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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.



For professional transfer pricing consulting services, contact Economic Consulting Services at 202-466-7720.
Or email jerrie.mirga@economic-consulting.com