§ 1.482-7(b)(5)(iii) Example 4.

Category: (b) Cost sharing arrangement, Transfer Pricing Guidelines, US IRC Section 482 on Transfer Pricing, § 1.482-7 Methods to determine taxable income in connection with a cost sharing arrangement | Tag: , , ,
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(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 P-Cap 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.

(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 P-Cap 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.






Related Guidelines

  1. TPG2022 Chapter VIII paragraph 8.12For the conditions of a CCA to satisfy the arm’s length principle, the value of participants’ contributions must be consistent with what independent enterprises would have agreed to contribute under comparable circumstances given their proportionate share of the total anticipated benefits they reasonably...
  2. TPG2022 Chapter VIII Annex example 521. The facts are the same as in Example 4 except that the functional analysis indicates Company A has no capacity to make decisions to take on or decline the risk-bearing opportunity represented by its participation in the CCA, or to make decisions...
  3. TPG2022 Chapter VIII paragraph 8.51The transfer pricing documentation standard set out in Chapter V requires reporting under the master file of important service arrangements and important agreements related to intangibles, including CCAs. The local file requires transactional information including a description of the transactions, the amounts of...
  4. TPG2022 Chapter VIII paragraph 8.15A party would also not be a participant in a CCA if it does not exercise control over the specific risks it assumes under the CCA and does not have the financial capacity to assume these risks, as this party would not be...
  5. TPG2022 Chapter VIII paragraph 8.22Whatever the method used to evaluate participants’ relative shares of expected benefits, adjustments to the measure used may be necessary to account for differences between the respective shares of expected and actual benefits received by the participants. The CCA should require periodic reassessment...
  6. TPG2022 Chapter VIII paragraph 8.5A key feature of a CCA is the sharing of contributions. In accordance with the arm’s length principle, at the time of entering into a CCA, each participant’s proportionate share of the overall contributions to a CCA must be consistent with its proportionate...
  7. TPG2022 Chapter VIII paragraph 8.14Because the concept of mutual benefit is fundamental to a CCA, it follows that a party may not be considered a participant if the party does not have a reasonable expectation that it will benefit from the objectives of the CCA activity itself...
  8. TPG2022 Chapter VIII paragraph 8.6Some benefits of the CCA activity can be determined in advance, whereas others will be uncertain. Some types of CCA activities will produce current benefits, while others have a longer time frame or may not be successful. Nevertheless, in a CCA there is...
  1. Transfer Pricing in the Mining IndustryLike other sectors of the economy, there are base erosion and profit shifting risks in the mining sector. Based on the ongoing work on BEPS, the IGF (Intergovernmental Forum on Mining) and OECD has released guidance for source countries on transfer pricing in...
  2. OECD publishes Guidance on the Handling of Multilateral MAPs and APAs1 February 2023 OECD published guidance on Multilateral MAP and APAs. The Manual is intended as a guide to multilateral MAP and APA processes from both a legal and procedural perspective and provides tax administrations and taxpayers with information on the operation of...

Related Case Law

  1. US vs Altera. February 2016, AppealOn July 27, 2015 the United States Tax Court issued its ruling regarding the petition filed by Altera Corporation and its subsidiaries against the Commissioner of Internal Revenue. The court found in favor of Altera, and concluded that on an arm’s length basis...
  2. Taiwan vs Intracom, November 2018, Supreme Administrative Court, Case No 691 of 107Intracom Taiwan had deducted losses on intra-group receivables and management fees in its taxable income. These deductions had been partially denied by the Taiwanese tax administration due to lack of documentation and economic substance. Intracom brought the case to court. The Supreme Administrative...
  3. US vs Altera Corp, June 2020, Supreme Court – review denied, Case no 19-1009Altera’s request for a Supreme Court review of the decision issued by the US Court of Appeal in June 2019 has been denied. A case cannot, as a matter of right, be appealed to the U.S. Supreme Court. A party seeking to appeal...
  4. US vs Medtronic, August 2022, U.S. Tax Court, T.C. Memo. 2022-84Medtronic had used the comparable uncontrolled transactions (CUT) method to determine the arm’s length royalty rates received from its manufacturing subsidiary in Puerto Rico for use of IP under an inter-group license agreement. The tax authorities found that Medtronic left too much profit...