Cost Sharing
Note:
This user
guide is intended to help clarify the concepts
and identify issues in the application of the
U.S. regulations. It does not constitute legal
advice, and should not be relied on as such.
For professional transfer pricing
consulting services, contact Economic Consulting
Services at
202-466-7720.
A. Application/Timing
For all cases in which two or more related parties agree to jointly develop an
intangible and both expect to derive an economic benefit once the intangible is
developed, the "cost sharing" section of the 482 regulations must be considered.
The
final cost sharing regulations became
effective December 16, 2011.
B. Structure
The 482
cost sharing regulations specify the structure for cost sharing agreements
("CSA"), including the
payments, expected benefits, and covered intangibles. The arm’s length
analysis begins with an analysis that defines
the facts and functions of the transaction(s)
among controlled taxpayers.
In a CSA, there are
two types of economic contributions made by the
controlled parties, specifically (i) cost
contributions and (ii) platform contributions.
Cost contributions are commitments to share
intangible development costs in proportion to
each controlled party’s reasonably anticipated
benefits from taking advantage of the cost
shared intangibles. Platform contributions
provide any existing resources, capabilities, or
rights that are reasonably anticipated to
contribute to developing cost shared
intangibles. 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).
C.
Valuation Guidance and Choice of Method
The Cost Sharing Regulations provide valuation
guidance on how to determine the most reliable
arm’s length results for the economic
contributions over the duration of the activity
associated with the CSA.
The arm’s length
standard strives to determine the results that
would be obtained had uncontrolled taxpayers
engaged in the same transaction under the same
circumstances. An arrangement amongst
uncontrolled taxpayers need not be denominated
as a “cost sharing agreement,” provided that the
arrangement involves the same or similar
circumstances. Therefore, long-term licenses or
research and development services contracts may
provide comparable transactions, so long as 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.
If comparable
uncontrolled transactions are not available,
reference may be made to the results the
controlled taxpayers could have realized by
choosing a realistic alternative. A
specified income method is adopted by the
final cost sharing regulations that represents
an application of the realistic alternatives
principle. The final cost sharing regulations
adopt a 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, a
specified residual profit split method (RPSM)
may be used, which is also an application of the
realistic alternatives principle.
The final cost
sharing regulations also adopt guidance on the
application of two other specified methods—the
acquisition price method and the
market capitalization method. An unspecified
method may also be used if none of the other
methods can be used.
D. Buy-in/Buy-out/Transfer
In addition to the actual cost share arrangement, the regulations cover buy-ins,
buy-outs, and transfers within the cost sharing arrangement. In a buy-in, an entity wants
to join a cost sharing relationship with another entity(ies) that have already done some
intangible development. The entering entity pays its expected share of the
current value of the intangible to the entity(ies) that will lose that share of
the intangible. After the initial buy-in, the future development costs are split according
to the new split of expected benefit shares.
In a buy-out, an entity wants to exit a cost sharing relationship that has already
performed some intangible development. The exiting entity receives its share of the
current value of the intangible from the entity(ies) that will gain its share of the
intangible. After the buy-out, the future development costs are split according to the new
split of expected benefit shares.
In a transfer, an entity wants to receive more (less) of a share in the benefits or
an entity realizes that it is receiving a larger (smaller) share of the
benefits than intended. The entity that is increasing (or has increased) its
benefit share must pay the entity that is losing (or has lost) its benefit
share an amount equal to: (current
intangible value) * (share being transferred). After the transfer, the future development
costs are split according to the new split of expected benefit shares.
E.
IRS Regulations
The IRS regulations are contained
in
Section 1.482-7.
