Evaluation of PCT Payor’s cost
sharing alternative. The present value of
the PCT Payor’s cost sharing alternative
is the present value of the stream of the
reasonably anticipated residuals over
the duration of the CSA Activity of
divisional profits or losses, minus
operating cost contributions, minus cost
contributions, minus PCT Payments.
(iii) Evaluation of PCT Payor’s
licensing alternative—(A) Evaluation
based on CUT. The present value of the
PCT Payor’s licensing alternative may
be determined using the comparable
uncontrolled transaction method, as
described in § 1.482–4(c)(1) and (2). In
this case, the present value of the PCT
Payor’s licensing alternative is the
present value of the stream, over what
would be the duration of the CSA
Activity under the cost sharing
alternative, of the reasonably
anticipated residuals of the divisional
profits or losses that would be achieved
under the cost sharing alternative,
minus operating cost contributions that
would be made under the cost sharing
alternative, minus the licensing
payments as determined under the
comparable uncontrolled transaction
method.
(B) Evaluation based on CPM. The
present value of the PCT Payor’s
licensing alternative may be determined
using the comparable profits method, as
described in § 1.482–5. In this case, the
present value of the licensing alternative
is determined as in paragraph
(g)(4)(iii)(A) of this section, except that
the PCT Payor’s licensing payments, as
defined in paragraph (j)(1)(i) of this
section, are determined in each period
to equal the reasonably anticipated
residuals of the divisional profits or
losses that would be achieved under the
cost sharing alternative, minus
operating cost contributions that would
be made under the cost sharing
alternative, minus market returns for
routine contributions, as defined in
paragraph (j)(1)(i) of this section.
However, treatment of net operating
contributions as operating cost
contributions shall be coordinated with
the treatment of other routine
contributions pursuant to this paragraph
so as to avoid duplicative market
returns to such contributions.
(iv) Lump sum payment form. Where
the form of PCT Payment is a lump sum

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as of the date of the PCT, then, based on
paragraphs (g)(4)(i) through (iii) of this
section, the PCT Payment equals the
difference between—
(A) The present value, using the
discount rate appropriate for the cost
sharing alternative, of the stream of the
reasonably anticipated residuals over
the duration of the CSA Activity of
divisional profits or losses, minus cost
contributions and operating cost
contributions; and
(B) The present value of the licensing
alternative.
(v) [Reserved].
(vi) Best method analysis
considerations. (A) Coordination with
§ 1.482–1(c). Whether results derived
from this method are the most reliable
measure of an arm’s length result is
determined using the factors described
under the best method rule in § 1.482–
1(c). Thus, comparability and the
quality of data, the reliability of the
assumptions, and the sensitivity of the
results to possible deficiencies in the
data and assumptions, must be
considered in determining whether this
method provides the most reliable
measure of an arm’s length result.
(B) Assumptions Concerning Tax
Rates. This method will be more reliable
to the extent that the controlled
participants’ respective tax rates are not
materially affected by whether they
enter into the cost sharing or licensing
alternative. Even if this assumption of
invariant tax rates across alternatives
does not hold, this method may still be
reliable to the extent that reliable
adjustments can be made to reflect the
variation in tax rates.
(C) Coordination with § 1.482–4(c)(2).
If the licensing alternative is evaluated
using the comparable uncontrolled
transactions method, as described in
paragraph (g)(4)(iii)(A) of this section,
any additional comparability and
reliability considerations stated in
§ 1.482–4(c)(2) may apply.
(D) Coordination with § 1.482–5(c). If
the licensing alternative is evaluated
using the comparable profits method, as
described in paragraph (g)(4)(iii)(B) of
this section, any additional
comparability and reliability
considerations stated in § 1.482–5(c)
may apply.
(E) Certain Circumstances Concerning
PCT Payor. This method may be used
even if the PCT Payor furnishes
significant operating contributions, or
commits to assume the risk of
significant operating cost contributions,
to the PCT Payor’s division. However, in
such a case, any comparable
uncontrolled transactions described in
paragraph (g)(4)(iii)(A) of this section,
and any comparable transactions used

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations

under § 1.482–5(c) as described in
paragraphs (g)(4)(iii)(B) of this section,
should be consistent with such
contributions (or reliable adjustments
must be made for material differences).
(F) Discount rates.
(1) Reflection of similar risk profiles of
cost sharing alternative and licensing
alternative. Because the financial
projections associated with the licensing
and cost sharing alternatives are the
same, except for the licensing payments
to be made under the licensing
alternative and the cost contributions
and PCT Payments to be made under the
cost sharing alternative, the analysis of
the risk profile and financial projections
for a realistic alternative to the cost
sharing alternative must be closely
associated with the risk profile and
financial projections associated with the
cost sharing alternative, differing only
in the treatment of licensing payments,
cost contributions, and PCT Payments.
When using discount rates in applying
the income method, this means that
even if different discount rates are
warranted for the two alternatives, the
risk profiles for the two discount rates
are closely related to each other because
the discount rate for the licensing
alternative and the discount rate for the
cost sharing alternative are both derived
from the single probability-weighted
financial projections associated with the
CSA Activity. The difference, if any, in
market-correlated risks between the
licensing and cost sharing alternatives is
due solely to the different effects on
risks of the PCT Payor making licensing
payments under the licensing
alternative, on the one hand, and the
PCT Payor making cost contributions
and PCT Payments under the cost
sharing alternative, on the other hand.
That is, the difference in the risk profile
between the two scenarios solely
reflects the incremental risk, if any,
associated with the cost contributions
taken on by the PCT Payor in

developing the cost shared intangible
under the cost sharing alternative, and
the difference, if any, in risk associated
with the particular payment forms of the
licensing payments and the PCT
Payments, in light of the fact that the
licensing payments in the licensing
alternative are partially replaced by cost
contributions and partially replaced by
PCT Payments in the cost sharing
alternative, each with its own payment
form. An analysis under the income
method that uses a different discount
rate for the cost sharing alternative than
for the licensing alternative will be more
reliable the greater the extent to which
the difference, if any, between the two
discount rates reflects solely these
differences in the risk profiles of these
two alternatives. See, for example,
paragraph (g)(2)(iii), Example 2 of this
section.
(2) [Reserved].
(vii) Routine platform and operating
contributions. For purposes of this
paragraph (g)(4), any routine
contributions that are platform or
operating contributions, the valuation
and PCT Payments for which are
determined and made independently of
the income method, are treated similarly
to cost contributions and operating cost
contributions, respectively.
Accordingly, wherever used in this
paragraph (g)(4), the term ‘‘routine
contributions’’ shall not include routine
platform or operating contributions, and
wherever the terms ‘‘cost contributions’’
and ‘‘operating cost contributions’’
appear in this paragraph, they shall
include net routine platform
contributions and net routine operating
contributions, respectively. Net routine
platform contributions are the value of
a controlled participant’s total
reasonably anticipated routine platform
contributions, plus its reasonably
anticipated PCT Payments to other
controlled participants in respect of
their routine platform contributions,

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(1)
Year

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Example 1. (i) For simplicity of calculation
in this Example 1, all financial flows are
assumed to occur at the beginning of each
period. USP, a software company, has
developed version 1.0 of a new software
application that it is currently marketing. In
Year 1 USP enters into a CSA with its
wholly-owned foreign subsidiary, FS, to
develop future versions of the software
application. Under the CSA, USP will have
the rights to exploit the future versions in the
United States, and FS will have the rights to
exploit them in the rest of the world. The
future rights in version 1.0, and USP’s
development team, are reasonably
anticipated to contribute to the development
of future versions and therefore the rights in
version 1.0 and the research and
development team are platform contributions
for which compensation is due from FS as
part of a PCT. USP does not transfer the
current exploitation rights in version 1.0 to
FS. FS will not perform any research or
development activities and does not furnish
any platform contributions nor does it
control any operating intangibles at the
inception of the CSA that would be relevant
to the exploitation of version 1.0 or future
versions of the software.
(ii) FS undertakes financial projections in
its territory of the CSA:

(3)
Operating
costs

(2)
Sales

1 .................................................................................................................
2 .................................................................................................................
3 .................................................................................................................
4 .................................................................................................................
5 .................................................................................................................
6 .................................................................................................................
7 .................................................................................................................
8 .................................................................................................................
9 .................................................................................................................
10 ...............................................................................................................
11 ...............................................................................................................
12 ...............................................................................................................

minus the reasonably anticipated PCT
Payments it is to receive from other
controlled participants in respect of its
routine platform contributions. Net
routine operating contributions are the
value of a controlled participant’s total
reasonably anticipated routine operating
contributions, plus its reasonably
anticipated arm’s length compensation
to other controlled participants in
respect of their routine operating
contributions, minus the reasonably
anticipated arm’s length compensation
it is to receive from other controlled
participants in respect of its routine
operating contributions.
(viii) Examples. The following
examples illustrate the principles of this
paragraph (g)(4):

(4)
Cost
contributions

0
0
100
200
300
325
350
375
375
338
304
273

E:\FR\FM\22DER3.SGM

22DER3

50
50
50
50
60
65
70
75
75
68
61
55

(5)
Operating
income
under cost
sharing
alternative
(excluding PCT)
¥50
¥50
50
150
240
260
280
300
300
269
243
219

Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations

(1)
Year

13 ...............................................................................................................
14 ...............................................................................................................
15 ...............................................................................................................

FS anticipates that activity on this
application will cease after Year 15. The
application was derived from software
developed by Company Q, an uncontrolled
party. FS has a license under Company Q’s
copyright, but that license expires after Year
15 and will not be renewed.
(iii) In evaluating the cost sharing
alternative, FS concludes that the cost
sharing alternative represents a riskier
alternative for FS than the licensing
alternative because, in cost sharing, FS will

jlentini on DSK4TPTVN1PROD with RULES3

(iv) Based on these projections and
applying the appropriate discount rate, FS
determines that under the cost sharing
alternative, the present value of the stream of
residuals of its anticipated divisional profits,
reduced by the anticipated operating cost
contributions and cost contributions, but not
reduced by any PCT Payments (that is, the
stream of anticipated operating income as
shown in column 5) would be $889 million.
Under the licensing alternative, the present
value of the stream of residuals of its
anticipated divisional profits and losses
minus the operating cost contributions (that
is, the stream of anticipated operating income
before licensing payments, which is the
present value of column 7 reduced by
column 8) would be $1.419 billion, and the
present value of the licensing payments
would be $994 million. Therefore, the total
value of the licensing alternative would be
$425 million. In order for the present value
of the cost sharing alternative to equal the

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200
400
600
650
700
750
750
675
608
547
410
308
231

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0
70
140
210
228
245
263
263
236
213
191
144
108
81

Comparable
uncontrolled
discount rate

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(10)
Operating
income under
licensing
alternative

(9)
Licensing
payments

present value of the licensing alternative, the
present value of the PCT Payments must
equal $464 million. Therefore, the taxpayer
makes and reports PCT Payments with a
present value of $464 million.
Example 2. Arm’s length range. (i) The
facts are the same as in Example 1. The
Commissioner accepts the financial
projections undertaken by FS. Further, the
Commissioner determines that the licensing
discount rate and the CUT licensing rate are
most reliably determined by reference to
comparable uncontrolled discount rates and
license rates, respectively. The observations
that are in the interquartile range of the
respective input parameters (see paragraph
(g)(2)(ix) of this section) are as follows:

1 ........................................

41
31
23

11%

(5)
Operating
income
under cost
sharing
alternative
(excluding PCT)
164
123
93

charged an uncontrolled licensee for a
license of future versions of the software (if
USP had further developed version 1.0 on its
own) is 35% of the sales price, as determined
under the CUT method in § 1.482–4(c). FS
also determines that the tax rate applicable
to it will be the same in the licensing
alternative as in the CSA. Accordingly, the
financial projections associated with the
licensing alternative are:

0
0
100
200
300
325
350
375
375
338
304
273
205
154
115

Observations that are within interquartile range

(4)
Cost
contributions

205
154
115

(8)
Operating
costs

(7)
Sales

1 .....................................................................................
2 .....................................................................................
3 .....................................................................................
4 .....................................................................................
5 .....................................................................................
6 .....................................................................................
7 .....................................................................................
8 .....................................................................................
9 .....................................................................................
10 ...................................................................................
11 ...................................................................................
12 ...................................................................................
13 ...................................................................................
14 ...................................................................................
15 ...................................................................................

19:36 Dec 21, 2011

410
308
231

take on the additional risks associated with
cost contributions. Taking this difference into
account, FS concludes that the appropriate
discount rate to apply in assessing the
licensing alternative, based on discount rates
of comparable uncontrolled companies
undertaking comparable licensing
transactions, would be 13% per year,
whereas the appropriate discount rate to
apply in assessing the cost sharing alternative
would be 15% per year. FS determines that
the arm’s length rate USP would have

(6)
Year

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(3)
Operating
costs

(2)
Sales

80109

0
0
30
60
90
97
105
112
112
101
91
83
61
46
35

Observations that are within interquartile range
2
3
4
5

........................................
(Median) ........................
........................................
........................................

Observations that are within interquartile range
1
2
3
4
5

........................................
........................................
(Median) ........................
........................................
........................................

(11)
Operating income
under cost
sharing
alternative
minus operating
income under
licensing
alternative
¥50
¥50
20
90
150
163
175
188
188
168
152
136
103
77
58

Comparable
uncontrolled
discount rate
12
13
15
17
Comparable
uncontrolled
licensing rate
30%
32
35
37
40

(ii) Following the principles of paragraph
(g)(2)(ix) of this section, the Commissioner
undertakes 25 different applications of the

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations

income method, using each combination of
the discount rate and licensing rate
parameters. In undertaking this analysis, the
Commissioner assumes that the ratio of the

applications of the income method, sorted in
ascending order of calculated present value
of the PCT Payment, are as follows:

median discount rate for the cost sharing
alternative to the median discount rate for
the licensing alternative (that is, 15% to
13%) is maintained. The results of the 25

LINCOME METHOD APPLICATION NUMBER:
Comparable
uncontrolled
licensing
discount rate

Income method application number:

jlentini on DSK4TPTVN1PROD with RULES3

1 ..........................................................................
2 ..........................................................................
3 ..........................................................................
4 ..........................................................................
5 ..........................................................................
6 ..........................................................................
7 ..........................................................................
8 ..........................................................................
9 ..........................................................................
10 ........................................................................
11 ........................................................................
12 ........................................................................
13 ........................................................................
14 ........................................................................
15 ........................................................................
16 ........................................................................
17 ........................................................................
18 ........................................................................
19 ........................................................................
20 ........................................................................
21 ........................................................................
22 ........................................................................
23 ........................................................................
24 ........................................................................
25 ........................................................................

(iii) Accordingly, the Commissioner
determines that a taxpayer will not be subject
to adjustment if its initial (ex ante)
determination of the present value of PCT
Payments is between $354 million and $520
million (the lower and upper quartile results
as shown in the last column). Because FS’s
determination of the present value of the PCT
Payments, $464 million, is within the
interquartile range, no adjustments are
warranted.
Example 3. (i) For simplicity of calculation
in this Example 3, all financial flows are
assumed to occur at the beginning of each
period. USP, a U.S. software company, has
developed version 1.0 of a new software
application, employed to store and retrieve
complex data sets in certain types of storage
media. Version 1.0 is currently being
marketed. In Year 1, USP enters into a CSA
with its wholly-owned foreign subsidiary,
FS, to develop future versions of the software
application. Under the CSA, USP will have
the exclusive rights to exploit the future
versions in the U.S., and FS will have the
exclusive rights to exploit them in the rest of
the world. USP’s rights in version 1.0, and its
development team, are reasonably
anticipated to contribute to the development
of future versions of the software application
and, therefore, the rights in version 1.0 are
platform contributions for which
compensation is due from FS as part of a
PCT. USP also transfers the current
exploitation rights in version 1.0 to FS and
the arm’s length amount of the compensation
for such transfer is determined in the

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17%
17
15
15
13
17
12
17
13
11
15
12
15
17
11
13
12
15
13
11
12
13
11
12
11

Comparable
uncontrolled
CSA
discount rate

Comparable
uncontrolled
licensing
rate

19.6%
19.6
17.3
17.3
15
19.6
13.8
19.6
15
12.7
17.3
13.8
17.3
19.6
12.7
15
13.8
17.3
15
12.7
13.8
15
12.7
13.8
12.7

aggregate with the arm’s length PCT
Payments in this Example 3. FS does not
furnish any platform contributions to the
CSA nor does it control any operating
intangibles at the inception of the CSA that
would be relevant to the exploitation of
version 1.0 or future versions of the software.
It is reasonably anticipated that FS will have
gross sales of $1000X in its territory for 5
years attributable to its exploitation of
version 1.0 and the cost shared intangibles,
after which time the software application
will be rendered obsolete and unmarketable
by the obsolescence of the storage medium
technology to which it relates. FS’s costs
reasonably attributable to the CSA, other than
cost contributions and operating cost
contributions, are anticipated to be $250X
per year. Certain operating cost contributions
that will be borne by FS are reasonably
anticipated to equal $200X per annum for 5
years. In addition, FS is reasonably
anticipated to pay cost contributions of
$200X per year as a controlled participant in
the CSA.
(ii) FS concludes that its realistic
alternative would be to license software from
an uncontrolled licensor that would
undertake the commitment to bear the entire
risk of software development. Applying CPM
using the profit levels experienced by
uncontrolled licensees with contractual
provisions and allocations of risk that are
comparable to those of FS’s licensing
alternative, FS determines that it could, as a
licensee, reasonably expect a (pre-tax)
routine return equal to 14% of gross sales or

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Calculated
lump sum
PCT payment

30%
32
30
32
30
35
30
37
32
30
35
32
37
40
32
35
35
40
37
35
37
40
37
40
40

217
263
264
315
321
331
354
376
378
391
391
415
442
444
455
464
505
517
520
551
566
605
615
655
710

Interquartile
range of PCT
payments

LQ = 354

Median = 442

UQ = 520

$140X per year for 5 years. The remaining net
revenue would be paid to the uncontrolled
licensor as a license fee of $410X per year.
FS determines that the discount rate that
would be applied to determine the present
value of income and costs attributable to its
participation in the licensing alternative
would be 12.5% as compared to the 15%
discount rate that would be applicable in
determining the present valuable of the net
income attributable to its participation in the
CSA (reflecting the increased risk borne by
FS in bearing a share of the R&D costs in the
cost sharing alternative). FS also determines
that the tax rate applicable to it will be the
same in the licensing alternative as in the
CSA.
(iii) On these facts, the present value to FS
of entering into the cost sharing alternative
equals the present value of the annual
divisional profits ($1,000X minus $250X)
minus operating cost contributions ($200X)
minus cost contributions ($200X) minus PCT
Payments, determined over 5 years by
discounting at a discount rate of 15%. Thus,
the present value of the residuals, prior to
subtracting the present value of the PCT
Payments, is $1349X.
(iv) On these facts, the present value to FS
of entering into the licensing alternative
would be $561X determined by discounting,
over 5 years, annual divisional profits
($1,000X minus $250X) minus operating cost
contributions ($200X) and licensing
payments ($410X) at a discount rate of 12.5%
per annum. The present value of the cost
sharing alternative must also equal $561X but

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
equals $1349X prior to subtracting the
present value of the PCT Payments.
Consequently, the PCT Payments must have
a present value of $788X.
Example 4. Pre-tax PCT Payment derived
from post-tax information. (i) For simplicity
of calculation in this Example 4, it is
assumed that all payments are made at the
end of each year. Domestic controlled
participant USP has developed a technology,
Z, that it would like to exploit for three years
in a CSA. USP enters into a CSA with its
wholly-owned foreign subsidiary, FS, that

provides for PCT Payments from FS to USP
with respect to USP’s platform contribution
to the CSA of Z in the form of three annual
installment payments due from FS to USP on
the last day of each of the first three years
of the CSA. FS makes no platform
contributions to the CSA. Prior to entering
into the CSA, FS considers that it has the
realistic alternative available to it of licensing
Z from USP rather than entering into a CSA
with USP to further develop Z for three years.
(ii) FS undertakes financial projections for
both the licensing and cost sharing
Present value
(12.5% DR)

Licensing alternative

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(1)
(2)
(3)
(4)
(5)
(6)

Sales ..........................................................................................
License Fee ................................................................................
Operating costs ..........................................................................
Operating Income .......................................................................
Tax (25%) ...................................................................................
Post-tax income .........................................................................

alternatives for exploitation of Z in its
territory of the CSA. These projections are set
forth in the following tables. The example
assumes that there is a reasonably anticipated
effective tax rate of 25% in each of years 1
through 3 under both the licensing and cost
sharing alternatives. FS determines that the
appropriate post-tax discount rate under the
licensing alternative is 12.5%, and that the
appropriate post-tax discount rate under the
cost sharing alternative is 15%.

Year 1

............................
............................
............................
$261
............................
$196

80111

Year 2

$1000
400
500
100
25
$75

$1100
440
550
110
28
$82

Year 3
$1210
484
605
121
30
$91

Cost sharing alternative

Present value
(15% DR)

Year 1

Year 2

Year 3

(7) Sales ..........................................................................................
(8) Cost Contributions ......................................................................
(9) PCT Payments ...........................................................................
(10) Operating costs ........................................................................
(11) Operating income excluding PCT ............................................
(12) Operating income .....................................................................
(13) Tax ...........................................................................................
(14) Post-tax income excluding PCT ...............................................
(15) Post-tax income .......................................................................

............................
............................
D
............................
$749
H
............................
$562
L

$1000
200
A
500
300
E
............................
$225
I

$1100
220
B
550
330
F
............................
$248
J

$1210
242
C
605
363
G
............................
$272
K

(iii) Under paragraph (g)(4) of this section,
the arm’s length charge for a PCT Payment
will be an amount such that a controlled
participant’s present value, as of the date of
the PCT of its cost sharing alternative of
entering into a CSA equals the present value
of its best realistic alternative. This requires
that L, the present value of the post-tax
income under the CSA, equals the present
value of the post-tax income under the
licensing alternative, or $196.
(iv) FS determines that PCT Payments for
Z should be $196 in Year 1 (A), $215 in Year
2 (B), and $236 in Year 3 (C). By using these
amounts for A, B, and C in the table above,
FS is able to derive the values of E, F, G, I,
J, and K in the table above. Based on these
PCT Payments for Z, the post-tax income will
be $78 in Year 1 (I), $86 in Year 2 (J), and
$95 in Year 3 (K). When this post-tax income
stream is discounted at the appropriate rate
for the cost sharing alternative (15%), the net
present value is $196 (L). The present value
of the PCT Payments, when discounted at the
appropriate post-tax rate, is $488 (D).
(v) The Commissioner undertakes an audit
of the PCT Payments made by FS to USP for
Z in Years 1 through 3. The Commissioner
concludes that the PCT Payments for Z are
arm’s length in accordance with this
paragraph (g)(4).
Example 5. Pre-tax PCT Payment derived
from post-tax information. (i) The facts are
the same as in paragraphs (i) and (ii) of
Example 4. In addition, under this paragraph
(g)(4), the arm’s length charge for a PCT
Payment will be an amount such that a
controlled participant’s present value, as of

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19:36 Dec 21, 2011

Jkt 226001

the date of the PCT of its cost sharing
alternative equals the present value of its best
realistic alternative. This requires that L, the
present value of the post-tax income under
the CSA, equals the present value of the posttax income under the licensing alternative, or
$196.
(ii) FS determines that the post-tax present
value of the cost sharing alternative
(excluding PCT Payments) is $562. The posttax present value of the licensing alternative
is $196. Accordingly, payments with a posttax present value of $366 are required.
(iii) The Commissioner undertakes an audit
of the PCT Payments made by FS to USP for
Z in Years 1 through 3. In correspondence to
the Commissioner, USP maintains that the
arm’s length PCT Payment for Z should have
a present value of $366 (D).
(iv) The Commissioner considers that if FS
makes PCT Payments for Z with a present
value of $366, then the post-tax present value
under the CSA (considering the deductibility
of the PCT Payments) will be $287,
substantially higher than the post-tax present
value of the licensing arrangement, $196. The
Commissioner determines that, under the
specific facts and assumptions of this
example, the present value of the post-tax
payments may be grossed up by a factor of
(one minus the tax rate), resulting in a
present value of pre-tax payments of $488.
Accordingly, FS must make yearly PCT
Payments (A, B, and C) such that the present
value of the Payments is $488 (D). (When
FS’s post-tax income after these PCT
Payments for Z is discounted at the
appropriate rate for the cost sharing

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alternative (15%), the net present value is
$196 (L), which is equal to the present value
of post-tax income under the licensing
alternative.) The Commissioner concludes
that the calculations that it has made for the
PCT Payments for Z are arm’s length in
accordance with this paragraph (g)(4) and,
accordingly, makes the appropriate
adjustments to USP’s income tax return to
account for the gross-up required by
paragraph (g)(2)(x) of this section.
Example 6. Pre-tax PCT Payment derived
from pre-tax information. (i) The facts are the
same as in paragraphs (i) and (ii) of Example
4. In addition, under paragraph (g)(4) of this
section, the arm’s length charge for a PCT
Payment will be an amount such that a
controlled participant’s present value, as of
the date of the PCT of its cost sharing
alternative of entering into a CSA equals the
present value of its best realistic alternative.
This requires that ‘‘L,’’ the present value of
the post-tax income under the CSA, equals
the present value of the post-tax income
under the licensing alternative, or $196.
(ii) Under the specific facts and
assumptions of this Example 6 (see
paragraph (g)(4)(i)(G) of this section), and
using the same (post-tax) discount rates as in
Example 4, the present value of pre-tax
income under the licensing alternative (that
is, the operating income) is $261, and the
present value of pre-tax income under the
cost sharing alternative (excluding PCT
Payments) is $749. Accordingly, FS
determines that its PCT Payments for Z
should have a present value equal to the
difference between the two, or $488 (D). Such

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PCT Payments for Z result in a present value
of post-tax income under the cost sharing
alternative of $196 (L), which is equal to the
present value of post-tax income under the
licensing alternative.
(iii) The Commissioner undertakes an audit
of the PCT Payments for Z made by FS to
USP in Years 1 through 3. The Commissioner
concludes that the PCT Payments for Z are
arm’s length in accordance with this
paragraph (g)(4).
Example 7. Application of income method
with a terminal value calculation. (i) For
simplicity of calculation in this Example 7,
all financial flows are assumed to occur at
the beginning of each period. USP’s research
and development team, Q, has developed a
technology, Z, for which it has several
applications on the market now and several
planned for release at future dates. In Year
1, USP, enters into a CSA with its whollyowned subsidiary, FS, to develop future
applications of Z. Under the CSA, USP will
have the rights to further develop and exploit
the future applications of Z in the United
States, and FS will have the rights to further
develop and exploit the future applications
of Z in the rest of the world. Both Q and the
rights to further develop and exploit future
applications of Z are reasonably anticipated
to contribute to the development of future
applications of Z. Therefore, both Q and the
rights to further develop and exploit the
future applications of Z are platform
contributions for which compensation is due
from FS to USP as part of a PCT. USP does
not transfer the current exploitation rights for
current applications of Z to FS. FS will not
perform any research or development
activities on Z and does not furnish any
platform contributions to the CSA, nor does

it control any operating intangibles at the
inception of the CSA that would be relevant
to the exploitation of either current or future
applications of Z.
(ii) At the outset of the CSA, FS undertakes
an analysis of the PCTs involving Q and the
rights with respect to Z in order to determine
the arm’s length PCT Payments owing from
FS to USP under the CSA. In that evaluation,
FS concludes that the cost sharing alternative
represents a riskier alternative for FS than the
licensing alternative. FS further concludes
that the appropriate discount rate to apply in
assessing the licensing alternative, based on
discount rates of comparable uncontrolled
companies undertaking comparable licensing
transactions, would be 13% per annum,
whereas the appropriate discount rate to
apply in assessing the cost sharing alternative
would be 14% per annum. FS undertakes
financial projections and anticipates making
$100 million in sales during the first two
years of the CSA in its territory with sales in
Years 3 through 8 increasing to $200 million,
$400 million, $600 million, $650 million,
$700 million, and $750 million, respectively.
After Year 8, FS expects its sales of all
products based upon exploitation of Z in the
rest of the world to grow at 3% per annum
for the future. FS and USP do not anticipate
cessation of the CSA Activity with respect to
Z at any determinable date. FS anticipates
that its manufacturing and distribution costs
for exploiting Z (including its operating cost
contributions), will equal 60% of gross sales
of Z from Year 1 onwards, and anticipates its
cost contributions will equal $25 million per
annum for Years 1 and 2, $50 million per
annum for Years 3 and 4, and 10% of gross
sales per annum thereafter.

(iii) Based on this analysis, FS determines
that the arm’s length royalty rate that USP
would have charged an uncontrolled licensee
for a license of future applications of Z if
USP had further developed future
applications of Z on its own is 30% of the
sales price of the Z-based product, as
determined under the comparable
uncontrolled transaction method in § 1.482–
4(c). In light of the expected sales growth and
anticipation that the CSA Activity will not
cease as of any determinable date, FS’s
determination includes a terminal value
calculation. FS further determines that under
the cost sharing alternative, the present value
of FS’s divisional profits, reduced by the
present values of the anticipated operating
cost contributions and cost contributions,
would be $1,361 million. Under the licensing
alternative, the present value of the operating
divisional profits and losses, reduced by the
operating cost contributions, would be
$2,113 million, and the present value of the
licensing payments would be $1,585 million.
Therefore, the total value of the licensing
alternative would be $528 million. In order
for the present value of the cost sharing
alternative to equal the present value of the
licensing alternative, the present value of the
PCT Payments must equal $833 million.
Accordingly, FS pays USP a lump sum PCT
Payment of $833 million in Year 1 for USP’s
platform contributions of Z and Q.
(iv) The Commissioner undertakes an audit
of the PCTs and concludes, based on his own
analysis, that this lump sum PCT Payment is
within the interquartile range of arm’s length
results for these platform contributions. The
calculations made by FS in determining the
PCT Payment in this Example 7 are set forth
in the following tables:

COST SHARING ALTERNATIVE
Time Period (Y = Year, TV = Terminal Value).
Discount Period ................................
Items of Income/Expense at Beginning of Year:
1 Sales ....................................
2

Routine Cost and Operating
Cost Contributions (60% of
sales amount in row 1 of relevant year).
3 Cost Contributions (10% of
sales amount in row 1 for relevant year after Year 5).
4 Profit = amount in row 1 reduced by amounts in rows 2
and 3.
5 PV (using 14% discount
rate).

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6

Y1

Y2

Y3

Y4

Y5

Y6

Y7

Y8

TV

0

1

2

3

4

5

6

7

100

100

200

400

600

650

700

750

60

60

120

240

360

390

420

450

25

25

50

50

60

65

70

75

(10% of annual sales in row 1 for
each year).

15

15

30

110

180

195

210

225

(row 1 minus rows 2 and 3 for each
year).

15

13.2

23.1

74.2

107

101

95.7

89.9

842.

7

(3% annual growth in each year
from previous year).
(60% of annual sales in row 1 for
each year).

TOTAL PV of Cost Sharing Alternative = Sum of all PV amounts in Row 5 for all Time Periods = $1,361 million.

LICENSING ALTERNATIVE
Time Period (Y = Year, TV = Terminal Value).
Discount Period ................................
Items of Income/Expense at Beginning of Year:

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Y1

Y2

Y3

Y4

Y5

Y6

Y7

Y8

0

1

2

3

4

5

6

7

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7

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80113

LICENSING ALTERNATIVE—Continued
7

Sales ....................................

100

100

200

400

600

650

700

750

Routine Cost and Operating
Cost Contributions (60% of
sales amount in row 7 of relevant year).
9 Operating Profit = amount in
Row 7 reduced by amount in
Row 8.
10 PV of row 9 (using 13%
discount rate).

60

60

120

240

360

390

420

450

40

40

80

160

240

260

280

300

(Row 7 minus row 8 for each year).

40

35.4

62.7

111

147

141

135

128

1313.

(30% of amount in row 7 for each
year).
985.

8

11

TOTAL PV FOR ALL AMOUNTS IN ROW 10 = $2,112.7 million

12 Licensing Payments (30%
of sales amount in row 7).
13 PV of amount in row 12
(using 13% discount rate).
14
15

(3% annual growth in each year
from previous year).
(60% of annual sales in row 7 for
each year).

30

30

60

120

180

195

210

225

30

26.5

47

83.2

110

106

101

95.6

TOTAL PV FOR ALL AMOUNTS IN ROW 13 = $1,584.5 million.
TOTAL PV of Licensing Alternative = Row 11 minus Row 14 = $528 million.

CALCULATION OF PCT PAYMENT

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16 ......................
17 ......................
18 ......................

TOTAL PV OF COST SHARING ALTERNATIVE (FROM ROW 6 ABOVE) = ................................................
TOTAL PV OF LICENSING ALTERNATIVE (FROM ROW 15 ABOVE) = ......................................................
LUMP SUM PCT PAYMENT = ROW 16 ¥ ROW 17 = ..................................................................................

(5) Acquisition price method—(i) In
general. The acquisition price method
applies the comparable uncontrolled
transaction method of § 1.482–4(c), or
the comparable uncontrolled services
price method described in § 1.482–9(c),
to evaluate whether the amount charged
in a PCT, or group of PCTs, is arm’s
length by reference to the amount
charged (the acquisition price) for the
stock or asset purchase of an entire
organization or portion thereof (the
target) in an uncontrolled transaction.
The acquisition price method is
ordinarily used where substantially all
the target’s nonroutine contributions, as
such term is defined in paragraph
(j)(1)(i) of this section, made to the PCT
Payee’s business activities are covered
by a PCT or group of PCTs.
(ii) Determination of arm’s length
charge. Under this method, the arm’s
length charge for a PCT or group of
PCTs covering resources, capabilities,
and rights of the target is equal to the
adjusted acquisition price, as divided
among the controlled participants
according to their respective RAB
shares.
(iii) Adjusted acquisition price. The
adjusted acquisition price is the
acquisition price of the target increased
by the value of the target’s liabilities on
the date of the acquisition, other than
liabilities not assumed in the case of an
asset purchase, and decreased by the
value of the target’s tangible property on
that date and by the value on that date
of any other resources, capabilities, and

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rights not covered by a PCT or group of
PCTs.
(iv) Best method analysis
considerations. The comparability and
reliability considerations stated in
§ 1.482–4(c)(2) apply. Consistent with
those considerations, the reliability of
applying the acquisition price method
as a measure of the arm’s length charge
for the PCT Payment normally is
reduced if—
(A) A substantial portion of the
target’s nonroutine contributions to the
PCT Payee’s business activities is not
required to be covered by a PCT or
group of PCTs, and that portion of the
nonroutine contributions cannot
reliably be valued;
(B) A substantial portion of the
target’s assets consists of tangible
property that cannot reliably be valued;
or
(C) The date on which the target is
acquired and the date of the PCT are not
contemporaneous.
(v) Example. The following example
illustrates the principles of this
paragraph (g)(5):
Example. USP, a U.S. corporation, and its
newly incorporated, wholly-owned foreign
subsidiary (FS) enter into a CSA at the start
of Year 1 to develop Group Z products.
Under the CSA, USP and FS will have the
exclusive rights to exploit the Group Z
products in the U.S. and the rest of the
world, respectively. At the start of Year 2,
USP acquires Company X for cash
consideration worth $110 million. At this
time USP’s RAB share is 60%, and FS’s RAB
share is 40% and is not reasonably

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$1,361 million.
$528 million.
$833 million.

anticipated to change as a result of this
acquisition. Company X joins in the filing of
a U.S. consolidated income tax return with
USP. Under paragraph (j)(2)(i) of this section,
Company X and USP are treated as one
taxpayer for purposes of this section.
Accordingly, the rights in any of Company
X’s resources and capabilities that are
reasonably anticipated to contribute to the
development activities of the CSA will be
considered platform contributions furnished
by USP. Company X’s resources and
capabilities consist of its workforce, certain
technology intangibles, $15 million of
tangible property and other assets and $5
million in liabilities. The technology
intangibles, as well as Company X’s
workforce, are reasonably anticipated to
contribute to the development of the Group
Z products under the CSA and, therefore, the
rights in the technology intangibles and the
workforce are platform contributions for
which FS must make a PCT Payment to USP.
None of Company X’s existing intangible
assets or any of its workforce are anticipated
to contribute to activities outside the CSA.
For purposes of this example, it is assumed
that no additional adjustment on account of
tax liabilities is needed. Applying the
acquisition price method, the value of USP’s
platform contributions is the adjusted
acquisition price of $100 million ($110
million acquisition price plus $5 million
liabilities less $15 million tangible property
and other assets). FS must make a PCT
Payment to USP for these platform
contributions with a reasonably anticipated
present value of $40 million, which is the
product of $100 million (the value of the
platform contributions) and 40% (FS’s RAB
share).

(6) Market capitalization method—(i)
In general. The market capitalization

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method applies the comparable
uncontrolled transaction method of
§ 1.482–4(c), or the comparable
uncontrolled services price method
described in § 1.482–9(c), to evaluate
whether the amount charged in a PCT,
or group of PCTs, is arm’s length by
reference to the average market
capitalization of a controlled participant
(PCT Payee) whose stock is regularly
traded on an established securities
market. The market capitalization
method is ordinarily used where
substantially all of the PCT Payee’s
nonroutine contributions to the PCT
Payee’s business are covered by a PCT
or group of PCTs.
(ii) Determination of arm’s length
charge. Under the market capitalization
method, the arm’s length charge for a
PCT or group of PCTs covering
resources, capabilities, and rights of the
PCT Payee is equal to the adjusted
average market capitalization, as
divided among the controlled
participants according to their
respective RAB shares.
(iii) Average market capitalization.
The average market capitalization is the
average of the daily market
capitalizations of the PCT Payee over a
period of time beginning 60 days before
the date of the PCT and ending on the
date of the PCT. The daily market
capitalization of the PCT Payee is
calculated on each day its stock is
actively traded as the total number of
shares outstanding multiplied by the
adjusted closing price of the stock on
that day. The adjusted closing price is
the daily closing price of the stock, after
adjustments for stock-based transactions
(dividends and stock splits) and other
pending corporate (combination and
spin-off) restructuring transactions for
which reliable arm’s length adjustments
can be made.
(iv) Adjusted average market
capitalization. The adjusted average
market capitalization is the average
market capitalization of the PCT Payee
increased by the value of the PCT
Payee’s liabilities on the date of the PCT
and decreased by the value on such date
of the PCT Payee’s tangible property and
of any other resources, capabilities, or
rights of the PCT Payee not covered by
a PCT or group of PCTs.
(v) Best method analysis
considerations. The comparability and
reliability considerations stated in
§ 1.482–4(c)(2) apply. Consistent with
those considerations, the reliability of
applying the comparable uncontrolled
transaction method using the adjusted
market capitalization of a company as a
measure of the arm’s length charge for
the PCT Payment normally is reduced
if—

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(A) A substantial portion of the PCT
Payee’s nonroutine contributions to its
business activities is not required to be
covered by a PCT or group of PCTs, and
that portion of the nonroutine
contributions cannot reliably be valued;
(B) A substantial portion of the PCT
Payee’s assets consists of tangible
property that cannot reliably be valued;
or
(C) Facts and circumstances
demonstrate the likelihood of a material
divergence between the average market
capitalization of the PCT Payee and the
value of its resources, capabilities, and
rights for which reliable adjustments
cannot be made.
(vi) Examples. The following
examples illustrate the principles of this
paragraph (g)(6):
Example 1. (i) USP, a publicly traded U.S.
company, and its newly incorporated whollyowned foreign subsidiary (FS) enter into a
CSA on Date 1 to develop software. At that
time USP has in-process software but has no
software ready for the market. Under the
CSA, USP and FS will have the exclusive
rights to exploit the software developed
under the CSA in the United States and the
rest of the world, respectively. On Date 1,
USP’s RAB share is 70% and FS’s RAB share
is 30%. USP’s assembled team of researchers
and its in-process software are reasonably
anticipated to contribute to the development
of the software under the CSA. Therefore, the
rights in the research team and in-process
software are platform contributions for which
compensation is due from FS. Further, these
rights are not reasonably anticipated to
contribute to any business activity other than
the CSA Activity.
(ii) On Date 1, USP had an average market
capitalization of $205 million, tangible
property and other assets that can be reliably
valued worth $5 million, and no liabilities.
Aside from those assets, USP had no assets
other than its research team and in-process
software. Applying the market capitalization
method, the value of USP’s platform
contributions is $200 million ($205 million
average market capitalization of USP less $5
million of tangible property and other assets).
The arm’s length value of the PCT Payments
FS must make to USP for the platform
contributions, before any adjustment on
account of tax liability as described in
paragraph (g)(2)(ii) of this section, is $60
million, which is the product of $200 million
(the value of the platform contributions) and
30% (FS’s RAB share on Date 1).
Example 2. Aggregation with make-or-sell
rights. (i) The facts are the same as in
Example 1, except that on Date 1 USP also
has existing software ready for the market.
USP separately enters into a license
agreement with FS for make-or-sell rights for
all existing software outside the United
States. No marketing has occurred, and USP
has no marketing intangibles. This license of
current make-or-sell rights is a transaction
governed by § 1.482–4. However, after
analysis, it is determined that the arm’s
length PCT Payments and the arm’s length
payments for the make-or-sell license may be

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most reliably determined in the aggregate
using the market capitalization method,
under principles described in paragraph
(g)(2)(iv) of this section, and it is further
determined that those principles are most
reliably implemented by computing the
aggregate arm’s length charge as the product
of the aggregate value of the existing and inprocess software and FS’s RAB share on
Date 1.
(ii) Applying the market capitalization
method, the aggregate value of USP’s
platform contributions and the make-or-sell
rights in its existing software is $250 million
($255 million average market capitalization
of USP less $5 million of tangible property
and other assets). The total arm’s length
value of the PCT Payments and licensing
payments FS must make to USP for the
platform contributions and current make-orsell rights, before any adjustment on account
of tax liability, if any, is $75 million, which
is the product of $250 million (the value of
the platform contributions and the make-orsell rights) and 30% (FS’s RAB share on Date
1).
Example 3. Reduced reliability. The facts
are the same as in Example 1 except that USP
also has significant nonroutine assets that
will be used solely in a nascent business
division that is unrelated to the subject of the
CSA and that cannot themselves be reliably
valued. Those nonroutine contributions are
not platform contributions and accordingly
are not required to be covered by a PCT. The
reliability of using the market capitalization
method to determine the value of USP’s
platform contributions to the CSA is
significantly reduced in this case because
that method would require adjusting USP’s
average market capitalization to account for
the significant nonroutine contributions that
are not required to be covered by a PCT.

(7) Residual profit split method—(i) In
general. The residual profit split method
evaluates whether the allocation of
combined operating profit or loss
attributable to one or more platform
contributions subject to a PCT is arm’s
length by reference to the relative value
of each controlled participant’s
contribution to that combined operating
profit or loss. The combined operating
profit or loss must be derived from the
most narrowly identifiable business
activity (relevant business activity) of
the controlled participants for which
data are available that include the CSA
Activity. The residual profit split
method may not be used where only one
controlled participant makes significant
nonroutine contributions (including
platform or operating contributions) to
the CSA Activity. The provisions of
§ 1.482–6 shall apply to CSAs only to
the extent provided and as modified in
this paragraph (g)(7). Any other
application to a CSA of a residual profit
method not described in paragraphs
(g)(7)(ii) and (iii) of this section will
constitute an unspecified method for
purposes of sections 482 and 6662(e)

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
and the regulations under those
sections.
(ii) Appropriate share of profits and
losses. The relative value of each
controlled participant’s contribution to
the success of the relevant business
activity must be determined in a manner
that reflects the functions performed,
risks assumed, and resources employed
by each participant in the relevant
business activity, consistent with the
best method analysis described in
§ 1.482–1(c) and (d). Such an allocation
is intended to correspond to the
division of profit or loss that would
result from an arrangement between
uncontrolled taxpayers, each performing
functions similar to those of the various
controlled participants engaged in the
relevant business activity. The profit
allocated to any particular controlled
participant is not necessarily limited to
the total operating profit of the group
from the relevant business activity. For
example, in a given year, one controlled
participant may earn a profit while
another controlled participant incurs a
loss. In addition, it may not be assumed
that the combined operating profit or
loss from the relevant business activity
should be shared equally, or in any
other arbitrary proportion.
(iii) Profit split—(A) In general. Under
the residual profit split method, the
present value of each controlled
participant’s residual divisional profit
or loss attributable to nonroutine
contributions (nonroutine residual
divisional profit or loss) is allocated
between the controlled participants that
each furnish significant nonroutine
contributions (including platform or
operating contributions) to the relevant
business activity in that division.
(B) Determine nonroutine residual
divisional profit or loss. The present
value of each controlled participant’s
nonroutine residual divisional profit or
loss must be determined to reflect the
most reliable measure of an arm’s length
result. The present value of nonroutine
residual divisional profit or loss equals
the present value of the stream of the
reasonably anticipated residuals over
the duration of the CSA Activity of
divisional profit or loss, minus market
returns for routine contributions, minus
operating cost contributions, minus cost
contributions, using a discount rate
appropriate to such residuals in
accordance with paragraph (g)(2)(v) of
this section. As used in this paragraph
(g)(7), the phrase ‘‘market returns for
routine contributions’’ includes market
returns for operating cost contributions
and excludes market returns for cost
contributions.
(C) Allocate nonroutine residual
divisional profit or loss—(1) In general.

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The present value of nonroutine
residual divisional profit or loss in each
controlled participant’s division must
be allocated among all of the controlled
participants based upon the relative
values, determined as of the date of the
PCTs, of the PCT Payor’s as compared
to the PCT Payee’s nonroutine
contributions to the PCT Payor’s
division. For this purpose, the PCT
Payor’s nonroutine contribution consists
of the sum of the PCT Payor’s
nonroutine operating contributions and
the PCT Payor’s RAB share of the PCT
Payor’s nonroutine platform
contributions. For this purpose, the PCT
Payee’s nonroutine contribution
consists of the PCT Payor’s RAB share
of the PCT Payee’s nonroutine platform
contributions.
(2) Relative value determination. The
relative values of the controlled
participants’ nonroutine contributions
must be determined so as to reflect the
most reliable measure of an arm’s length
result. Relative values may be measured
by external market benchmarks that
reflect the fair market value of such
nonroutine contributions. Alternatively,
the relative value of nonroutine
contributions may be estimated by the
capitalized cost of developing the
nonroutine contributions and updates,
as appropriately grown or discounted so
that all contributions may be valued on
a comparable dollar basis as of the same
date. If the nonroutine contributions by
a controlled participant are also used in
other business activities (such as the
exploitation of make-or-sell rights
described in paragraph (c)(4) of this
section), an allocation of the value of the
nonroutine contributions must be made
on a reasonable basis among all the
business activities in which they are
used in proportion to the relative
economic value that the relevant
business activity and such other
business activities are anticipated to
derive over time as the result of such
nonroutine contributions.
(3) Determination of PCT Payments.
Any amount of the present value of a
controlled participant’s nonroutine
residual divisional profit or loss that is
allocated to another controlled
participant represents the present value
of the PCT Payments due to that other
controlled participant for its platform
contributions to the relevant business
activity in the relevant division. For
purposes of paragraph (j)(3)(ii) of this
section, the present value of a PCT
Payor’s PCT Payments under this
paragraph shall be deemed reduced to
the extent of the present value of any
PCT Payments owed to it from other
controlled participants under this
paragraph (g)(7). The resulting

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80115

remainder may be converted to a fixed
or contingent form of payment in
accordance with paragraph (h) (Form of
payment rules) of this section.
(4) Routine platform and operating
contributions. For purposes of this
paragraph (g)(7), any routine platform or
operating contributions, the valuation
and PCT Payments for which are
determined and made independently of
the residual profit split method, are
treated similarly to cost contributions
and operating cost contributions,
respectively. Accordingly, wherever
used in this paragraph (g)(7), the term
‘‘routine contributions’’ shall not
include routine platform or operating
contributions, and wherever the terms
‘‘cost contributions’’ and ‘‘operating cost
contributions’’ appear in this paragraph
(g)(7), they shall include net routine
platform contributions and net routine
operating contributions, respectively, as
defined in paragraph (g)(4)(vii) of this
section. However, treatment of net
operating contributions as operating
cost contributions shall be coordinated
with the treatment of other routine
contributions pursuant to paragraphs
(g)(4)(iii)(B) and (7)(iii)(B) of this section
so as to avoid duplicative market
returns to such contributions.
(iv) Best method analysis
considerations—(A) In general. Whether
results derived from this method are the
most reliable measure of the arm’s
length result is determined using the
factors described under the best method
rule in § 1.482–1(c). Thus, comparability
and quality of data, reliability of
assumptions, and sensitivity of results
to possible deficiencies in the data and
assumptions, must be considered in
determining whether this method
provides the most reliable measure of an
arm’s length result. The application of
these factors to the residual profit split
in the context of the relevant business
activity of developing and exploiting
cost shared intangibles is discussed in
paragraphs (g)(7)(iv)(B) through (D) of
this section.
(B) Comparability. The derivation of
the present value of nonroutine residual
divisional profit or loss includes a
carveout on account of market returns
for routine contributions. Thus, the
comparability considerations that are
relevant for that purpose include those
that are relevant for the methods that are
used to determine market returns for the
routine contributions.
(C) Data and assumptions. The
reliability of the results derived from the
residual profit split is affected by the
quality of the data and assumptions
used to apply this method. In particular,
the following factors must be
considered:

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jlentini on DSK4TPTVN1PROD with RULES3

(1) The reliability of the allocation of
costs, income, and assets between the
relevant business activity and the
controlled participants’ other activities
that will affect the reliability of the
determination of the divisional profit or
loss and its allocation among the
controlled participants. See § 1.482–
6(c)(2)(ii)(C)(1).
(2) The degree of consistency between
the controlled participants and
uncontrolled taxpayers in accounting
practices that materially affect the items
that determine the amount and
allocation of operating profit or loss
affects the reliability of the result. See
§ 1.482–6(c)(2)(ii)(C)(2).
(3) The reliability of the data used and
the assumptions made in estimating the
relative value of the nonroutine
contributions by the controlled
participants. In particular, if capitalized
costs of development are used to
estimate the relative value of nonroutine
contributions, the reliability of the
results is reduced relative to the
reliability of other methods that do not
require such an estimate. This is
because, in any given case, the costs of
developing a nonroutine contribution
may not be related to its market value
and because the calculation of the
capitalized costs of development may
require the allocation of indirect costs
between the relevant business activity
and the controlled participant’s other
activities, which may affect the
reliability of the analysis.
(D) Other factors affecting reliability.
Like the methods described in §§ 1.482–
3 through 1.482–5 and § 1.482–9(c), the
carveout on account of market returns
for routine contributions relies
exclusively on external market
benchmarks. As indicated in § 1.482–
1(c)(2)(i), as the degree of comparability
between the controlled participants and
uncontrolled transactions increases, the
relative weight accorded the analysis
under this method will increase. In
addition, to the extent the allocation of
nonroutine residual divisional profit or
loss is not based on external market
benchmarks, the reliability of the
analysis will be decreased in relation to
an analysis under a method that relies
on market benchmarks. Finally, the
reliability of the analysis under this
method may be enhanced by the fact
Time Period (Y = Year) (TV = Terminal Value) ..............
Discount Period ...............................................................
[1] Sales ..........................................................................
[2] Growth Rate ...............................................................
[3] Exploitation Costs and Operating Cost Contributions
(52% of Sales [1]) ........................................................
[4] Return on [3] (6% of [3]) ............................................
[5] Cost Contributions (10% of Sales [1] after Year 5) ...
[6] Residual Profit = [1] minus {[3] + [4] + [5]} ...............

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that all the controlled participants are
evaluated under the residual profit split.
However, the reliability of the results of
an analysis based on information from
all the controlled participants is affected
by the reliability of the data and the
assumptions pertaining to each
controlled participant. Thus, if the data
and assumptions are significantly more
reliable with respect to one of the
controlled participants than with
respect to the others, a different method,
focusing solely on the results of that
party, may yield more reliable results.
(v) Examples. The following examples
illustrate the principles of this
paragraph (g)(7):
Example 1. (i) For simplicity of calculation
in this Example 1, all financial flows are
assumed to occur at the beginning of each
period. USP, a U.S. electronic data storage
company, has partially developed technology
for a type of extremely small compact storage
devices (nanodisks) which are expected to
provide a significant increase in data storage
capacity in various types of portable devices
such as cell phones, MP3 players, laptop
computers and digital cameras. At the same
time, USP’s wholly-owned subsidiary, FS,
has developed significant marketing
intangibles outside the United States in the
form of customer lists, ongoing relations with
various OEMs, and trademarks that are well
recognized by consumers due to a long
history of marketing successful data storage
devices and other hardware used in various
types of consumer electronics. At the
beginning of Year 1, USP enters into a CSA
with FS to develop nanodisk technologies for
eventual commercial exploitation. Under the
CSA, USP will have the right to exploit
nanodisks in the United States, while FS will
have the right to exploit nanodisks in the rest
of the world. The partially developed
nanodisk technologies owned by USP are
reasonably anticipated to contribute to the
development of commercially exploitable
nanodisks and therefore the rights in the
nanodisk technologies constitute platform
contributions of USP for which
compensation is due under PCTs. FS does
not have any platform contributions for the
CSA. Due to the fact that nanodisk
technologies have yet to be incorporated into
any commercially available product, neither
USP nor FS transfers rights to make or sell
current products in conjunction with the
CSA.
(ii) Because only in FS’s territory do both
controlled participants make significant
nonroutine contributions, USP and FS
determine that they need to determine the
relative value of their respective

contributions to residual divisional profit or
loss attributable to the CSA Activity only in
FS’s territory. FS anticipates making no
nanodisk sales during the first year of the
CSA in its territory with revenues in Year 2
reaching $200 million. Revenues through
Year 5 are reasonably anticipated to increase
by 50% per year. The annual growth rate for
revenues is then expected to decline to 30%
per annum in Years 6 and 7, 20% per annum
in Years 8 and 9 and 10% per annum in Year
10. Revenues are then expected to decline
10% in Year 11 and 5% per annum,
thereafter. The routine costs (defined here as
costs other than cost contributions, routine
platform and operating contributions, and
nonroutine contributions) that are allocable
to this revenue in calculating FS’s divisional
profit or loss, are anticipated to equal $40
million for the first year of the CSA and $130
for the second year and $200 and $250
million in Years 3 and 4. Total operating
expenses attributable to product exploitation
(including operating cost contributions)
equal 52% of sales per year. FS undertakes
routine distribution activities in its markets
that constitute routine contributions to the
relevant business activity of exploiting
nanodisk technologies. USP and FS estimate
that the total market return on these routine
contributions will amount to 6% of the
routine costs. FS expects its cost
contributions to be $60 million in Year 1, rise
to $100 million in Years 2 and 3, and then
decline again to $60 million in Year 4.
Thereafter, FS’s cost contributions are
expected to equal 10% of revenues.
(iii) USP and FS determine the present
value of the stream of the reasonably
anticipated residuals in FS’s territory over
the duration of the CSA Activity of the
divisional profit or loss (revenues minus
routine costs), minus the market returns for
routine contributions, the operating cost
contributions, and the cost contributions.
USP and FS determine, based on the
considerations discussed in paragraph
(g)(2)(v) of this section, that the appropriate
discount rate is 17.5% per annum. Therefore,
the present value of the nonroutine residual
divisional profit is $1,395 million.
(iv) After analysis, USP and FS determine
that the relative value of the nanodisk
technologies contributed by USP to CSA
(giving effect only to its value in FS’s
territory) is roughly 150% of the value of FS’s
marketing intangibles (which only have value
in FS’s territory). Consequently, 60% of the
nonroutine residual divisional profit is
attributable to USP’s platform contribution.
Therefore, FS’s PCT Payments should have
an expected present value equal to $837
million (.6 x $1,395 million).
(v) The calculations for this Example 1 are
displayed in the following table:

Y1
0
0
..........

Y2
1
200
..........

Y3
2
300
50%

Y4
3
450
50%

Y5
4
675
50%

Y6
5
878
30%

Y7
6
1141
30%

Y8
7
1369
20%

Y9
8
1643
20%

Y10
9
1807
10%

Y11
10
1626
¥10%

40
2.4
60
¥102

130
8
100
¥38

200
12
100
¥12

250
15
60
125

351
21
68
235

456
27
88
306

593
36
114
398

712
43
137
477

854
51
164
573

940
56
181
630

846
51
163
567

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
[7] Residual Profit [6] Discounted at 17.5% discount
rate ..............................................................................

¥102

¥32

¥9

77

124

137

151

154

158

148

80117
113

477

[8] Sum of all amounts in [7] for all time periods = $1,395 million
[9] Relative value in FS’s division of USP’s nanotechnology to FS’s marketing intangibles = 150%
[10] Profit Split (USP) ......................................................

60% = 1.5 x [11]

[11] Profit Split (FS) ........................................................

40%

[12] FS’s PCT Payments ................................................

[8] x [10] = $1,395 million x 60% = $837 million

Example 2. (i) For simplicity of calculation
in this Example 2, all financial flows are
assumed to occur at the beginning of each
period. USP is a U.S. automobile
manufacturing company that has completed
significant research on the development of
diesel-electric hybrid engines that, if they
could be successfully manufactured, would
result in providing a significant increased
fuel economy for a wide variety of motor
vehicles. Successful commercialization of the
diesel-electric hybrid engine will require the
development of a new class of advanced
battery that will be light, relatively cheap to
manufacture and yet capable of holding a
substantial electric charge. FS, a foreign
subsidiary of USP, has completed significant
research on developing lithium-ion batteries
that appear likely to have the requisite
characteristics. At the beginning of Year 1,
USP enters into a CSA with FS to further
develop diesel-electric hybrid engines and
lithium-ion battery technologies for eventual
commercial exploitation. Under the CSA,
USP will have the right to exploit the dieselelectric hybrid engine and lithium-ion
battery technologies in the United States,
while FS will have the right to exploit such
technologies in the rest of the world. The
partially developed diesel-electric hybrid
engine and lithium-ion battery technologies
owned by USP and FS, respectively, are
reasonably anticipated to contribute to the
development of commercially exploitable
automobile engines and therefore the rights
in both these technologies constitute
platform contributions of USP and of FS for
which compensation is due under PCTs. At
the time of inception of the CSA, USP owns
operating intangibles in the form of selfdeveloped marketing intangibles which have
significant value in the United States, but not
in the rest of the world, and that are relevant
to exploiting the cost shared intangibles.
Similarly, FS owns self-developed marketing
intangibles which have significant value in
the rest of the world, but not in the United

States, and that are relevant to exploiting the
cost shared intangibles. Although the new
class of diesel-electric hybrid engine using
lithium-ion batteries is not yet ready for
commercial exploitation, components based
on this technology are beginning to be
incorporated in current-generation gasolineelectric hybrid engines and the rights to make
and sell such products are transferred from
USP to FS and vice-versa in conjunction with
the inception of the CSA, following the same
territorial division as in the CSA.
(ii) USP’s estimated RAB share is 66.7%.
During Year 1, it is anticipated that sales in
USP’s territory will be $1000X in Year 1.
Sales in FS’s territory are anticipated to be
$500X. Thereafter, as revenue from the use of
components in gasoline-electric hybrids is
supplemented by revenues from the
production of complete diesel-electric hybrid
engines using lithium-ion battery technology,
anticipated sales in both territories will
increase rapidly at a rate of 50% per annum
through Year 4. Anticipated sales are then
anticipated to increase at a rate of 40% per
annum for another 4 years. Sales are then
anticipated to increase at a rate of 30% per
annum through Year 10. Thereafter, sales are
anticipated to decrease at a rate of 5% per
annum for the foreseeable future as new
automotive drivetrain technologies displace
diesel-electric hybrid engines and lithiumion batteries. Total operating expenses
attributable to product exploitation
(including operating cost contributions)
equal 40% of sales per year for both USP and
FS. USP and FS estimate that the total market
return on these routine contributions to the
CSA will amount to 6% of these operating
expenses. USP is expected to bear 2⁄3 of the
total cost contributions for the foreseeable
future. Cost contributions are expected to
total $375X in Year 1 (of which $250X are
borne by USP) and increase at a rate of 25%
per annum through Year 6. In Years 7
through 10, cost contributions are expected
to increase 10% a year. Thereafter, cost

contributions are expected to decrease by 5%
a year for the foreseeable future.
(iii) USP and FS determine the present
value of the stream of FS’s reasonably
anticipated residual divisional profit, which
is the stream of FS’s reasonably anticipated
divisional profit or loss, minus the market
returns for routine contributions, minus
operating cost contributions, minus cost
contributions. USP and FS determine, based
on the considerations discussed in paragraph
(g)(2)(v) of this section, that the appropriate
discount rate is 12% per year. Therefore, the
present value of the nonroutine residual
divisional profit in USP’s territory is
$41,727X and in CFC’s territory is $20,864X.
(iv) After analysis, USP and FS determine
that, in the United States the relative value
of the technologies contributed by USP and
FS to the CSA and of the operating
intangibles used by USP in the exploitation
of the cost shared intangibles (reported as
equaling 100 in total), equals: USP’s platform
contribution (59.5); FS’s platform
contribution (25.5); and USP’s operating
intangibles (15). Consequently, the present
value of the arm’s length amount of the PCT
Payments that USP should pay to FS for FS’s
platform contribution is $10,640X (.255 x
$41,727X). Similarly, USP and FS determine
that, in the rest of the world, the relative
value of the technologies contributed by USP
and FS to the CSA and of the operating
intangibles used by FS in the exploitation of
the cost shared intangibles can be divided as
follows: USP’s platform contribution (63);
FS’s platform contribution (27); and FS’s
operating intangibles (10). Consequently, the
present value of the arm’s length amount of
the PCT Payments that FS should pay to USP
for USP’s platform contribution is $13,144X
(.63 × $20,864X). Therefore, FS is required to
make a net payment to USP with a present
value of $2,504X ($13,144X ¥ 10,640X).
(v) The calculations for this Example 2 are
displayed in the following tables:

jlentini on DSK4TPTVN1PROD with RULES3

CALCULATION OF USP’S PCT PAYMENT TO FS
Time Period (Y = Year) (TV = Terminal Value) .....................................
Discount Period .......................................................................................
[1] Sales ..................................................................................................
[2] Growth Rate .......................................................................................
[3] Exploitation Costs and Operating Cost Contributions (40% of Sales
[1]) .......................................................................................................
[4] Return on [3] = 6% of [3] ...................................................................
[5] Cost Contributions .............................................................................
[6] Residual Profit = [1] minus {[3] + [4] + [5]} .......................................
[7] Residual Profit [6] Discounted at 12% discount rate .........................

Y1
0
1000
..........

Y2
1
1500
50%

Y3
2
2250
50%

Y4
3
3375
50%

Y5
4
4725
40%

Y6
5
6615
40%

Y7
6
9261
40%

Y8
7
12965
40%

Y9
8
16855
30%

Y10
9
21912
30%

400
24
250
326
326

600
36
313
552
492

900
54
391
905
722

1350
81
488
1456
1036

1890
113
610
2111
1342

2646
159
763
3047
1729

3704
222
839
4495
2277

5186
311
923
6545
2961

6742
405
1015
8693
3511

8765
526
1117
11504
4148

[8] Sum of all amounts in [7] for all time periods = $41,727X
Profit Split for Calculation of USP’s PCT Payment to FS: [Total of US contributions = 74.5%]
[9] USP’s Platform Contribution = 59.5%

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
CALCULATION OF USP’S PCT PAYMENT TO FS—Continued

[10] FS’s Platform Contribution = 25.5%
[11] USP’s Operating Intangibles = 15%
[12] USP’s PCT Payment to FS = [8] × [10] = $41,727X multiplied by 25.5% = $10,640X

CALCULATION OF FS’S NET PCT PAYMENT TO USF
Time Period (Y = Year) (TV = Terminal Value) .....................................
Discount Period .......................................................................................
[13] Sales ................................................................................................
[14] Growth Rate .....................................................................................
[15] Exploitation Costs and Operating Cost Contributions (40% of
Sales [13]) ...........................................................................................
[16] Return on [15] = 6% of [15] .............................................................
[17] Cost Contributions ...........................................................................
[18] Residual Profit = [13] minus {[15] + [16] + [17]} .............................
[19] Residual Profit [18] Discounted at 12% discount rate .....................

Y1
0
500
..........

Y2
1
750
50%

Y3
2
1125
50%

Y4
3
1688
50%

Y5
4
2363
40%

Y6
5
3308
40%

Y7
6
4631
40%

Y8
7
6483
40%

Y9
8
8428
30%

Y10
9
10956
30%

200
12
125
163
163

300
18
156
276
246

450
27
195
453
361

675
41
244
728
518

945
57
305
1056
671

1323
79
381
1524
865

1852
111
420
2248
1139

2593
156
462
3272
1480

3371
202
508
4347
1755

4382
263
559
5752
2074

TV
9

32144
11591

[20] Sum of all amounts in [19] for all time periods = $20,864X
Profit Split for Calculation of FS’s PCT Payment to USP: [Total of FS’s contributions = 37%]
[21] USP’s Platform Contribution = 63%
[22] FS’s Platform Contribution = 27%
[23] FS’s Operating Intangibles = 10%
[24] FS’s PCT Payment to USP = [20] × [21] = $20,864X multiplied by 63% = $13,144X

jlentini on DSK4TPTVN1PROD with RULES3

[25] FS’s Net PCT Payment to USP = [24] minus [12] = $13,144X minus $10,640X = $2,504X

(8) Unspecified methods. Methods not
specified in paragraphs (g)(3) through
(7) of this section may be used to
evaluate whether the amount charged
for a PCT is arm’s length. Any method
used under this paragraph (g)(8) must be
applied in accordance with the
provisions of § 1.482–1 and of paragraph
(g)(2) of this section. 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, and only
enter into a particular transaction if
none of the alternatives is preferable to
it. Therefore, in establishing whether a
PCT achieved an arm’s length result, an
unspecified method should provide
information on the prices or profits that
the controlled participant could have
realized by choosing a realistic
alternative to the CSA. See paragraph
(k)(2)(ii)(J) of this section. As with any
method, an unspecified method will not
be applied unless it provides the most
reliable measure of an arm’s length
result under the principles of the best
method rule. See § 1.482–1(c) (Best
method rule). In accordance with
§ 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.

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(h) Form of payment rules—(1) CST
Payments. CST Payments may not be
paid in shares of stock in the payor (or
stock in any member of the controlled
group that includes the controlled
participants).
(2) PCT Payments—(i) In general. The
consideration under a PCT for a
platform contribution may take one or a
combination of both of the following
forms:
(A) Payments of a fixed amount (fixed
payments), either paid in a lump sum
payment or in installment payments
spread over a specified period, with
interest calculated in accordance with
§ 1.482–2(a) (Loans or advances).
(B) Payments contingent on the
exploitation of cost shared intangibles
by the PCT Payor (contingent
payments). Accordingly, controlled
participants have flexibility to adopt a
form and period of payment, provided
that such form and period of payment
are consistent with an arm’s length
charge as of the date of the PCT. See
also paragraphs (h)(2)(iv) and (3) of this
section.
(ii) No PCT Payor Stock. PCT
Payments may not be paid in shares of
stock in the PCT Payor (or stock in any
member of the controlled group that
includes the controlled participants).
(iii) Specified form of payment—(A)
In general. The form of payment
selected (subject to the rules of this
paragraph (h)) for any PCT, including,
in the case of contingent payments, the
contingent base and structure of the
payments as set forth in paragraph
(h)(2)(iii)(B) of this section, must be

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specified no later than the due date of
the applicable tax return (including
extensions) for the later of the taxable
year of the PCT Payor or PCT Payee that
includes the date of that PCT.
(B) Contingent payments. In
accordance with paragraph (k)(1)(iv)(A)
of this section, a provision of a written
contract described in paragraph (k)(1) of
this section, or of the additional
documentation described in paragraph
(k)(2) of this section, that provides for
payments for a PCT (or group of PCTs)
to be contingent on the exploitation of
cost shared intangibles will be respected
as consistent with economic substance
only if the allocation between the
controlled participants of the risks
attendant on such form of payment is
determinable before the outcomes of
such allocation that would have
materially affected the PCT pricing are
known or reasonably knowable. A
contingent payment provision must
clearly and unambiguously specify the
basis on which the contingent payment
obligations are to be determined. In
particular, the contingent payment
provision must clearly and
unambiguously specify the events that
give rise to an obligation to make PCT
Payments, the royalty base (such as
sales or revenues), and the computation
used to determine the PCT Payments.
The royalty base specified must be one
that permits verification of its proper
use by reference to books and records
maintained by the controlled
participants in the normal course of
business (for example, books and
records maintained for financial

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jlentini on DSK4TPTVN1PROD with RULES3

accounting or business management
purposes).
(C) Examples. The following
examples illustrate the principles of this
paragraph (h)(2).
Example 1. A CSA provides that PCT
Payments with respect to a particular
platform contribution shall be contingent
payments equal to 15% of the revenues from
sales of products that incorporate cost shared
intangibles. The terms further permit (but do
not require) the controlled participants to
adjust such contingent payments in
accordance with a formula set forth in the
arrangement so that the 15% rate is subject
to adjustment by the controlled participants
at their discretion on an after-the-fact,
uncompensated basis. The Commissioner
may impute payment terms that are
consistent with economic substance with
respect to the platform contribution because
the contingent payment provision does not
specify the computation used to determine
the PCT Payments.
Example 2. Taxpayer, an automobile
manufacturer, is a controlled participant in a
CSA that involves research and development
to perfect certain manufacturing techniques
necessary to the actual manufacture of a
state-of-the-art, hybrid fuel injection system
known as DRL337. The arrangement involves
the platform contribution of a design patent
covering DRL337. Pursuant to paragraph
(h)(2)(iii)(B) of this section, the CSA provides
for PCT Payments with respect to the
platform contribution of the patent in the
form of royalties contingent on sales of
automobiles that contain the DRL337 system.
However, Taxpayer’s system of book- and
record-keeping does not enable Taxpayer to
track which automobile sales involve
automobiles that contain the DRL337 system.
Because Taxpayer has not complied with
paragraph (h)(2)(iii)(B) of this section, the
Commissioner may impute payment terms
that are consistent with economic substance
and susceptible to verification by the
Commissioner.
Example 3. (i) Controlled participants A
and B enter into a CSA that provides for PCT
Payments from A to B with respect to B’s
platform contribution, Z, in the form of three
annual installment payments due from A to
B on the last day of each of the first three
years of the CSA.
(ii) On audit, based on all the facts and
circumstances, the Commissioner determines
that the installment PCT Payments are
consistent with an arm’s length charge as of
the date of the PCT. Accordingly, the
Commissioner does not make an adjustment
with respect to the PCT Payments in any
year.
Example 4. (i) The facts are the same as in
Example 3 except that the CSA contains an
additional term with respect to the PCT
Payments. Under this provision, A and B
further agreed that, if the present value (as of
the CSA Start Date) of A’s actual divisional
operating profit or loss during the three-year
period is less than the present value (as of
the CSA Start Date) of the divisional
operating profit or loss that the parties
projected for A upon formation of the CSA
for that period, then the third installment

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payment shall be subject to a compensating
adjustment in the amount necessary to
reduce the present value (as of the CSA Start
Date) of the aggregate PCT Payments for those
three years to the amount that would have
been calculated if the actual results had been
used for the calculation instead of the
projected results.
(ii) This provision further specifies that A
will pay B an additional amount, $Q, in the
first year of the CSA to compensate B for
taking on additional downside risk through
the contingent payment term described in
paragraph (i) of this Example 4.
(iii) During the first two years, A pays B
installment payments as agreed, as well as
the additional amount, $Q. In the third year,
A and B determine that the present value (as
of the CSA Start Date) of A’s actual divisional
operating profit or loss during the three-year
period is less than the present value (as of
the CSA Start Date) of the divisional
operating profit or loss that the parties
projected for A upon formation of the CSA
for that period. A reduces the PCT Payment
to B in the third year in the amount necessary
to reduce the present value (as of the CSA
Start Date) of the aggregate PCT Payments for
those three years to the amount that would
have been calculated if the actual results had
been used for the calculation instead of the
projected results.
(iv) On audit, based on all the facts and
circumstances, the Commissioner determines
that the installment PCT Payments agreed to
be paid by A to B were consistent with an
arm’s length charge as of the date of the PCT.
The Commissioner further determines that
the contingency was sufficiently specified
such that its occurrence or nonoccurrence
was unambiguous and determinable; that the
projections were reliable; and that the
contingency did, in fact, occur. Finally, the
Commissioner determines, based on all the
facts and circumstances, that $Q was within
the arm’s length range for the additional
allocation of risk to B. Accordingly, no
adjustment is made with respect to the
installment PCT Payments, or the additional
PCT Payment for the contingent payment
term, in any year.
Example 5. (i) The facts are the same as in
Example 4 except that the CSA states the
amount that A will pay B for the contingent
payment term is $X, an amount that is less
than $Q, and A pays B $X in the first year
of the CSA.
(ii) On audit, based on all the facts and
circumstances, the Commissioner determines
that the installment PCT Payments agreed to
be paid by A to B were consistent with an
arm’s length charge as of the date of the PCT.
The Commissioner further determines that
the contingency was sufficiently specified
such that its occurrence or nonoccurrence
was unambiguous and determinable; that the
projections were reliable; and that the
contingency did, in fact, occur. However, the
Commissioner also determines, based on all
the facts and circumstances, that the
additional PCT Payment of $X from A to B
for the contingent payment term was not an
arm’s length charge for the additional
allocation of risk as of the CSA Start Date in
connection with the contingent payment
term. Accordingly, the Commissioner makes

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80119

an adjustment to B’s results equal to the
difference between $X and the median of the
arm’s length range of charges for the
contingent payment term.
Example 6. (i) The facts are the same as in
Example 3 except that A and B further agreed
that, if the present value (as of the CSA Start
Date) of A’s actual divisional operating profit
or loss during the three-year period is either
less or greater than the present value (as of
the CSA Start Date) of the divisional
operating profit or loss that the parties
projected for A upon formation of the CSA
for that period, then A may make a
compensating adjustment to the third
installment payment in the amount necessary
to reduce (if actual divisional operating profit
or loss is less than the projections) or
increase (if actual divisional operating profit
or loss exceeds the projections) the present
value (as of the CSA Start Date) of the
aggregate PCT Payments for those three years
to the amount that would have been
calculated if the actual results had been used
for the calculation instead of the projected
results.
(ii) On audit, the Commissioner determines
that the contingent payment term lacks
economic substance under §§ 1.482–
1(d)(3)(iii)(B) and 1.482–7(h)(2)(iii)(B). It
lacks economic substance because the
allocation of the risks between A and B was
indeterminate as of the CSA Start Date due
to the elective nature of the potential
compensating adjustments. Specifically, the
parties agreed upfront only that A might
make compensating adjustments to the
installment payments. By the terms of the
agreement, A could decide whether to make
such adjustments after the outcome of the
risks was known or reasonably knowable.
Even though the contingency and potential
compensating adjustments were clearly
defined in the CSA, no compensating
adjustments were required by the CSA
regardless of the occurrence or
nonoccurrence of the contingency. As a
result, the contingent payment terms did not
clearly and unambiguously specify the events
that give rise to an obligation to make PCT
Payments, and, accordingly, the obligation to
make compensating adjustments pursuant to
the contingency was indeterminate. The
contingent payment term allows the taxpayer
to make adjustments that are favorable to its
overall tax position in those years where the
agreement allows it to make such
adjustments, but decline to exercise its right
to make any adjustment in those years in
which such an adjustment would be
unfavorable to its overall tax position. Such
terms do not reflect a substantive upfront
allocation of risk. In addition, the vagueness
of the agreement makes it impossible to
determine whether such contingent payment
term warrants an additional arm’s length
charge and, if so, how much.
(iii) Accordingly, the Commissioner may
disregard the contingent payment term under
§§ 1.482–1(d)(3)(ii)(B)(1) and 1.482–
7(k)(1)(iv) and may impute other contractual
terms in its place consistent with the
economic substance of the CSA.
Example 7. (i) The facts are the same as in
Example 6 except that the contingent
payment term provides that, if the present

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value (as of the CSA Start Date) of A’s actual
divisional operating profit or loss during the
three-year period is either less or greater than
the present value (as of the CSA Start Date)
of the divisional operating profit or loss that
the parties projected for A upon formation of
the CSA for that period, then A will make a
compensating adjustment to the third
installment payment. The CSA does not
specify the amount of (or a formula for) any
such compensating adjustments.
(ii) On audit, the Commissioner determines
that the contingent payment term lacks
economic substance under §§ 1.482–
1(d)(3)(iii)(B) and 1.482–7(h)(2)(iii)(B). It
lacks economic substance because the
allocation of the risks between A and B was
indeterminate as of the CSA Start Date due
to the failure to specify the amount of (or a
formula for) the compensating adjustments
that must be made if a contingency occurs.
The basis on which the compensating
adjustments were to be determined was
neither clear nor unambiguous. Even though
the contingency was clearly defined in the
CSA and the requirement of a compensating
adjustment in the event of a contingency was
clearly specified in the CSA, the parties had
no agreement regarding the amount of such
compensating adjustments. As a result, the
computation used to determine the PCT
Payments was indeterminate. The parties
could choose to make a small positive
compensating adjustment if the actual results
turned out to be much greater than the
projections, and could choose to make a
significant negative compensating adjustment
if the actual results turned out to be less than
the projections. Such terms do not reflect a
substantive upfront allocation of risk. In
addition, the vagueness of the agreement
makes it impossible to determine whether
such contingent payment term warrants an
additional arm’s length charge and, if so, how
much.
(iii) Accordingly, the Commissioner may
disregard the contingent price term under
§§ 1.482–1(d)(3)(ii)(B)(1) and 1.482–
7(k)(1)(iv) and may impute other contractual
terms in its place consistent with economic
substance of the CSA.

(iv) Conversion from fixed to
contingent form of payment. With
regard to a conversion of a fixed present
value to a contingent form of payment,
see paragraphs (g)(2)(v) (Discount rate)
and (vi) (Financial projections) of this
section.
(3) Coordination of best method rule
and form of payment. A method
described in paragraph (g)(1) of this
section evaluates the arm’s length
amount charged in a PCT in terms of a
form of payment (method payment
form). For example, the method
payment form for the acquisition price
method described in paragraph (g)(5) of
this section, and for the market
capitalization method described in
paragraph (g)(6) of this section, is fixed
payment. Applications of the income
method provide different method
payment forms. See paragraphs

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(g)(4)(i)(E) and (iv) of this section. The
method payment form may not
necessarily correspond to the form of
payment specified pursuant to
paragraphs (h)(2)(iii) and (k)(2)(ii)(l) of
this section (specified payment form).
The determination under § 1.482–1(c) of
the method that provides the most
reliable measure of an arm’s length
result is to be made without regard to
whether the respective method payment
forms under the competing methods
correspond to the specified payment
form. If the method payment form of the
method determined under § 1.482–1(c)
to provide the most reliable measure of
an arm’s length result differs from the
specified payment form, then the
conversion from such method payment
form to such specified payment form
will be made to the satisfaction of the
Commissioner.
(i) Allocations by the Commissioner in
connection with a CSA—(1) In general.
The Commissioner may make
allocations to adjust the results of a
controlled transaction in connection
with a CSA so that the results are
consistent with an arm’s length result,
in accordance with the provisions of
this paragraph (i).
(2) CST allocations—(i) In general.
The Commissioner may make
allocations to adjust the results of a CST
so that the results are consistent with an
arm’s length result, including any
allocations to make each controlled
participant’s IDC share, as determined
under paragraph (d)(4) of this section,
equal to that participant’s RAB share, as
determined under paragraph (e)(1) of
this section. Such allocations may result
from, for purposes of CST
determinations, adjustments to—
(A) Redetermine IDCs by adding any
costs (or cost categories) that are directly
identified with, or are reasonably
allocable to, the IDA, or by removing
any costs (or cost categories) that are not
IDCs;
(B) Reallocate costs between the IDA
and other business activities;
(C) Improve the reliability of the
selection or application of the basis
used for measuring benefits for purposes
of estimating a controlled participant’s
RAB share;
(D) Improve the reliability of the
projections used to estimate RAB shares,
including adjustments described in
paragraph (i)(2)(ii) of this section; and
(E) Allocate among the controlled
participants any unallocated interests in
cost shared intangibles.
(ii) Adjustments to improve the
reliability of projections used to
estimate RAB shares—(A) Unreliable
projections. A significant divergence
between projected benefit shares and

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benefit shares adjusted to take into
account any available actual benefits to
date (adjusted benefit shares) may
indicate that the projections were not
reliable for purposes of estimating RAB
shares. In such a case, the
Commissioner may use adjusted benefit
shares as the most reliable measure of
RAB shares and adjust IDC shares
accordingly. The projected benefit
shares will not be considered unreliable,
as applied in a given taxable year, based
on a divergence from adjusted benefit
shares for every controlled participant
that is less than or equal to 20% of the
participant’s projected benefits share.
Further, the Commissioner will not
make an allocation based on such
divergence if the difference is due to an
extraordinary event, beyond the control
of the controlled participants, which
could not reasonably have been
anticipated at the time that costs were
shared. The Commissioner generally
may adjust projections of benefits used
to calculate benefit shares in accordance
with the provisions of § 1.482–1. In
particular, if benefits are projected over
a period of years, and the projections for
initial years of the period prove to be
unreliable, this may indicate that the
projections for the remaining years of
the period are also unreliable and thus
should be adjusted. For purposes of this
paragraph (i)(2)(ii)(A), all controlled
participants that are not U.S. persons
are treated as a single controlled
participant. Therefore, an adjustment
based on an unreliable projection of
RAB shares will be made to the IDC
shares of foreign controlled participants
only if there is a matching adjustment
to the IDC shares of controlled
participants that are U.S. persons.
Nothing in this paragraph (i)(2)(ii)(A)
prevents the Commissioner from making
an allocation if a taxpayer did not use
the most reliable basis for measuring
anticipated benefits. For example, if the
taxpayer measures its anticipated
benefits based on units sold, and the
Commissioner determines that another
basis is more reliable for measuring
anticipated benefits, then the fact that
actual units sold were within 20% of
the projected unit sales will not
preclude an allocation under this
section.
(B) Foreign-to-foreign adjustments.
Adjustments to IDC shares based on an
unreliable projection also may be made
among foreign controlled participants if
the variation between actual and
projected benefits has the effect of
substantially reducing U.S. tax.
(C) Correlative adjustments to PCTs.
Correlative adjustments will be made to
any PCT Payments of a fixed amount
that were determined based on RAB

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shares that are subsequently adjusted on
a finding that they were based on
unreliable projections. No correlative
adjustments will be made to contingent
PCT Payments regardless of whether
RAB shares were used as a parameter in
the valuation of those payments.
(D) Examples. The following
examples illustrate the principles of this
paragraph (i)(2)(ii):
Example 1. U.S. Parent (USP) and Foreign
Subsidiary (FS) enter into a CSA to develop
new food products, dividing costs on the
basis of projected sales two years in the
future. In Year 1, USP and FS project that
their sales in Year 3 will be equal, and they
divide costs accordingly. In Year 3, the
Commissioner examines the controlled
participants’ method for dividing costs. USP
and FS actually accounted for 42% and 58%
of total sales, respectively. The
Commissioner agrees that sales two years in
the future provide a reliable basis for
estimating benefit shares. Because the
differences between USP’s and FS’s adjusted
and projected benefit shares are less than
20% of their projected benefit shares, the
projection of future benefits for Year 3 is
reliable.
Example 2. The facts are the same as in
Example 1, except that in Year 3 USP and FS
actually accounted for 35% and 65% of total
sales, respectively. The divergence between
USP’s projected and adjusted benefit shares
is greater than 20% of USP’s projected
benefit share and is not due to an
extraordinary event beyond the control of the
controlled participants. The Commissioner
concludes that the projected benefit shares
were unreliable, and uses adjusted benefit
shares as the basis for an adjustment to the
cost shares borne by USP and FS.
Example 3. U.S. Parent (USP), a U.S.
corporation, and its foreign subsidiary (FS)
enter into a CSA in Year 1. They project that
they will begin to receive benefits from cost
shared intangibles in Years 4 through 6, and
that USP will receive 60% of total benefits
and FS 40% of total benefits. In Years 4
through 6, USP and FS actually receive 50%
each of the total benefits. In evaluating the
reliability of the controlled participants’
projections, the Commissioner compares the
adjusted benefit shares to the projected
benefit shares. Although USP’s adjusted
benefit share (50%) is within 20% of its
projected benefit share (60%), FS’s adjusted
benefit share (50%) is not within 20% of its
projected benefit share (40%). Based on this
discrepancy, the Commissioner may
conclude that the controlled participants’
projections were unreliable and may use
adjusted benefit shares as the basis for an
adjustment to the cost shares borne by USP
and FS.
Example 4. Three controlled taxpayers,
USP, FS1, and FS2 enter into a CSA. FS1 and
FS2 are foreign. USP is a domestic
corporation that controls all the stock of FS1
and FS2. The controlled participants project
that they will share the total benefits of the
cost shared intangibles in the following
percentages: USP 50%; FS1 30%; and FS2
20%. Adjusted benefit shares are as follows:
USP 45%; FS1 25%; and FS2 30%. In

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evaluating the reliability of the controlled
participants’ projections, the Commissioner
compares these adjusted benefit shares to the
projected benefit shares. For this purpose,
FS1 and FS2 are treated as a single controlled
participant. The adjusted benefit share
received by USP (45%) is within 20% of its
projected benefit share (50%). In addition,
the non-US controlled participant’s adjusted
benefit share (55%) is also within 20% of
their projected benefit share (50%).
Therefore, the Commissioner concludes that
the controlled participant’s projections of
future benefits were reliable, despite the fact
that FS2’s adjusted benefit share (30%) is not
within 20% of its projected benefit share
(20%).
Example 5. The facts are the same as in
Example 4. In addition, the Commissioner
determines that FS2 has significant operating
losses and has no earnings and profits, and
that FS1 is profitable and has earnings and
profits. Based on all the evidence, the
Commissioner concludes that the controlled
participants arranged that FS1 would bear a
larger cost share than appropriate in order to
reduce FS1’s earnings and profits and
thereby reduce inclusions USP otherwise
would be deemed to have on account of FS1
under subpart F. Pursuant to paragraph
(i)(2)(ii)(B) of this section, the Commissioner
may make an adjustment solely to the cost
shares borne by FS1 and FS2 because FS2’s
projection of future benefits was unreliable
and the variation between adjusted and
projected benefits had the effect of
substantially reducing USP’s U.S. income tax
liability (on account of FS1 subpart F
income).
Example 6. (i)(A) Foreign Parent (FP) and
U.S. Subsidiary (USS) enter into a CSA in
1996 to develop a new treatment for
baldness. USS’s interest in any treatment
developed is the right to produce and sell the
treatment in the U.S. market while FP retains
rights to produce and sell the treatment in
the rest of the world. USS and FP measure
their anticipated benefits from the CSA based
on their respective projected future sales of
the baldness treatment. The following sales
projections are used:

SALES
[In millions of dollars]
Year

USS

1 ........................
2 ........................
3 ........................
4 ........................
5 ........................
6 ........................
7 ........................
8 ........................
9 ........................
10 ......................

FP
5
20
30
40
40
40
40
20
10
5

10
20
30
40
40
40
40
20
10
5

(B) In Year 1, the first year of sales, USS
is projected to have lower sales than FP due
to lags in U.S. regulatory approval for the
baldness treatment. In each subsequent year,
USS and FP are projected to have equal sales.
Sales are projected to build over the first
three years of the period, level off for several
years, and then decline over the final years

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of the period as new and improved baldness
treatments reach the market.
(ii) To account for USS’s lag in sales in the
Year 1, the present discounted value of sales
over the period is used as the basis for
measuring benefits. Based on the risk
associated with this venture, a discount rate
of 10 percent is selected. The present
discounted value of projected sales is
determined to be approximately $154.4
million for USS and $158.9 million for FP.
On this basis USS and FP are projected to
obtain approximately 49.3% and 50.7% of
the benefit, respectively, and the costs of
developing the baldness treatment are shared
accordingly.
(iii)(A) In Year 6, the Commissioner
examines the CSA. USS and FP have
obtained the following sales results through
Year 5:

SALES
[In millions of dollars]
Year
1
2
3
4
5

USS

........................
........................
........................
........................
........................

FP
0
17
25
38
39

17
35
35
41
41

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

SALES
[In millions of dollars]
Year
1 ........................
2 ........................
3 ........................

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FP
0
17
25

17
35
44

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SALES—Continued
[In millions of dollars]

Year

USS

4 ........................
5 ........................

FP
34
36

54
55

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

SALES
[In millions of dollars]
Year

USS

6 ........................
7 ........................
8 ........................
9 ........................
10 ......................

FP
36
36
18
9
4.5

55
55
28
14
7

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

(iii) Timing of CST allocations. If the
Commissioner makes an allocation to
adjust the results of a CST, the
allocation must be reflected for tax
purposes in the year in which the IDCs
were incurred. When a CST payment is
owed by one controlled participant to
another controlled participant, the
Commissioner may make appropriate
allocations to reflect an arm’s length rate
of interest for the time value of money,
consistent with the provisions of
§ 1.482–2(a) (Loans or advances).
(3) PCT allocations. The
Commissioner may make allocations to
adjust the results of a PCT so that the
results are consistent with an arm’s
length result in accordance with the
provisions of the applicable sections of
the regulations under section 482, as
determined pursuant to paragraph (a)(2)
of this section.
(4) Allocations regarding changes in
participation under a CSA. The
Commissioner may make allocations to

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adjust the results of any controlled
transaction described in paragraph (f) of
this section if the controlled
participants do not reflect arm’s length
results in relation to any such
transaction.
(5) Allocations when CSTs are
consistently and materially
disproportionate to RAB shares. If a
controlled participant bears IDC shares
that are consistently and materially
greater or lesser than its RAB share, then
the Commissioner may conclude that
the economic substance of the
arrangement between the controlled
participants is inconsistent with the
terms of the CSA. In such a case, the
Commissioner may disregard such terms
and impute an agreement that is
consistent with the controlled
participants’ course of conduct, under
which a controlled participant that bore
a disproportionately greater IDC share
received additional interests in the cost
shared intangibles. See §§ 1.482–
1(d)(3)(ii)(B) (Identifying contractual
terms) and 1.482–4(f)(3)(ii)
(Identification of owner). Such
additional interests will consist of
partial undivided interests in the other
controlled participant’s interest in the
cost shared intangible. Accordingly, that
controlled participant must receive
arm’s length consideration from any
controlled participant whose IDC share
is less than its RAB share over time,
under the provisions of §§ 1.482–1 and
1.482–4 through 1.482–6 to provide
compensation for the latter controlled
participants’ use of such partial
undivided interest.
(6) Periodic adjustments—(i) In
general. Subject to the exceptions in
paragraph (i)(6)(vi) of this section, the
Commissioner may make periodic
adjustments for an open taxable year
(the Adjustment Year) and for all
subsequent taxable years for the
duration of the CSA Activity with
respect to all PCT Payments, if the
Commissioner determines that, for a
particular PCT (the Trigger PCT), a
particular controlled participant that
owes or owed a PCT Payment relating
to that PCT (such controlled participant
being referred to as the PCT Payor for
purposes of this paragraph (i)(6)) has
realized an Actually Experienced Return
Ratio (AERR) that is outside the Periodic
Return Ratio Range (PRRR). The
satisfaction of the condition stated in
the preceding sentence is referred to as
a Periodic Trigger. See paragraphs
(i)(6)(ii) through (vi) of this section
regarding the PRRR, the AERR, and
periodic adjustments. In determining
whether to make such adjustments, the
Commissioner may consider whether
the outcome as adjusted more reliably

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reflects an arm’s length result under all
the relevant facts and circumstances,
including any information known as of
the Determination Date. The
Determination Date is the date of the
relevant determination by the
Commissioner. The failure of the
Commissioner to determine for an
earlier taxable year that a PCT Payment
was not arm’s length will not preclude
the Commissioner from making a
periodic adjustment for a subsequent
year. A periodic adjustment under this
paragraph (i)(6) may be made without
regard to whether the taxable year of the
Trigger PCT or any other PCT remains
open for statute of limitations purposes
or whether a periodic adjustment has
previously been made with respect to
any PCT Payment.
(ii) PRRR. Except as provided in the
next sentence, the PRRR will consist of
return ratios that are not less than .667
nor more than 1.5. Alternatively, if the
controlled participants have not
substantially complied with the
documentation requirements referenced
in paragraph (k) of this section, as
modified, if applicable, by paragraphs
(m)(2) and (3) of this section, the PRRR
will consist of return ratios that are not
less than .8 nor more than 1.25.
(iii) AERR—(A) In general. The AERR
is the present value of total profits
(PVTP) divided by the present value of
investment (PVI). In computing PVTP
and PVI, present values are computed
using the applicable discount rate
(ADR), and all information available as
of the Determination Date is taken into
account.
(B) PVTP. The PVTP is the present
value, as of the CSA Start Date, as
defined in section (j)(1)(i) of this
section, of the PCT Payor’s actually
experienced divisional profits or losses
from the CSA Start Date through the end
of the Adjustment Year.
(C) PVI. The PVI is the present value,
as of the CSA Start Date, of the PCT
Payor’s investment associated with the
CSA Activity, defined as the sum of its
cost contributions and its PCT
Payments, from the CSA Start Date
through the end of the Adjustment Year.
For purposes of computing the PVI, PCT
Payments means all PCT Payments due
from a PCT Payor before netting against
PCT Payments due from other
controlled participants pursuant to
paragraph (j)(3)(ii) of this section.
(iv) ADR—(A) In general. Except as
provided in paragraph (i)(6)(iv)(B) of
this section, the ADR is the discount
rate pursuant to paragraph (g)(2)(v) of
this section, subject to such adjustments
as the Commissioner determines
appropriate.

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
(B) Publicly traded companies. If the
PCT Payor meets the conditions of
paragraph (i)(6)(iv)(C) of this section,
the ADR is the PCT Payor WACC as of
the date of the Trigger PCT. However, if
the Commissioner determines, or the
controlled participants establish to the
satisfaction of the Commissioner, that a
discount rate other than the PCT Payor
WACC better reflects the degree of risk
of the CSA Activity as of such date, the
ADR is such other discount rate.
(C) Publicly traded. A PCT Payor
meets the conditions of this paragraph
(i)(6)(iv)(C) if—
(1) Stock of the PCT Payor is publicly
traded; or
(2) Stock of the PCT Payor is not
publicly traded, provided the PCT Payor
is included in a group of companies for
which consolidated financial statements
are prepared; and a publicly traded
company in such group owns, directly
or indirectly, stock in PCT Payor. Stock
of a company is publicly traded within
the meaning of this paragraph
(i)(6)(iv)(C) if such stock is regularly
traded on an established United States
securities market and the company
issues financial statements prepared in
accordance with United States generally
accepted accounting principles for the
taxable year.
(D) PCT Payor WACC. The PCT Payor
WACC is the WACC, as defined in
paragraph (j)(1)(i) of this section, of the
PCT Payor or the publicly traded
company described in paragraph
(i)(6)(iv)(C)(2)(ii) of this section, as the
case may be.
(E) Generally accepted accounting
principles. For purposes of paragraph
(i)(6)(iv)(C) of this section, a financial
statement prepared in accordance with
a comprehensive body of generally
accepted accounting principles other
than United States generally accepted
accounting principles is considered to
be prepared in accordance with United
States generally accepted accounting
principles provided that the amounts of
debt, equity, and interest expense are
reflected in any reconciliation between
such other accounting principles and
United States generally accepted
accounting principles required to be
incorporated into the financial
statement by the securities laws
governing companies whose stock is
regularly traded on United States
securities markets.
(v) Determination of periodic
adjustments. In the event of a Periodic
Trigger, subject to paragraph (i)(6)(vi) of
this section, the Commissioner may
make periodic adjustments with respect
to all PCT Payments between all PCT
Payors and PCT Payees for the
Adjustment Year and all subsequent

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years for the duration of the CSA
Activity pursuant to the residual profit
split method as provided in paragraph
(g)(7) of this section, subject to the
further modifications in this paragraph
(i)(6)(v). A periodic adjustment may be
made for a particular taxable year
without regard to whether the taxable
years of the Trigger PCT or other PCTs
remain open for statute of limitation
purposes.
(A) In general. Periodic adjustments
are determined by the following steps:
(1) First, determine the present value,
as of the date of the Trigger PCT, of the
PCT Payments under paragraph
(g)(7)(iii)(C)(3) of this section pursuant
to the Adjusted RPSM as defined in
paragraph (i)(6)(v)(B) of this section
(first step result).
(2) Second, convert the first step
result into a stream of contingent
payments on a base of reasonably
anticipated divisional profits or losses
over the entire duration of the CSA
Activity, using a level royalty rate
(second step rate). See paragraph
(h)(2)(iv) of this section (Conversion
from fixed to contingent form of
payment). This conversion is made
based on all information known as of
the Determination Date.
(3) Third, apply the second step rate
to the actual divisional profit or loss for
taxable years preceding and including
the Adjustment Year to yield a stream
of contingent payments for such years,
and convert such stream to a present
value as of the CSA Start Date under the
principles of paragraph (g)(2)(v) of this
section (third step result). For this
purpose, the second step rate applied to
a loss for a particular year will yield a
negative contingent payment for that
year.
(4) Fourth, convert any actual PCT
Payments up through the Adjustment
Year to a present value as of the CSA
Start Date under the principles of
paragraph (g)(2)(v) of this section. Then
subtract such amount from the third
step result. Determine the nominal
amount in the Adjustment Year that
would have a present value as of the
CSA Start Date equal to the present
value determined in the previous
sentence to determine the periodic
adjustment in the Adjustment Year.
(5) Fifth, apply the second step rate to
the actual divisional profit or loss for
each taxable year after the Adjustment
Year up to and including the taxable
year that includes the Determination
Date to yield a stream of contingent
payments for such years. For this
purpose, the second step rate applied to
a loss will yield a negative contingent
payment for that year. Then subtract
from each such payment any actual PCT

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80123

Payment made for the same year to
determine the periodic adjustment for
such taxable year.
(6) For each taxable year subsequent
to the year that includes the
Determination Date, the periodic
adjustment for such taxable year (which
is in lieu of any PCT Payment that
would otherwise be payable for that
year under the taxpayer’s position)
equals the second step rate applied to
the actual divisional profit or loss for
that year. For this purpose, the second
step rate applied to a loss for a
particular year will yield a negative
contingent payment for that year.
(7) If the periodic adjustment for any
taxable year is a positive amount, then
it is an additional PCT Payment owed
from the PCT Payor to the PCT Payee for
such year. If the periodic adjustment for
any taxable year is a negative amount,
then it is an additional PCT Payment
owed by the PCT Payee to the PCT
Payor for such year.
(B) Adjusted RPSM as of
Determination Date. The Adjusted
RPSM is the residual profit split method
pursuant to paragraph (g)(7) of this
section applied to determine the present
value, as of the date of the Trigger PCT,
of the PCT Payments under paragraph
(g)(7)(iii)(C)(3) of this section, with the
following modifications.
(1) Actual results up through the
Determination Date shall be substituted
for what otherwise were the projected
results over such period, as reasonably
anticipated as of the date of the Trigger
PCT.
(2) Projected results for the balance of
the CSA Activity after the
Determination Date, as reasonably
anticipated as of the Determination
Date, shall be substituted for what
otherwise were the projected results
over such period, as reasonably
anticipated as of the date of the Trigger
PCT.
(3) The requirement in paragraph
(g)(7)(i) of this section, that at least two
controlled participants make significant
nonroutine contributions, does not
apply.
(vi) Exceptions to periodic
adjustments—(A) Controlled
participants establish periodic
adjustment not warranted. No periodic
adjustment will be made under
paragraphs (i)(6)(i) and (v) of this
section if the controlled participants
establish to the satisfaction of the
Commissioner that all the conditions
described in one of paragraphs
(i)(6)(vi)(A)(1) through (4) of this section
apply with respect to the Trigger PCT.
(1) Transactions involving the same
platform contribution as in the Trigger
PCT.

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations

(i) The same platform contribution is
furnished to an uncontrolled taxpayer
under substantially the same
circumstances as those of the relevant
Trigger PCT and with a similar form of
payment as the Trigger PCT;
(ii) This transaction serves as the basis
for the application of the comparable
uncontrolled transaction method
described in paragraph (g)(3) of this
section, in the first year and all
subsequent years in which substantial
PCT Payments relating to the Trigger
PCT were required to be paid; and
(iii) The amount of those PCT
Payments in that first year was arm’s
length.
(2) Results not reasonably anticipated.
The differential between the AERR and
the nearest bound of the PRRR is due to
extraordinary events beyond the control
of the controlled participants that could
not reasonably have been anticipated as
of the date of the Trigger PCT.
(3) Reduced AERR does not cause
Periodic Trigger. The Periodic Trigger
would not have occurred had the PCT
Payor’s divisional profits or losses used
to calculate its PVTP both taken into
account expenses on account of
operating cost contributions and routine
platform contributions, and excluded
those profits or losses attributable to the
PCT Payor’s routine contributions to its
exploitation of cost shared intangibles,
nonroutine contributions to the CSA
Activity, operating cost contributions,
and routine platform contributions.
(4) Increased AERR does not cause
Periodic Trigger—(i) The Periodic
Trigger would not have occurred had
the divisional profits or losses of the
PCT Payor used to calculate its PVTP
included its reasonably anticipated
divisional profits or losses after the
Adjustment Year from the CSA Activity,

intangibles resulting from the CSA, if
the AERR falls below the lower bound
of the PRRR.
(vii) Examples. The following
examples illustrate the rules of this
paragraph (i)(6):
Example 1. (i) For simplicity of calculation
in this Example 1, all financial flows are
assumed to occur at the beginning of the
year. At the beginning of Year 1, USP, a
publicly traded U.S. company, and FS, its
wholly-owned foreign subsidiary, enter into
a CSA to develop new technology for cell
phones. USP has a platform contribution, the
rights for an in-process technology that when
developed will improve the clarity of calls,
for which compensation is due from FS. FS
has no platform contributions to the CSA, no
operating contributions, and no operating
cost contributions. USP and FS agree to fixed
PCT payments of $40 million in Year 1 and
$10 million per year for Years 2 through 10.
At the beginning of Year 1, the weighted
average cost of capital of the controlled group
that includes USP and FS is 15%. In Year 9,
the Commissioner audits Years 5 through 7
of the CSA and considers whether any
periodic adjustments should be made. USP
and FS have substantially complied with the
documentation requirements of paragraph (k)
of this section.
(ii) FS experiences the results reported in
the following table from its participation in
the CSA through Year 7. In the table, all
present values (PV) are reported as of the
CSA Start Date, which is the same as the date
of the PCT (and reflect a 15% discount rate
as discussed in paragraph (iii) of this
Example 1). Thus, in any year the present
value of the cumulative investment is PVI
and of the cumulative divisional profit or
loss is PVTP. All amounts in this table and
the tables that follow are reported in millions
of dollars and cost contributions are referred
to as ‘‘CCs’’ (for simplicity of calculation in
this Example 1, all financial flows are
assumed to occur at the beginning of the
year).

a

b

c

d

e

f

g

h

Year

Sales

Non CC costs

CCs

PCT payments

Investment
(d+e)

Divisional
profit or loss
(b-c)

AERR
(PVTP/PVI)
(g/f)

1 ...................................
2 ...................................
3 ...................................
4 ...................................
5 ...................................
6 ...................................
7 ...................................
PV through Year 5 .......
PV through Year 6 .......
PV through Year 7 .......
jlentini on DSK4TPTVN1PROD with RULES3

including from its routine contributions,
its operating cost contributions, and its
nonroutine contributions to that
activity, and had the cost contributions
and PCT Payments of the PCT Payor
used to calculate its PVI included its
reasonably anticipated cost
contributions and PCT Payments after
the Adjustment Year. The reasonably
anticipated amounts in the previous
sentence are determined based on all
information available as of the
Determination Date.
(ii) For purposes of this paragraph
(i)(6)(vi)(A)(4), the controlled
participants may, if they wish, assume
that the average yearly divisional profits
or losses for all taxable years prior to
and including the Adjustment Year, in
which there has been substantial
exploitation of cost shared intangibles
resulting from the CSA (exploitation
years), will continue to be earned in
each year over a period of years equal
to 15 minus the number of exploitation
years prior to and including the
Determination Date.
(B) Circumstances in which Periodic
Trigger deemed not to occur. No
Periodic Trigger will be deemed to have
occurred at the times and in the
circumstances described in paragraph
(i)(6)(vi)(B)(1) or (2) of this section.
(1) 10-year period. In any year
subsequent to the 10-year period
beginning with the first taxable year in
which there is substantial exploitation
of cost shared intangibles resulting from
the CSA, if the AERR determined is
within the PRRR for each year of such
10-year period.
(2) 5-year period. In any year of the
5-year period beginning with the first
taxable year in which there is
substantial exploitation of cost shared

0
0
0
705
886
1,113
1,179
970
1,523
2,033

0
0
0
662
718
680
747
846
1,184
1,507

(iii) Because USP is publicly traded in the
United States and is a member of the
controlled group to which FS (the PCT Payor)
belongs, for purposes of calculating the AERR
for FS, the present values of its PVTP and
PVI are determined using an ADR of 15%,

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15
17
18
20
22
24
27
69
81
93

40
10
10
10
10
10
10
69
74
78

the weighted average cost of capital of the
controlled group. (It is assumed that no other
rate was determined or established, under
paragraph (i)(6)(iv)(B) of this section, to
better reflect the relevant degree of risk.) At
a 15% discount rate, the PVTP, calculated as

PO 00000

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55
27
28
30
32
34
37
138
155
171

0
0
0
46
168
433
432
124
340
526

........................
........................
........................
........................
........................
........................
........................
0.90
2.20
3.09

of Year 1, and based on actual profits realized
by FS through Year 7 from exploiting the
new cell phone technology developed by the
CSA, is $526 million. The PVI, based on FS’s
cost contributions and its PCT Payments, is
$171 million. The AERR for FS is equal to

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
its PVTP divided by its PVI, $526 million/
$171 million, or 3.09. There is a Periodic
Trigger because FS’s AERR of 3.09 falls
outside the PRRR of .67 to 1.5, the applicable
PRRR for controlled participants complying
with the documentation requirements of this
section.
(iv) At the time of the Determination Date,
it is determined that the first Adjustment
Year in which a Periodic Trigger occurred
was Year 6, when the AERR of FS was
determined to be 2.20. It is also determined
that for Year 6 none of the exceptions to

periodic adjustments described in paragraph
(i)(6)(vi) of this section applies. The
Commissioner exercises its discretion under
paragraph (i)(6)(i) of this section to make
periodic adjustments using Year 6 as the
Adjustment Year. Therefore, the arm’s length
PCT Payments from FS to USP shall be
determined for each taxable year using the
adjusted residual profit split method
described in paragraphs (g)(7) and (i)(6)(v)(B)
of this section. Periodic adjustments will be
made for each year to the extent the PCT
Payments actually made by FS differ from the

a

b

c

d

e

f

g

Year

Sales

Non-CC costs

Divisional
profit or loss
(b-c)

CCs

Routing return

Residual proift
(d-e-f)

1 ...............................................................
2 ...............................................................
3 ...............................................................
4 ...............................................................
5 ...............................................................
6 ...............................................................
7 ...............................................................
8 ...............................................................
9 ...............................................................
10 .............................................................
Cumulative PV through Year 10 as of
CSA Start Date .....................................

(vi) The periodic adjustments are
calculated in a series of steps set out in
paragraph (i)(6)(v)(A) of this section. First, a
lump sum for the PCT Payment is
determined using the adjusted residual profit
split method. Under the method, based on
the considerations discussed in paragraph
(g)(2)(v) of this section, the appropriate
discount rate is 15% per year. The
nonroutine residual divisional profit or loss
described in paragraph (g)(7)(iii)(B) of this
section is $612 million. Further, under
paragraph (g)(7)(iii)(C) of this section, the
entire nonroutine residual divisional profit
constitutes the PCT Payment because only
USP has nonroutine contributions.

jlentini on DSK4TPTVN1PROD with RULES3

PCT Payment calculation under the adjusted
residual profit split method.
(v) It is determined, as of the
Determination Date, that the cost shared
intangibles will be exploited through Year
10. FS’s return for routine contributions
(determined by the Commissioner, based on
the return for comparable functions
undertaken by comparable uncontrolled
companies, to be 8% of non-CC costs), and
its actual and projected results, are described
in the following table.

0
0
0
705
886
1,113
1,179
1,238
1,300
1,365

0
0
0
662
718
680
747
822
894
974

0
0
0
43
168
433
432
416
406
391

15
17
18
20
22
24
27
29
32
35

0
0
0
53
57
54
60
66
72
78

¥15
¥17
¥18
¥30
89
355
345
321
302
278

3,312

2,385

927

124

191

612

(vii) In step two, the first step result ($612
million) is converted into a level royalty rate
based on the reasonably anticipated
divisional profit or losses of the CSA
Activity, the PV of which is reported in the
table above (net PV of divisional profit or loss
for Years 1 through 10 is $927 million).
Consequently, the step two result is a level
royalty rate of 66.0% ($612/$927) of the
divisional profit in Years 1 through 10.
(viii) In step three, the Commissioner
calculates the PCT Payments due through
Year 6 by applying the step two royalty rate
to the actual divisional profits for each year
and then determines the aggregate PV of
these PCT Payments as of the CSA Start Date

($224 million as reported in the following
table). In step four, the PCT Payments
actually made through Year 6 are similarly
converted to PV as of the CSA Start Date ($74
million) and subtracted from the amount
determined in step three ($224 million—$74
million = $150 million). That difference of
$150 million, representing a net PV as of the
CSA Start Date, is then converted to a
nominal amount, as of the Adjustment Year,
of equivalent present value (again using a
discount rate of 15%). That nominal amount
is $302 million (not shown in the table), and
is the periodic adjustment in Year 6.

a

b

c

d

e

Year

Divisional profit

Royalty rate

Nominal royalty due
under adjusted
RPSM
(b*c)

Nominal payments
made

Year 1 ..............................................................................
Year 2 ..............................................................................
Year 3 ..............................................................................
Year 4 ..............................................................................
Year 5 ..............................................................................
Year 6 ..............................................................................
Cumulative PV as of Year 1 ............................................

0
0
0
43
168
433
................................

66.0
66.0
66.0
66.0
66.0
66.0
................................

(ix) Under step five, the royalties due from
FS to USP for Year 7 (the year after the
Adjustment Year) through Year 9 (the year
including the Determination Date) are
determined. (These determinations are made
for Years 8 and 9 after the divisional profit

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for those years becomes available.) For each
year, the periodic adjustment is a PCT
Payment due in addition to the $10 million
PCT Payment that must otherwise be paid
under the CSA as described in paragraph (i)
of this Example 1. That periodic adjustment

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$0
0
0
28
111
286
224

$40
10
10
10
10
10
74

is calculated as the product of the step two
royalty rate and the divisional profit, minus
the $10 million that was otherwise paid for
that year. The calculations are shown in the
following table:

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
a

b

c

d

e

f

Year

Divisional profit

Royalty rate

Royalty due
(b*c)

PCT Payments
otherwise paid

Periodic
adjustment
d-e)

7 .......................................................................
8 .......................................................................
9 .......................................................................

(x) Under step six, the periodic adjustment
for Year 10 (the only exploitation year after
the year containing the Determination Date)
will be determined by applying the step two

Year

432
416
406

$285
275
268

royalty rate to the divisional profit. This
periodic adjustment is a PCT Payment
payable from FS to USP, and is in lieu of the
$10 payment otherwise due. The calculations

Divisional profit

10 .....................................................................

Example 2. The facts are the same as in
paragraphs (i) through (iii) of Example 1. At
the time of the Determination Date, it is
determined that the first Adjustment Year in
which a Periodic Trigger occurred was Year
6, when the AERR of FS was determined to
be 2.73. Upon further investigation as to what
may have caused the high return in FS’s
market, the Commissioner learns that, in
Years 4 through 6, USP’s leading competitors
experienced severe, unforeseen disruptions
in their supply chains resulting in a
significant increase in USP’s and FS’s market
share for cell phones. Further analysis
determines that without this unforeseen
occurrence the Periodic Trigger would not
have occurred. Based on paragraph
(i)(6)(vi)(A)(2) of this section, the
Commissioner determines to his satisfaction
that no adjustments are warranted.
Example 3. (i) USP, a U.S. corporation, and
its wholly-owned foreign subsidiaries FS1,
FS2, and FS3 enter into a CSA at the start

66.0%
66.0
66.0

Royalty rate

391

$258

of Year 1 to develop version 2.0 of a
computer program. USP makes a platform
contribution, version 1.0 of the program
(upon which version 2.0 will be based), for
which compensation is due from FS1, FS2,
and FS3. None of the foreign subsidiaries
makes any platform contributions.
(ii) In Year 6, the Commissioner audits
Years 3 through 5 of the CSA and considers
whether any periodic adjustments should be
made. At the time of the Determination Date,
the Commissioner determines that the first
Adjustment Year in which a Periodic Trigger
occurred was Year 3, and further determines
that none of the exceptions to periodic
adjustments described in paragraph (i)(6)(vi)
of this section applies. The Commissioner
exercises his discretion under paragraph
(i)(6)(i) of this section to make periodic
adjustments using Year 3 as the Adjustment
Year. Therefore, the arm’s length PCT
Payments from FS1, FS2, and FS3 to USP
shall be determined using the adjusted

PCT payment
called for under
original agreement but not
made
$10 (not paid)

jlentini on DSK4TPTVN1PROD with RULES3

FS1 ..........................................................................................................................................
FS2 ..........................................................................................................................................
FS3 ..........................................................................................................................................

Because only USP had nonroutine
contributions, under paragraph (g)(7)(iii)(C)
of this section, the entire nonroutine residual
divisional profit constitutes the PCT Payment
owed to USP. Therefore, the present values
(as of the CSA Start Date) of the PCT
Payments owed are as follows:
PCT Payment owed from FS1 to USP: $314
million
PCT Payment owed from FS2 to USP: $159
million
PCT Payment owed from FS3 to USP: $295
million
Pursuant to paragraph (i)(6)(v)(A) of this
section, the steps in paragraphs (i)(6)(v)(A)(2)
through (7) of this section are performed

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separately for the PCT Payments that are
owed to USP by each of FS1, FS2, and FS3.
(iv) First, the steps are performed with
respect to FS1. In step two, the first step
result ($314 million) is converted into a level
royalty rate based on FS1’s reasonably
anticipated divisional profits or losses
through Year 7 (the PV of which is $667
million). Consequently, the step two result is
a level royalty rate of 47.1% ($314/$667) of
the divisional profits in Years 1 through 7.
In step three, the Commissioner calculates
the PCT Payments due through Year 3 (the
Adjustment Year) by applying the step two
royalty rate (47.1%) to FS1’s actual divisional
profits for each year up to and including Year

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Periodic
adjustment

$258

residual profit split method described in
paragraphs (g)(7)(v)(B) and (i)(6)(v)(B) of this
section. Periodic adjustments will be made
for each year to the extent the PCT Payments
actually made by FS1, FS2, and FS3 differ
from the PCT Payment calculation under the
adjusted residual profit split method.
(iii) The periodic adjustments are
calculated in a series of steps set out in
paragraph (i)(6)(v)(A) of this section. First, a
lump sum for the PCT Payments is
determined using the adjusted residual profit
split method. The following results are
calculated (based on actual results for years
for which actual results are available and
projected results for all years thereafter) in
order to apply the adjusted residual profit
split method (it is determined that the cost
shared intangibles will be exploited through
Year 7, so the results reported in the
following table are cumulative values
through Year 7):

Divisional profits
(cumulative PV through
year 7 as of the CSA
start date)

Participant

$275
265
258

are shown in the following table, based on a
divisional profit of $391 million. USP and FS
experienced the following results in Year 10.

Royalty due

66.0%

$10
10
10

$667
271
592

Residual profits
(cumulative PV through
year 7 as of the CSA
start date)
$314
159
295

3 and then determining the aggregate PV of
these PCT Payments as of Year 3. In step
four, the PCT Payments actually made by FS1
to USP through Year 3 are similarly
converted to a PV as of Year 3 and subtracted
from the amount determined in step three.
That difference is the periodic adjustment in
Year 3 with respect to the PCT Payments
made for Years 1 through 3 from FS1 to USP.
Under step five, the royalties due from FS1
to USP for Year 4 (the year after the
Adjustment Year) through Year 6 (the year
including the Determination Date) are
determined. The periodic adjustment for
each of these years is calculated as the
product of the step two royalty rate and the

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
divisional profit for that year, minus any
actual PCT Payment made by FS1 to USP in
that year. The periodic adjustment for each
such year is a PCT Payment due in addition
to the PCT Payment from FS1 to USP that
was already made under the CSA. Under step
six, the periodic adjustment for Year 7 (the
only exploitation year after the year
containing the Determination Date) will be
determined by applying the step two royalty
rate to FS1’s divisional profit for that year.
This periodic adjustment for Year 7 is a PCT
Payment payable from FS1 to USP and is in
lieu of any PCT Payment from FS1 to USP
otherwise due.
(v) Next, the steps in paragraphs
(i)(6)(v)(A)(2) through (7) of this section are
performed with respect to FS2. In step two,
the first step result ($159 million) is
converted into a level royalty rate based on
FS2’s reasonably anticipated divisional
profits or losses through Year 7 (the PV of
which is $271 million). Consequently, the
step two result is a level royalty rate of 58.7%
($159/$271) of the divisional profits in Years
1 through 7. In step three, the Commissioner
calculates the PCT Payments due through
Year 3 (the Adjustment Year) by applying the
step two royalty rate (58.7%) to FS2’s actual
divisional profits for each year up to and
including Year 3 and then determining the
aggregate PV of these PCT Payments as of
Year 3. In step four, the PCT Payments
actually made by FS2 to USP through Year
3 are similarly converted to a PV as of Year
3 and subtracted from the amount
determined in step three. That difference is
the periodic adjustment in Year 3 with
Term

Definition

Acquisition price .................................................
Adjusted acquisition price ..................................
Adjusted average market capitalization .............
Adjusted benefit shares ......................................
Adjusted RPSM ..................................................
Adjustment Year .................................................
ADR ....................................................................
AERR ..................................................................
Applicable Method ..............................................
Average market capitalization ............................
Benefits ...............................................................

..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
Benefits mean the sum of additional revenue
generated, plus cost savings, minus any
cost increases from exploiting cost shared
intangibles.
..........................................................................
..........................................................................
..........................................................................
..........................................................................
Controlled participant means a controlled taxpayer, as defined under § 1.482–1(i)(5), that
is a party to the contractual agreement that
underlies the CSA, and that reasonably anticipates that it will derive benefits, as defined in paragraph (e)(1)(i) of this section,
from exploiting one or more cost shared intangibles.
..........................................................................
..........................................................................

Capability variation .............................................
Change in participation under a CSA ................
Consolidated group ............................................
Contingent payments .........................................
Controlled participant .........................................

jlentini on DSK4TPTVN1PROD with RULES3

respect to the PCT Payments made for Years
1 through 3 from FS2 to USP. Under step
five, the royalties due from FS2 to USP for
Year 4 (the year after the Adjustment Year)
through Year 6 (the year including the
Determination Date) are determined. The
periodic adjustment for each of these years is
calculated as the product of the step two
royalty rate and the divisional profit for that
year, minus any actual PCT Payment made
by FS2 to USP in that year. The periodic
adjustment for each such year is a PCT
Payment due in addition to the PCT Payment
from FS2 to USP that was already made
under the CSA. Under step six, the periodic
adjustment for Year 7 (the only exploitation
year after the year containing the
Determination Date) will be determined by
applying the step two royalty rate to FS2’s
divisional profit for that year. This periodic
adjustment for Year 7 is a PCT Payment
payable from FS2 to USP and is in lieu of any
PCT Payment from FS2 to USP otherwise
due.
(vi) Finally, the steps in paragraphs
(i)(6)(v)(A)(2) through (7) of this section are
performed with respect to FS3. In step two,
the first step result ($295 million) is
converted into a level royalty rate based on
FS3’s reasonably anticipated divisional
profits or losses through Year 7 (the PV of
which is $592 million). Consequently, the
step two result is a level royalty rate of 49.8%
($295/$592) of the divisional profits in Years
1 through 7. In step three, the Commissioner
calculates the PCT Payments due through
Year 3 (the Adjustment Year) by applying the
step two royalty rate (49.8%) to FS3’s actual

Controlled transfer of interests ...........................
Cost contribution ................................................

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80127

divisional profits for each year up to and
including Year 3 and then determining the
aggregate PV of these PCT Payments as of
Year 3. In step four, the PCT Payments
actually made by FS3 to USP through Year
3 are similarly converted to a PV as of Year
3 and subtracted from the amount
determined in step three. That difference is
the periodic adjustment in Year 3 with
respect to the PCT Payments made for Years
1 through 3 from FS3 to USP. Under step
five, the royalties due from FS3 to USP for
Year 4 (the year after the Adjustment Year)
through Year 6 (the year including the
Determination Date) are determined. The
periodic adjustment for each of these years is
calculated as the product of the step two
royalty rate and the divisional profit for that
year, minus any actual PCT Payment made
by FS3 to USP in that year. The periodic
adjustment for each such year is a PCT
Payment due in addition to the PCT Payment
from FS3 to USP that was already made
under the CSA. Under step six, the periodic
adjustment for Year 7 (the only exploitation
year after the year containing the
Determination Date) will be determined by
applying the step two royalty rate to FS3’s
divisional profit for that year. This periodic
adjustment for Year 7 is a PCT Payment
payable from FS3 to USP and is in lieu of any
PCT Payment from FS3 to USP otherwise
due.

(j) Definitions and special rules—(1)
Definitions—(i) In general. For purposes
of this section—
Main cross references
§ 1.482–7(g)(5)(i).
§ 1.482–7(g)(5)(iii).
§ 1.482–7(g)(6)(iv).
§ 1.482–7(i)(2)(ii)(A).
§ 1.482–7(i)(6)(v)(B).
§ 1.482–7(i)(6)(i).
§ 1.482–7(i)(6)(iv).
§ 1.482–7(i)(6)(iii).
§ 1.482–7(g)(2)(ix)(A).
§ 1.482–7(g)(6)(iii).
§ 1.482–7(e)(1)(i).

§ 1.482–7(f)(3).
§ 1.482–7(f).
§ 1.482–7(j)(2)(i).
§ 1.482–7(h)(2)(i)(B).
§ 1.482–7(a)(1).

§ 1.482–7(f)(2).
§ 1.482–7(d)(4).

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
Term

Definition

Cost shared intangible .......................................

Cost shared intangible means any intangible,
within the meaning of § 1.482–4(b), that is
developed by the IDA, including any portion
of such intangible that reflects a platform
contribution. Therefore, an intangible developed by the IDA is a cost shared intangible
even though the intangible was not always
or was never a reasonably anticipated cost
shared intangible.
..........................................................................
..........................................................................
..........................................................................
A cross operating contribution is any resource
or capability or right, other than a platform
contribution, that a controlled participant
has developed, maintained, or acquired
prior to the CSA Start Date, or subsequent
to the CSA start date by means other than
operating cost contributions or cost contributions, that is reasonably anticipated to
contribute to the CSA Activity within another
controlled participant’s division.
CSA Activity is the activity of developing and
exploiting cost shared intangibles.
The CSA Start Date is the earlier of the date
of the CSA contract or the first occurrence
of any IDC to which the CSA applies, in accordance with § 1.482–7(k)(1)(iii).
..........................................................................
..........................................................................
..........................................................................
..........................................................................
Division means the territory or other division
that serves as the basis of the division of
interests under the CSA in the cost shared
intangibles pursuant to § 1.482–7(b)(4).
..........................................................................
Divisional profit or loss means the operating
profit or loss as separately earned by each
controlled participant in its division from the
CSA Activity, determined before any expense (including amortization) on account
of cost contributions, operating cost contributions, routine platform and operating
contributions, nonroutine contributions (including platform and operating contributions), and tax.
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
Licensing payments means payments pursuant to the licensing obligations under the licensing alternative.
..........................................................................
..........................................................................
Market returns for routine contributions means
returns determined by reference to the returns achieved by uncontrolled taxpayers
engaged in activities similar to the relevant
business activity in the controlled participant’s division, consistent with the methods
described in §§ 1.482–3, 1.482–4, 1.482–5,
or § 1.482–9(c).
..........................................................................

Cost sharing alternative .....................................
Cost sharing arrangement or CSA .....................
Cost sharing transactions or CSTs ....................
Cross operating contributions ............................

CSA Activity ........................................................
CSA Start Date ...................................................

CST Payments ...................................................
Date of PCT .......................................................
Determination Date ............................................
Differential income stream ..................................
Division ...............................................................

Divisional interest ...............................................
Divisional profit or loss .......................................

Fixed payments ..................................................
Implied discount rate ..........................................
IDC share ...........................................................
Input parameters ................................................
Intangible development activity or IDA ...............
Intangible development costs or IDCs ...............
Licensing alternative ...........................................
Licensing payments ............................................

jlentini on DSK4TPTVN1PROD with RULES3

Make-or-sell rights ..............................................
Market-based input parameter ...........................
Market returns for routine contributions

Method payment form ........................................

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Main cross references
§ 1.482–7(b).

§ 1.482–7(g)(4)(i)(B).
§ 1.482–7(a), (b).
§ 1.482–7(a)(1), (b)(1)(i).
§ 1.482–7(a)(3)(iii), (g)(2)(iv).

§ 1.482–7(c)(2)(i).
§ 1.482–7(i)(6)(iii)(B) and (k)(1)(ii) and (iii).

§ 1.482–7(b)(1).
§ 1.482–7(b)(3).
§ 1.482–7(i)(6)(i).
§ 1.482–7(g)(4)(vi)(F)(2).
See definitions of divisional profit or loss, operating contribution, and operating cost contribution.
§ 1.482–7(b)(1)(iii), (b)(4).
§ 1.482–7(g)(4)(iii).

§ 1.482–7(h)(2)(i)(A).
§ 1.482–7(g)(2)(v)(B)(2).
§ 1.482–7(d)(4).
§ 1.482–7(g)(2)(ix)(B).
§ 1.482–7(d)(1).
§ 1.482–7(a)(1), (d)(1).
§ 1.482–7(g)(4)(i)(C).
§ 1.482–7(g)(4)(iii).

§ 1.482–7(c)(4), (g)(2)(iv).
§ 1.482–7(g)(2)(ix)(B).
§ 1.482–7(g)(4), (g)(7).

§ 1.482–7(h)(3).

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
Term

Definition

Nonroutine contributions ....................................

Nonroutine contributions means a controlled
participant’s contributions to the relevant
business activities that are not routine contributions. Nonroutine contributions ordinarily include both nonroutine platform contributions and nonroutine operating contributions used by controlled participants in
the commercial exploitation of their interests
in the cost shared intangibles (for example,
marketing intangibles used by a controlled
participant in its division to sell products
that are based on the cost shared intangible).
..........................................................................
An operating contribution is any resource or
capability or right, other than a platform
contribution, that a controlled participant
has developed, maintained, or acquired
prior to the CSA Start Date, or subsequent
to the CSA Start Date by means other than
operating cost contributions or cost contributions, that is reasonably anticipated to
contribute to the CSA Activity within the
controlled participant’s division.
Operating cost contributions means all costs
in the ordinary course of business on or
after the CSA Start Date that, based on
analysis of the facts and circumstances, are
directly identified with, or are reasonably allocable to, developing resources, capabilities, or rights (other than reasonably anticipated cost shared intangibles) that are reasonably anticipated to contribute to the CSA
Activity within the controlled participant’s division.
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
A controlled participant’s reasonably anticipated benefits mean the benefits that reasonably may be anticipated to be derived
from exploiting cost shared intangibles. For
purposes of this definition, benefits mean
the sum of additional revenue generated,
plus cost savings, minus any cost increases
from exploiting cost shared intangibles.
..........................................................................
..........................................................................
..........................................................................

Nonroutine residual divisional profit or loss .......
Operating contributions ......................................

Operating cost contributions ..............................

PCT Payee .........................................................
PCT Payment .....................................................
PCT Payor ..........................................................
PCT Payor WACC ..............................................
Periodic adjustments ..........................................
Periodic Trigger ..................................................
Platform contribution transaction or PCT ...........
Platform contributions .........................................
Post-tax income ..................................................
Pre-tax income ...................................................
Projected benefit shares ....................................
PRRR .................................................................
PVI ......................................................................
PVTP ..................................................................
Reasonably anticipated benefits ........................

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Reasonably anticipated benefits or RAB shares
Reasonably anticipated cost shared intangible ..
Relevant business activity ..................................

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Main cross references
§ 1.482–7(g).

§ 1.482–7(g)(7)(iii).
§ 1.482–7(g)(2)(ii), (g)(4)(vi)(E),
and (C).

(g)(7)(iii)(A)

§ 1.482–7(g)(2)(ii), (g)(4)(iii), (g)(7)(iii)(B).

§ 1.482–7(b)(1)(ii).
§ 1.482–7(b)(1)(ii).
§ 1.482–7(b)(1)(ii), (i)(6)(i).
§ 1.482–7(i)(6)(iv)(D).
§ 1.482–7(i)(6)(i).
§ 1.482–7(i)(6)(i).
§ 1.482–7(a)(2), (b)(1)(ii).
§ 1.482–7(c)(1).
§ 1.482–7(g)(2)(v)(B)(4), (g)(4)(i)(G).
§ 1.482–7(g)(2)(v)(B)(4), (g)(4)(i)(G).
§ 1.482–7(i)(2)(ii)(A).
§ 1.482–7(i)(6)(ii).
§ 1.482–7(i)(6)(iii)(C).
§ 1.482–7(i)(6)(iii)(B).
§ 1.482–7(e)(1).

§ 1.482–7(a)(1), (e)(1).
§ 1.482–7(d)(1)(ii).
§ 1.482–7(g)(7)(i).

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
Term

Definition

Routine contributions ..........................................

Routine contributions means a controlled participant’s contributions to the relevant business activities that are of the same or similar kind to those made by uncontrolled taxpayers involved in similar business activities
for which it is possible to identify market returns. Routine contributions ordinarily include contributions of tangible property,
services and intangibles that are generally
owned by uncontrolled taxpayers engaged
in similar activities. A functional analysis is
required to identify these contributions according to the functions performed, risks assumed, and resources employed by each of
the controlled participants.
..........................................................................

Routine platform and operating contributions,
and net routine platform and operating contributions.
Specified payment form .....................................
Stock-based compensation ................................
Stock options ......................................................
Subsequent PCT ................................................
Target .................................................................
Tax rate ..............................................................

Trigger PCT ........................................................
Variable input parameter ....................................
WACC .................................................................

jlentini on DSK4TPTVN1PROD with RULES3

(ii) Examples. The following
examples illustrate certain definitions in
paragraph (j)(1)(i) of this section:
Example 1. Controlled participant.
Foreign Parent (FP) is a foreign corporation
engaged in the extraction of a natural
resource. FP has a U.S. subsidiary (USS) to
which FP sells supplies of this resource for
sale in the United States. FP enters into a
CSA with USS to develop a new machine to
extract the natural resource. The machine
uses a new extraction process that will be
patented in the United States and in other
countries. The CSA provides that USS will
receive the rights to exploit the machine in
the extraction of the natural resource in the
United States, and FP will receive the rights
in the rest of the world. This resource does
not, however, exist in the United States.
Despite the fact that USS has received the
right to exploit this process in the United
States, USS is not a controlled participant
because it will not derive a benefit from
exploiting the intangible developed under
the CSA.
Example 2. Controlled participants. (i) U.S.
Parent (USP), one foreign subsidiary (FS),
and a second foreign subsidiary constituting
the group’s research arm (R+D) enter into a
CSA to develop manufacturing intangibles
for a new product line A. USP and FS are
assigned the exclusive rights to exploit the
intangibles respectively in the United States
and the rest of the world, where each
presently manufactures and sells various

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Main cross references

..........................................................................
..........................................................................
..........................................................................
..........................................................................
..........................................................................
Reasonably anticipated effective tax rate with
respect to the pre-tax income to which the
tax rate is being applied. For example,
under the income method, this rate would
be the reasonably anticipated effective tax
rate of the PCT Payor or PCT Payee under
the cost sharing alternative or the licensing
alternative, as appropriate.
..........................................................................
..........................................................................
WACC means weighted average cost of capital.

existing product lines. R+D is not assigned
any rights to exploit the intangibles. R+D’s
activity consists solely in carrying out
research for the group. It is reliably projected
that the RAB shares of USP and FS will be
662⁄3% and 331⁄3%, respectively, and the
parties’ agreement provides that USP and FS
will reimburse 662⁄3% and 331⁄3%,
respectively, of the IDCs incurred by R+D
with respect to the new intangible.
(ii) R+D does not qualify as a controlled
participant within the meaning of paragraph
(j)(1)(i) of this section, because it will not
derive any benefits from exploiting cost
shared intangibles. Therefore, R+D is treated
as a service provider for purposes of this
section and must receive arm’s length
consideration for the assistance it is deemed
to provide to USP and FS, under the rules of
paragraph (a)(3) of this section and §§ 1.482–
4(f)(3)(iii) and (4), and 1.482–9, as
appropriate. Such consideration must be
treated as IDCs incurred by USP and FS in
proportion to their RAB shares (that is,
662⁄3% and 331⁄3%, respectively). R+D will
not be considered to bear any share of the
IDCs under the arrangement.
Example 3. Cost shared intangible,
reasonably anticipated cost shared
intangible. U.S. Parent (USP) has developed
and currently exploits an antihistamine, XY,
which is manufactured in tablet form. USP
enters into a CSA with its wholly-owned
foreign subsidiary (FS) to develop XYZ, a
new improved version of XY that will be
manufactured as a nasal spray. Work under

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§ 1.482–7(g)(4), (g)(7).

§ 1.482–7(g)(4)(vii), 1.482–7(g)(7)(iii)(C)(4).
§ 1.482–7(h)(3).
§ 1.482–7(d)(3).
§ 1.482–7(d)(3)(i).
§ 1.482–7(g)(2)(viii).
§ 1.482–7(g)(5)(i).
§ 1.482–7(g)(2)(v)(B)(4)(ii), (g)(4)(i)(G).

§ 1.482–7(i)(6)(i).
§ 1.482–7(g)(2)(ix)(C).
§ 1.482–7(i)(6)(iv)(D).

the CSA is fully devoted to developing XYZ,
and XYZ is developed. During the
development period, XYZ is a reasonably
anticipated cost shared intangible under the
CSA. Once developed, XYZ is a cost shared
intangible under the CSA.
Example 4. Cost shared intangible. The
facts are the same as in Example 3, except
that in the course of developing XYZ, the
controlled participants by accident discover
ABC, a cure for disease D. ABC is a cost
shared intangible under the CSA.
Example 5. Reasonably anticipated
benefits. Controlled parties A and B enter
into a cost sharing arrangement to develop
product and process intangibles for an
already existing Product P. Without such
intangibles, A and B would each reasonably
anticipate revenue, in present value terms, of
$100M from sales of Product P until it
became obsolete. With the intangibles, A and
B each reasonably anticipate selling the same
number of units each year, but reasonably
anticipate that the price will be higher.
Because the particular product intangible is
more highly regarded in A’s market, A
reasonably anticipates an increase of $20M in
present value revenue from the product
intangible, while B reasonably anticipates
only an increase of $10M. Further, A and B
each reasonably anticipate spending an extra
$5M present value in production costs to
include the feature embodying the product
intangible. Finally, A and B each reasonably
anticipate saving $2M present value in

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Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations
production costs by using the process
intangible. A and B reasonably anticipate no
other economic effects from exploiting the
cost shared intangibles. A’s reasonably
anticipated benefits from exploiting the cost
shared intangibles equal its reasonably
anticipated increase in revenue ($20M) plus
its reasonably anticipated cost savings ($2M)
minus its reasonably anticipated increased
costs ($5M), which equals $17M. Similarly,
B’s reasonably anticipated benefits from
exploiting the cost shared intangibles equal
its reasonably anticipated increase in revenue
($10M) plus its reasonably anticipated cost
savings ($2M) minus its reasonably
anticipated increased costs ($5M), which
equals $7M. Thus A’s reasonably anticipated
benefits are $17M and B’s reasonably
anticipated benefits are $7M.

(2) Special rules—(i) Consolidated
group. For purposes of this section, all
members of the same consolidated
group shall be treated as one taxpayer.
For these purposes, the term
consolidated group means all members
of a group of controlled entities created
or organized within a single country and
subjected to an income tax by such
country on the basis of their combined
income.
(ii) Trade or business. A participant
that is a foreign corporation or
nonresident alien individual will not be
treated as engaged in a trade or business
within the United States solely by
reason of its participation in a CSA. See
generally § 1.864–2(a).
(iii) Partnership. A CSA, or an
arrangement to which the Commissioner
applies the rules of this section, will not
be treated as a partnership to which the
rules of subchapter K of the Internal
Revenue Code apply. See § 301.7701–
1(c) of this chapter.
(3) Character—(i) CST Payments. CST
Payments generally will be considered
the payor’s costs of developing
intangibles at the location where such
development is conducted. For these
purposes, IDCs borne directly by a
controlled participant that are
deductible are deemed to be reduced to

the extent of any CST Payments owed
to it by other controlled participants
pursuant to the CSA. Each cost sharing
payment received by a payee will be
treated as coming pro rata from
payments made by all payors and will
be applied pro rata against the
deductions for the taxable year that the
payee is allowed in connection with the
IDCs. Payments received in excess of
such deductions will be treated as in
consideration for use of the land and
tangible property furnished for purposes
of the CSA by the payee. For purposes
of the research credit determined under
section 41, CST Payments among
controlled participants will be treated as
provided for intra-group transactions in
§ 1.41–6(i). Any payment made or
received by a taxpayer pursuant to an
arrangement that the Commissioner
determines not to be a CSA will be
subject to the provisions of §§ 1.482–1
through 1.482–6 and 1.482–9. Any
payment that in substance constitutes a
cost sharing payment will be treated as
such for purposes of this section,
regardless of its characterization under
foreign law.
(ii) PCT Payments. A PCT Payor’s
payment required under paragraph
(b)(1)(ii) of this section is deemed to be
reduced to the extent of any payments
owed to it under such paragraph from
other controlled participants. Each PCT
Payment received by a PCT Payee will
be treated as coming pro rata out of
payments made by all PCT Payors. PCT
Payments will be characterized
consistently with the designation of the
type of transaction pursuant to
paragraphs (c)(3) and (k)(2)(ii)(H) of this
section. Depending on such designation,
such payments will be treated as either
consideration for a transfer of an interest
in intangible property or for services.
(iii) Examples. The following
examples illustrate this paragraph (j)(3):
Example 1. U.S. Parent (USP) and its
wholly owned Foreign Subsidiary (FS) form

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

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Payments .........................................................................................................................................................
Receipts ...........................................................................................................................................................
Final .................................................................................................................................................................

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

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treated as receiving the 8X and 13X,
respectively, pro rata out of payments by C
and D of 15X and 6X, respectively.

(k) CSA administrative requirements.
A controlled participant meets the
requirements of this paragraph if it
substantially complies, respectively,
with the CSA contractual,
documentation, accounting, and
reporting requirements of paragraphs
(k)(1) through (4) of this section.

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A

B

<40>
48
8

<21>
34
13

C
<37.5>
22.5
<15>

D
<30>
24
<6>

(1) CSA contractual requirements—(i)
In general. A CSA must be recorded in
writing in a contract that is
contemporaneous with the formation
(and any revision) of the CSA and that
includes the contractual provisions
described in this paragraph (k)(1).
(ii) Contractual provisions. The
written contract described in this
paragraph (k)(1) must include
provisions that—

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(A) List the controlled participants
and any other members of the controlled
group that are reasonably anticipated to
benefit from the use of the cost shared
intangibles, including the address of
each domestic entity and the country of
organization of each foreign entity;
(B) Describe the scope of the IDA to
be undertaken and each reasonably
anticipated cost shared intangible or
class of reasonably anticipated cost
shared intangibles;
(C) Specify the functions and risks
that each controlled participant will
undertake in connection with the CSA;
(D) Divide among the controlled
participants all divisional interests in
cost shared intangibles and specify each
controlled participant’s divisional
interest in the cost shared intangibles, as
described in paragraphs (b)(1)(iii) and
(4) of this section, that it will own and
exploit without any further obligation to
compensate any other controlled
participant for such interest;
(E) Provide a method to calculate the
controlled participants’ RAB shares,
based on factors that can reasonably be
expected to reflect the participants’
shares of anticipated benefits, and
require that such RAB shares must be
updated, as described in paragraph
(e)(1) of this section (see also paragraph
(k)(2)(ii)(F) of this section);
(F) Enumerate all categories of IDCs to
be shared under the CSA;
(G) Specify that the controlled
participant must use a consistent
method of accounting to determine IDCs
and RAB shares, as described in
paragraphs (d) and (e) of this section,
respectively, and must translate foreign
currencies on a consistent basis;
(H) Require the controlled participant
to enter into CSTs covering all IDCs, as
described in paragraph (b)(1)(i) of this
section, in connection with the CSA;
(I) Require the controlled participants
to enter into PCTs covering all platform
contributions, as described in paragraph
(b)(1)(ii) of this section, in connection
with the CSA;
(J) Specify the form of payment due
under each PCT (or group of PCTs) in
existence at the formation (and any
revision) of the CSA, including
information and explanation that
reasonably supports an analysis of
applicable provisions of paragraph (h) of
this section; and
(K) Specify the date on which the
CSA is entered into (CSA Start Date)
and the duration of the CSA, the
conditions under which the CSA may be
modified or terminated, and the
consequences of a modification or
termination (including consequences
described under the rules of paragraph
(f) of this section).

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(iii) Meaning of contemporaneous—
(A) In general. For purposes of this
paragraph (k)(1), a written contractual
agreement is contemporaneous with the
formation (or revision) of a CSA if, and
only if, the controlled participants
record the CSA, in its entirety, in a
document that they sign and date no
later than 60 days after the first
occurrence of any IDC described in
paragraph (d) of this section to which
such agreement (or revision) is to apply.
(B) Example. The following example
illustrates the principles of this
paragraph (k)(1)(iii):
Example. Companies A and B, both of
which are members of the same controlled
group, commence an IDA on March 1, Year
1. Company A pays the first IDCs in relation
to the IDA, as cash salaries to A’s research
staff, for the staff’s work during the first week
of March, Year 1. A and B, however, do not
sign and date any written contractual
agreement until August 1, Year 1, whereupon
they execute a ‘‘Cost Sharing Agreement’’
that purports to be ‘‘effective as of’’ March 1
of Year 1. The arrangement fails the
requirement that the participants record their
arrangement in a written contractual
agreement that is contemporaneous with the
formation of a CSA. The arrangement has
failed to meet the requirements set forth in
paragraph (b)(2) of this section and, pursuant
to paragraph (b) of this section, cannot be a
CSA.

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

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paragraph (k)(1)(iv). In each example, it
is assumed that the Commissioner will
exercise the discretion granted pursuant
to paragraph (b)(5)(ii) of this section to
apply the provisions of this section to
the arrangement that purports to be a
CSA.
Example 1. The contractual provisions
recorded upon formation of an arrangement
that purports to be a CSA provide that PCT
Payments with respect to a particular
platform contribution will consist of
payments contingent on sales. Contrary to the
contractual provisions, the PCT Payments
actually made are contingent on profits.
Because the controlled participants’ actual
conduct is different from the contractual
terms, the Commissioner may determine,
based on the facts and circumstances, that—
(i) The actual payments have economic
substance and, therefore, impute payment
terms in the CSA consistent with the actual
payments; or
(ii) The contract terms reflect the economic
substance of the arrangement and, therefore,
the actual payments must be adjusted to
conform to the terms.
Example 2. An arrangement that purports
to be a CSA provides that PCT Payments with
respect to a particular platform contribution
shall be contingent payments equal to 10%
of sales of products that incorporate cost
shared intangibles. The contract terms further
provide that the controlled participants must
adjust such contingent payments in
accordance with a formula set forth in the
terms. During the first three years of the
arrangement, the controlled participants fail
to make the adjustments required by the
terms with respect to the PCT Payments. The
Commissioner may determine, based on the
facts and circumstances, that—
(i) The contingent payment terms with
respect to the platform contribution do not
have economic substance because the
controlled participants did not act in
accordance with their upfront risk allocation;
or
(ii) The contract terms reflect the economic
substance of the arrangement and, therefore,
the actual payments must be adjusted to
conform to the terms.

(2) CSA documentation
requirements—(i) In general. The
controlled participants must timely
update and maintain sufficient
documentation to establish that the
participants have met the CSA
contractual requirements of paragraph
(k)(1) of this section and the additional
CSA documentation requirements of
this paragraph (k)(2).
(ii) Additional CSA documentation
requirements. The controlled
participants to a CSA must timely
update and maintain documentation
sufficient to—
(A) Describe the current scope of the
IDA and identify—
(1) Any additions or subtractions from
the list of reasonably anticipated cost
shared intangibles reported pursuant to
paragraph (k)(1)(ii)(B) of this section;

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(2) Any cost shared intangible,
together with each controlled
participant’s interest therein; and
(3) Any further development of
intangibles already developed under the
CSA or of specified applications of such
intangibles which has been removed
from the IDA (see paragraphs (d)(1)(ii)
and (j)(1)(i) of this section for the
definitions of reasonably anticipated
cost shared intangible and cost shared
intangible) and the steps (including any
accounting classifications and
allocations) taken to implement such
removal.
(B) Establish that each controlled
participant reasonably anticipates that it
will derive benefits from exploiting cost
shared intangibles;
(C) Describe the functions and risks
that each controlled participant has
undertaken during the term of the CSA;
(D) Provide an overview of each
controlled participant’s business
segments, including an analysis of the
economic and legal factors that affect
CST and PCT pricing;
(E) Establish the amount of each
controlled participant’s IDCs for each
taxable year under the CSA, including
all IDCs attributable to stock-based
compensation, as described in
paragraph (d)(3) of this section
(including the method of measurement
and timing used in determining such
IDCs, and the data, as of the date of
grant, used to identify stock-based
compensation with the IDA);
(F) Describe the method used to
estimate each controlled participant’s
RAB share for each year during the
course of the CSA, including—
(1) All projections used to estimate
benefits;
(2) All updates of the RAB shares in
accordance with paragraph (e)(1) of this
section; and
(3) An explanation of why that
method was selected and why the
method provides the most reliable
measure for estimating RAB shares;
(G) Describe all platform
contributions;
(H) Designate the type of transaction
involved for each PCT or group of PCTs;
(I) Specify, within the time period
provided in paragraph (h)(2)(iii) of this
section, the form of payment due under
each PCT or group of PCTs, including
information and explanation that
reasonably supports an analysis of
applicable provisions of paragraph (h) of
this section;
(J) Describe and explain the method
selected to determine the arm’s length
payment due under each PCT,
including—
(1) An explanation of why the method
selected constitutes the best method, as

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described in § 1.482–1(c)(2), for
measuring an arm’s length result;
(2) The economic analyses, data, and
projections relied upon in developing
and selecting the best method, including
the source of the data and projections
used;
(3) Each alternative method that was
considered, and the reason or reasons
that the alternative method was not
selected;
(4) Any data that the controlled
participant obtains, after the CSA takes
effect, that would help determine if the
controlled participant’s method selected
has been applied in a reasonable
manner;
(5) The discount rate or rates, where
applicable, used for purposes of
evaluating PCT Payments, including
information and explanation that
reasonably supports an analysis of
applicable provisions of paragraph
(g)(2)(v) of this section;
(6) The estimated arm’s length values
of any platform contributions as of the
dates of the relevant PCTs, in
accordance with paragraph (g)(2)(ii) of
this section;
(7) A discussion, where applicable, of
why transactions were or were not
aggregated under the principles of
paragraph (g)(2)(iv) of this section;
(8) The method payment form and
any conversion made from the method
payment form to the specified payment
form, as described in paragraph (h)(3) of
this section; and
(9) If applicable under paragraph
(i)(6)(iv) of this section, the WACC of
the parent of the controlled group that
includes the controlled participants.
(iii) Coordination rules and
production of documents—(A)
Coordination with penalty regulations.
See § 1.6662–6(d)(2)(iii)(D) regarding
coordination of the rules of this
paragraph (k) with the documentation
requirements for purposes of the
accuracy-related penalty under section
6662(e) and (h).
(B) Production of documentation.
Each controlled participant must
provide to the Commissioner, within 30
days of a request, the items described in
this paragraph (k)(2) and paragraph
(k)(3) of this section. The time for
compliance described in this paragraph
(k)(2)(iii)(B) may be extended at the
discretion of the Commissioner.
(3) CSA accounting requirements—(i)
In general. The controlled participants
must maintain books and records (and
related or underlying data and
information) that are sufficient to—
(A) Establish that the controlled
participants have used (and are using) a
consistent method of accounting to
measure costs and benefits;

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80133

(B) Permit verification that the
amount of any contingent PCT
Payments due have been (and are being)
properly determined;
(C) Translate foreign currencies on a
consistent basis; and
(D) To the extent that the method of
accounting used materially differs from
U.S. generally accepted accounting
principles, explain any such material
differences.
(ii) Reliance on financial accounting.
For purposes of this section, the
controlled participants may not rely
solely upon financial accounting to
establish satisfaction of the accounting
requirements of this paragraph (k)(3).
Rather, the method of accounting must
clearly reflect income. Thor Power Tools
Co. v. Commissioner, 439 U.S. 522
(1979).
(4) CSA reporting requirements—(i)
CSA Statement. Each controlled
participant must file with the Internal
Revenue Service, in the manner
described in this paragraph (k)(4), a
‘‘Statement of Controlled Participant to
§ 1.482–7 Cost Sharing Arrangement’’
(CSA Statement) that complies with the
requirements of this paragraph (k)(4).
(ii) Content of CSA Statement. The
CSA Statement of each controlled
participant must—
(A) State that the participant is a
controlled participant in a CSA;
(B) Provide the controlled
participant’s taxpayer identification
number;
(C) List the other controlled
participants in the CSA, the country of
organization of each such participant,
and the taxpayer identification number
of each such participant;
(D) Specify the earliest date that any
IDC described in paragraph (d)(1) of this
section occurred; and
(E) Indicate the date on which the
controlled participants formed (or
revised) the CSA and, if different from
such date, the date on which the
controlled participants recorded the
CSA (or any revision)
contemporaneously in accordance with
paragraphs (k)(1)(i) and (iii) of this
section.
(iii) Time for filing CSA Statement—
(A) 90-day rule. Each controlled
participant must file its original CSA
Statement with the Internal Revenue
Service Ogden Campus (addressed as
follows: ‘‘Attn: CSA Statements, Mail
Stop 4912, Internal Revenue Service,
1973 North Rulon White Blvd., Ogden,
Utah 84404–0040’’), no later than 90
days after the first occurrence of an IDC
to which the newly-formed CSA
applies, as described in paragraph
(k)(1)(iii)(A) of this section, or, in the
case of a taxpayer that became a

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controlled participant after the
formation of the CSA, no later than 90
days after such taxpayer became a
controlled participant. A CSA Statement
filed in accordance with this paragraph
(k)(4)(iii)(A) must be dated and signed,
under penalties of perjury, by an officer
of the controlled participant who is duly
authorized (under local law) to sign the
statement on behalf of the controlled
participant.
(B) Annual return requirement—(1) In
general. Each controlled participant
must attach to its U.S. income tax
return, for each taxable year for the
duration of the CSA, a copy of the
original CSA Statement that the
controlled participant filed in
accordance with the 90-day rule of
paragraph (k)(4)(iii)(A) of this section. In
addition, the controlled participant
must update the information reflected
on the original CSA Statement annually
by attaching a schedule that documents
changes in such information over time.
(2) Special filing rule for annual
return requirement. If a controlled
participant is not required to file a U.S.
income tax return, the participant must
ensure that the copy or copies of the
CSA Statement and any updates are
attached to Schedule M of any Form
5471, any Form 5472 ‘‘Information
Return of a Foreign Owned
Corporation,’’ or any Form 8865 ‘‘Return
of U.S. Persons With Respect to Certain
Foreign Partnerships,’’ filed with
respect to that participant.
(iv) Examples. The following
examples illustrate this paragraph (k)(4).
In each example, Companies A and B
are members of the same controlled
group.
Example 1. A and B, both of which file
U.S. tax returns, agree to share the costs of
developing a new chemical formula in
accordance with the provisions of this
section. On March 30, Year 1, A and B record
their agreement in a written contract styled,
‘‘Cost Sharing Agreement.’’ The contract
applies by its terms to IDCs occurring after
March 1, Year 1. The first IDCs to which the
CSA applies occurred on March 15, Year 1.
To comply with paragraph (k)(4)(iii)(A) of
this section, A and B individually must file
separate CSA Statements no later than 90
days after March 15, Year 1 (June 13, Year
1). Further, to comply with paragraph
(k)(4)(iii)(B) of this section, A and B must
attach copies of their respective CSA
Statements to their respective Year 1 U.S.
income tax returns.
Example 2. The facts are the same as in
Example 1, except that a year has passed and
C, which files a U.S. tax return, joined the
CSA on May 9, Year 2. To comply with the
annual filing requirement described in
paragraph (k)(4)(iii)(B) of this section, A and
B must each attach copies of their respective
CSA Statements (as filed for Year 1) to their
respective Year 2 income tax returns, along

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with a schedule updated appropriately to
reflect the changes in information described
in paragraph (k)(4)(ii) of this section resulting
from the addition of C to the CSA. To comply
with both the 90-day rule described in
paragraph (k)(4)(iii)(A) of this section and the
annual filing requirement described in
paragraph (k)(4)(iii)(B) of this section, C must
file a CSA Statement no later than 90 days
after May 9, Year 2 (August 7, Year 2), and
must attach a copy of such CSA Statement to
its Year 2 income tax return.

(l) Effective/applicability date. This
section applies on December 16, 2011.
(m) Transition rule—(1) In general.
An arrangement in existence on January
5, 2009, will be considered a CSA, as
described under paragraph (b) of this
section, if, prior to such date, it was a
qualified cost sharing arrangement
under the provisions of § 1.482–7 (as
contained in the 26 CFR part 1 edition
revised as of January 1, 1996, hereafter
referred to as ‘‘former § 1.482–7’’), but
only if the written contract, as described
in paragraph (k)(1) of this section, is
amended, if necessary, to conform with,
and only if the activities of the
controlled participants substantially
comply with, the provisions of this
section, as modified by paragraphs
(m)(2) and (m)(3) of this section, by July
6, 2009.
(2) Transitional modification of
applicable provisions. For purposes of
this paragraph (m), conformity and
substantial compliance with the
provisions of this section shall be
determined with the following
modifications:
(i) CSTs and PCTs occurring prior to
January 5, 2009, shall be subject to the
provisions of former § 1.482–7 rather
than this section.
(ii) Except to the extent provided in
paragraph (m)(3) of this section, PCTs
that occur under a CSA that was a
qualified cost sharing arrangement
under the provisions of former § 1.482–
7 and remained in effect on January 5,
2009, shall be subject to the periodic
adjustment rules of § 1.482–4(f)(2) rather
than the rules of paragraph (i)(6) of this
section.
(iii) Paragraphs (b)(1)(iii) and (b)(4) of
this section shall not apply.
(iv) Paragraph (k)(1)(ii)(D) of this
section shall not apply.
(v) Paragraphs (k)(1)(ii)(H) and (I) of
this section shall be construed as
applying only to transactions entered
into on or after January 5, 2009.
(vi) The deadline for recordation of
the revised written contractual
agreement pursuant to paragraph
(k)(1)(iii) of this section shall be no later
than July 6, 2009.
(vii) Paragraphs (k)(2)(ii)(G) through
(J) of this section shall be construed as

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applying only with reference to PCTs
entered into on or after January 5, 2009.
(viii) Paragraph (k)(4)(iii)(A) of this
section shall be construed as requiring
a CSA Statement with respect to the
revised written contractual agreement
described in paragraph (m)(2)(vi) of this
section no later than September 2, 2009.
(ix) Paragraph (k)(4)(iii)(B) of this
section shall be construed as only
applying for taxable years ending after
the filing of the CSA Statement
described in paragraph (m)(2)(viii) of
this section.
(3) Special rule for certain periodic
adjustments. The periodic adjustment
rules in paragraph (i)(6) of this section
(rather than the rules of § 1.482–4(f)(2))
shall apply to PCTs that occur on or
after the date of a material change in the
scope of the CSA from its scope as of
January 5, 2009. A material change in
scope would include a material
expansion of the activities undertaken
beyond the scope of the intangible
development area, as described in
former § 1.482–7(b)(4)(iv). For this
purpose, a contraction of the scope of a
CSA, absent a material expansion into
one or more lines of research and
development beyond the scope of the
intangible development area, does not
constitute a material change in scope of
the CSA. Whether a material change in
scope has occurred is determined on a
cumulative basis. Therefore, a series of
expansions, any one of which is not a
material expansion by itself, may
collectively constitute a material
expansion.
§ 1.482–7T

[Removed]

Par. 14. Section 1.482–7T is removed.
Par. 15. Section 1.482–8 is amended
by:
■ 1. Revising Examples 13 through 18 at
the end of paragraph (b).
■ 2. Revising paragraph (c)(1).
The additions and revision reads as
follows:
■
■

§ 1.482–8
rule.

*

Examples of the best method

*
*
(b) * * *

*

*

Example 13. Preference for acquisition
price method. (i) USP develops,
manufacturers, and distributes
pharmaceutical products. USP and FS, USP’s
wholly-owned subsidiary, enter into a CSA to
develop a new oncological drug, Oncol.
Immediately prior to entering into the CSA,
USP acquires Company X, an unrelated U.S.
pharmaceutical company. Company X is
solely engaged in oncological pharmaceutical
research, and its only significant resources
and capabilities are its workforce and its sole
patent, which is associated with Compound
X, a promising molecular compound derived
from a rare plant, which USP reasonably

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anticipates will contribute to developing
Oncol. All of Company X researchers will be
engaged solely in research that is reasonably
anticipated to contribute to developing Oncol
as well. The rights in the Compound X and
the commitment of Company X’s researchers
to the development of Oncol are platform
contributions for which compensation is due
from FS as part of a PCT.
(ii) In this case, the acquisition price
method, based on the lump sum price paid
by USP for Company X, is likely to provide
a more reliable measure of an arm’s length
PCT Payment due to USP than the
application of any other method. See
§§ 1.482–4(c)(2) and 1.482–7(g)(5)(iv)(A).
Example 14. Preference for market
capitalization method. (i) Company X is a
publicly traded U.S. company solely engaged
in oncological pharmaceutical research and
its only significant resources and capabilities
are its workforce and its sole patent, which
is associated with Compound Y, a promising
molecular compound derived from a rare
plant. Company X has no marketable
products. Company X enters into a CSA with
FS, a newly-formed foreign subsidiary, to
develop a new oncological drug, Oncol,
derived from Compound Y. Compound Y is
reasonably anticipated to contribute to
developing Oncol. All of Company X
researchers will be engaged solely in research
that is reasonably anticipated to contribute to
developing Oncol under the CSA. The rights
in Compound Y and the commitment of
Company X’s researchers are platform
contributions for which compensation is due
from FS as part of a PCT.
(ii) In this case, given that Company X’s
platform contributions covered by PCTs
relate to its entire economic value, the
application of the market capitalization
method, based on the market capitalization of
Company X, provides a reliable measure of
an arm’s length result for Company X’s PCTs
to the CSA. See §§ 1.482–4(c)(2) and 1.482–
7(g)(6)(v)(A).
Example 15. Preference for market
capitalization method. (i) MicroDent, Inc.
(MDI) is a publicly traded company that
developed a new dental surgical microscope
ScopeX–1, which drastically shortens many
surgical procedures. On January 1 of Year 1,
MDI entered into a CSA with a whollyowned foreign subsidiary (FS) to develop
ScopeX–2, the next generation of ScopeX–1.
In the CSA, divisional interests are divided
on a territorial basis. The rights associated
with ScopeX–1, as well as MDI’s research
capabilities are reasonably anticipated to
contribute to the development of ScopeX–2
and are therefore platform contributions for
which compensation is due from FS as part
of a PCT. At the time of the PCT, MDI’s only
product was the ScopeX–I microscope,
although MDI was in the process of
developing ScopeX–2. Concurrent with the
CSA, MDI separately transfers exclusive and
perpetual exploitation rights associated with
ScopeX–1 to FS in the same territory as
assigned to FS in the CSA.
(ii) Although the transactions between MDI
and FS under the CSA are distinct from the
transactions between MDI and FS relating to
the exploitation rights for ScopeX–1, it is
likely to be more reliable to evaluate the

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combined effect of the transactions than to
evaluate them in isolation. This is because
the combined transactions between MDI and
FS relate to all of the economic value of MDI
(that is, the exploitation rights and research
rights associated with ScopeX–1, as well as
the research capabilities of MDI). In this case,
application of the market capitalization
method, based on the enterprise value of MDI
on January 1 of Year 1, is likely to provide
a reliable measure of an arm’s length
payment for the aggregated transactions. See
§§ 1.482–4(c)(2) and 1.482–7(g)(6)(v)(A).
(iii) Notwithstanding that the market
capitalization method provides the most
reliable measure of the aggregated
transactions between MDI and FS, see
§ 1.482–7(g)(2)(iv) for further considerations
of when further analysis may be required to
distinguish between the remuneration to MDI
associated with PCTs under the CSA (for
research rights and capabilities associated
with ScopeX–1) and the remuneration to MDI
for the exploitation rights associated with
ScopeX–1.
Example 16. Income method (applied
using CPM) preferred to acquisition price
method. The facts are the same as in Example
13, except that the acquisition occurred
significantly in advance of formation of the
CSA, and reliable adjustments cannot be
made for this time difference. In addition,
Company X has other valuable molecular
patents and associated research capabilities,
apart from Compound X, that are not
reasonably anticipated to contribute to the
development of Oncol and that cannot be
reliably valued. The CSA divides divisional
interests on a territorial basis. Under the
terms of the CSA, USP will undertake all
R&D (consisting of laboratory research and
clinical testing) and manufacturing
associated with Oncol, as well as the
distribution activities for its territory (the
United States). FS will distribute Oncol in its
territory (the rest of the world). FS’s
distribution activities are routine in nature,
and the profitability from its activities may
be reliably determined from third-party
comparables. FS does not furnish any
platform contributions. At the time of the
PCT, reliable (ex ante) financial projections
associated with the development of Oncol
and its separate exploitation in each of USP’s
and FSub’s assigned geographical territories
are undertaken. In this case, application of
the income method using CPM is likely to
provide a more reliable measure of an arm’s
length result than application of the
acquisition price method based on the price
paid by USP for Company X. See § 1.482–
7(g)(4)(vi) and (5)(iv)(C).
Example 17. Evaluation of alternative
methods. (i) The facts are the same as in
Example 13, except that the acquisition
occurred sometime prior to the CSA, and
Company X has some areas of promising
research that are not reasonably anticipated
to contribute to developing Oncol. For
purposes of this example, the CSA is
assumed to divide divisional interests on a
territorial basis. In general, the Commissioner
determines that the acquisition price data is
useful in informing the arm’s length price,
but not necessarily determinative. Under the
terms of the CSA, USP will undertake all

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R&D (consisting of laboratory research and
clinical testing) and manufacturing
associated with Oncol, as well as the
distribution activities for its territory (the
United States). FS will distribute Oncol in its
territory (the rest of the world). FS’s
distribution activities are routine in nature,
and the profitability from its activities may
be reliably determined from third-party
comparables. At the time of the PCT,
financial projections associated with the
development of Oncol and its separate
exploitation in each of USP’s and FSub’s
assigned geographical territories are
undertaken.
(ii) Under the facts, it is possible that the
acquisition price method or the income
method using CPM might reasonably be
applied. Whether the acquisition price
method or the income method provides the
most reliable evidence of the arm’s length
price of USP’s contributions depends on a
number of factors, including the reliability of
the financial projections, the reliability of the
discount rate chosen, and the extent to which
the acquisition price of Company X can be
reliably adjusted to account for changes in
value over the time period between the
acquisition and the formation of the CSA and
to account for the value of the in-process
research done by Company X that does not
constitute platform contributions to the CSA.
See § 1.482–7(g)(4)(vi) and (5)(iv)(A) and (C).
Example 18. Evaluation of alternative
methods. (i) The facts are the same as in
Example 17, except that FS has a patent on
Compound Y, which the parties reasonably
anticipate will be useful in mitigating
potential side effects associated with
Compound X and thereby contribute to the
development of Oncol. The rights in
Compound Y constitute a platform
contribution for which compensation is due
from USP as part of a PCT. The value of FS’s
platform contribution cannot be reliably
measured by market benchmarks.
(ii) Under the facts, it is possible that either
the acquisition price method and the income
method together or the residual profit split
method might reasonably be applied to
determine the arm’s length PCT Payments
due between USP and FS. Under the first
option the PCT Payment for the platform
contributions related to Company X’s
workforce and Compound X would be
determined using the acquisition price
method referring to the lump sum price paid
by USP for Company X. Because the value of
these platform contributions can be
determined by reference to a market
benchmark, they are considered routine
platform contributions. Accordingly, under
this option, the platform contribution related
to Compound Y would be the only
nonroutine platform contribution and the
relevant PCT Payment is determined using
the income method. Under the second
option, rather than looking to the acquisition
price for Company X, all the platform
contributions are considered nonroutine and
the RPSM is applied to determine the PCT
Payments for each platform contribution.
Under either option, the PCT Payments will
be netted against each other.
(iii) Whether the acquisition price method
together with the income method or the

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residual profit split method provides the
most reliable evidence of the arm’s length
price of the platform contributions of USP
and FS depends on a number of factors,
including the reliability of the determination
of the relative values of the platform
contributions for purposes of the RPSM, and
the extent to which the acquisition price of
Company X can be reliably adjusted to
account for changes in value over the time
period between the acquisition and the
formation of the CSA and to account for the
value of the rights in the in-process research
done by Company X that does not constitute
platform contributions to the CSA. In these
circumstances, it is also relevant to consider
whether the results of each method are
consistent with each other, or whether one or
both methods are consistent with other
potential methods that could be applied. See
§ 1.482–7(g)(4)(vi), (5)(iv), and (7)(iv).

(c) Effective/applicability date—(1) In
general. Paragraphs (a) and (b) Examples
10 through 12 of this section are
generally applicable for taxable years
beginning after December 31, 2006.
Paragraph (b) Examples 13 through 18
of this section are generally applicable
on January 5, 2009.
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§ 1.482–8T

[Removed].

Par. 16. Section 1.482–8T is removed.
■ Par. 17. Section 1.482–9 is amended
by revising paragraph (m)(3) to read as
follows:
■

§ 1.482–9 Methods to determine taxable
income in connection with a controlled
services transaction.

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(m) * * *
(3) Coordination with rules governing
cost sharing arrangements. Section
1.482–7 provides the specific methods
to be used to determine arm’s length
results of controlled transactions in
connection with a cost sharing
arrangement. This section provides the
specific methods to be used to
determine arm’s length results of a
controlled service transaction, including
in an arrangement for sharing the costs
and risks of developing intangibles
other than a cost sharing arrangement
covered by § 1.482–7. In the case of such
an arrangement, consideration of the
principles, methods, comparability, and
reliability considerations set forth in
§ 1.482–7 is relevant in determining the
best method, including an unspecified
method, under this section, as

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appropriately adjusted in light of the
differences in the facts and
circumstances between such
arrangement and a cost sharing
arrangement.
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■

§ 1.482–9T

■

■

[Removed].

Par. 18. Section 1.482–9T is removed.

Par. 19. Section 1.861–17 is amended
by revising paragraph (c)(3)(iv) to read
as follows:

■

§ 1.861–17 Allocation and apportionment
of research and experimental expenditures.

*

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(c) * * *
(3) * * *
(iv) Effect of cost sharing
arrangements. If the corporation
controlled by the taxpayer has entered
into a cost sharing arrangement, in
accordance with the provisions of
§ 1.482–7, with the taxpayer for the
purpose of developing intangible
property, then that corporation shall not
reasonably be expected to benefit from
the taxpayer’s share of the research
expense.
*
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PART 301—PROCEDURE AND
ADMINISTRATION
Par. 21. The authority citation for part
301 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Par. 22. Section 301.7701–1 is
amended by revising paragraph (c) to
read as follows:

§ 301.7701–1 Classification of
organizations for Federal tax purposes.

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(c) Cost sharing arrangements. A cost
sharing arrangement that is described in
§ 1.482–7 of this chapter, including any
arrangement that the Commissioner
treats as a CSA under § 1.482–7(b)(5) of
this chapter, is not recognized as a
separate entity for purposes of the
Internal Revenue Code. See § 1.482–7 of
this chapter for the rules regarding
CSAs.
*
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PART 602—OMB CONTROL NUMBER
UNDER THE PAPERWORK
REDUCTION ACT
Par. 23. The authority citation for part
602 continues to read as follows:

■

Authority: 26 U.S.C. 7805.

Par. 24. In § 602.101, paragraph (b) is
amended as follows:
1. The following entry to the table is
removed:

■

■

§ 1.6662–6 Transaction between persons
described in section 482 and net section
482 transfer price adjustments.

§ 602.101

Par. 20. Section 1.6662–6 is amended
by revising paragraph (d)(2)(iii)(D) to
read as follows:

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

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(b) * * *

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Current
OMB control
No.

CFR part or section where
identified and described

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1.482–7T ...................................
1545–1364
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Steven T. Miller,
Deputy Commissioner for Services and
Enforcement.
Approved: December 8, 2011.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury
(Tax Policy).
[FR Doc. 2011–32458 Filed 12–16–11; 2 pm]
BILLING CODE 4830–01–P

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