Global Tax Alert (News from Transfer Pricing) | 27 August 2013

IRS releases final cost sharing regulations

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Executive summary

The IRS and Treasury on 26 August 2013, have issued final regulations on the determination of taxable income in cost-sharing arrangements (T.D. 9630). The regulations provide additional guidance on evaluating the results of an application of the Income Method, in which different discount rates are applied to the cost sharing and licensing alternatives. The temporary and proposed regulations were finalized without change.

Detailed discussion

Background

Final cost sharing regulations were published on 22 December 2011 (final cost sharing regulations). Corrections to the final cost sharing regulations were published on 25 January 2012, and 14 February 2012. Certain guidance regarding application of the Income Method in which different discount rates are applied to the cost sharing and licensing alternatives were issued as temporary or proposed regulations 23 December 2011 because the Treasury Department and the IRS believed it was appropriate to solicit public comments on that subject matter. Comments were submitted. The Treasury Department and the IRS are finalizing the temporary and proposed regulations without any change.

Discussion

The Treasury Decision adopts as final Section 1.482-7(g)(2)(v)(B)(2), which introduces the idea of an “implied discount rate,” a discount rate applicable to certain activities that can be determined based on explicit calculations contained in an application of the Income Method. This is illustrated by Example 8 in which the Commissioner undertakes a reevaluation of an application of the Income Method by reviewing the difference between the expected income stream to the platform contribution transaction (PCT) payor under the cost sharing and the licensing alternatives. The Commissioner concludes that the taxpayer’s calculation impliedly discounts this income stream to present value at a single discount rate of 34.4% per annum and such discount rate cannot be justified.

The Treasury Decision also finalizes Section 1.482-7(g)(4)(v), which presents a new application of the Income Method to determine the present value of the PCT payments as the amount that would make the PCT payee no worse off by entering into the CSA than by entering into the hypothetical licensing alternative. This is illustrated in Example 9.

Finally, the Treasury Decision finalizes Section 1.482-7(g)(4)(vi)(F)(2), which provides an approach to assessing the reliability of an application of the Income Method by reference to the evidence supporting the “implied discount rate.”

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services - Transfer Pricing, Washington DC

  • Ken Christman
    +1 202 327 8766
    kenneth.christmanjr@ey.com
  • Karen Kirwan
    +1 202 327 8731
    karen.kirwan@ey.com
  • Carlos Mallo
    +1 202 327 5689
    carlos.mallo@ey.com

EYG no. CM3765