Section 482: Methods To Determine Taxable Income in Connection With a Cost Sharing Arrangement, 340-391 [E8-30715]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 74, Number 2 (Monday, January 5, 2009)]
[Rules and Regulations]
[Pages 340-391]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-30715]



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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301, and 602



Section 482: Methods To Determine Taxable Income in Connection With a 
Cost Sharing Arrangement; Final Rule

Federal Register / Vol. 74, No. 2 / Monday, January 5, 2009 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9441]
RIN 1545-BI46


Section 482: Methods To Determine Taxable Income in Connection 
With a Cost Sharing Arrangement

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that provide 
further guidance and clarification regarding methods under section 482 
to determine taxable income in connection with a cost sharing 
arrangement in order to address issues that have arisen in 
administering the current regulations. The temporary regulations affect 
domestic and foreign entities that enter into cost sharing arrangements 
described in the temporary regulations. The text of these temporary 
regulations also serves as the text of the proposed regulations set 
forth in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective on January 5, 
2009.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.482-1T(j)(6)(i), 1.482-2T(f), 1.482-4T(h), 1.482-7T(l), 1.482-8T(c), 
1.482-9T(n)(3), and 1.301-7701-1(f).

FOR FURTHER INFORMATION CONTACT: Kenneth P. Christman, (202) 435-5265 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and pending receipt and 
valuation of public comments, approved by the Office of Management and 
Budget under control number 1545-1364.
    The collections of information in these temporary regulations are 
in Sec.  1.482-7T(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 the collection of 
information 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 are confidential, as required by 26 U.S.C. 6103.

Background

    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) 
on (REG-144615-02) August 29, 2005 (the 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 substantial comments 
on a wide range of issues addressed in the 2005 proposed regulations. 
In response to these comments, these temporary regulations make several 
significant changes to the rules of the 2005 proposed regulations. The 
temporary regulations are generally applicable for CSAs commencing on 
or after January 5, 2009, with transition rules for certain preexisting 
arrangements. These regulations are being issued in temporary and 
proposed form so that taxpayers and the IRS may apply the new cost 
sharing rules while maintaining the opportunity for further input and 
refinements before the issuance of final rules.

Explanation of Provisions

A. Overview

    The temporary regulations generally provide guidance regarding the 
application of section 482 and the arm's length method to cost sharing 
arrangements. Several comments on the proposed regulations questioned 
whether and how the proposed regulations conform to the arm's length 
standard, as well as its corollary, the commensurate with income (CWI) 
requirement added by the Tax Reform Act of 1986. In response, the 
temporary regulations provide further guidance on the evaluation of the 
arm's length results of cost sharing transactions (CSTs) and platform 
contribution transactions (PCTs). The regulations address the material 
functional and risk allocations in the context of a CSA, including the 
reasonably anticipated duration of the commitments, the intended scope 
of the intangible development, the degree and uncertainty of profit 
potential of the intangibles to be developed, and the extent of 
platform and other contributions of resources, capabilities, and rights 
to the development and exploitation of cost shared intangibles (CSA 
Activity).
    Under the temporary regulations, if available data of uncontrolled 
transactions reflect, or may be reliably adjusted to reflect, similar 
facts and circumstances to a CSA, they may be the basis for application 
of a comparable uncontrolled transaction method to value the CST and 
PCT results. Because of the difficulty of finding data that reliably 
reflects such facts and circumstances (even after adjustments), the 
temporary regulations also provide for other methods. These include the 
newly specified income, acquisition price, market capitalization, and 
residual profit split methods. The temporary regulations also make 
related changes to other sections of the regulations, including Temp. 
Treas. Reg. Sec. Sec.  1.482-1T, 1.482-4T, 1.482-8T, and 1.482-9T, and 
Treas. Reg. Sec.  1.6662-6.

B. Flexibility and Scope of CSA Coverage

    Commentators criticized the 2005 proposed regulations for lack of 
flexibility concerning the types and provisions of arrangements 
eligible for CSA treatment. Some comments also addressed non-conforming 
intangible development arrangements that would not be treated as CSAs.
    In response to these comments, the temporary regulations provide 
taxpayers with greater flexibility in designing certain aspects of 
CSAs. The temporary regulations also address the treatment of non-
conforming intangible development arrangements.
1. Intangible Development Arrangements Other Than CSAs--Temp. Treas. 
Reg. Sec. Sec.  1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), 1.482-
7T(b)(5), and 1.482-9T(m)(3)
    The 2005 proposed regulations defined the contractual terms, risk 
allocations, and other material provisions of a CSA covered by the cost 
sharing rules. While other intangible development arrangements might be 
referred to colloquially as cost sharing arrangements, they were not to 
be treated as CSAs by the 2005 proposed regulations unless either a 
taxpayer

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substantially complied with the CSA administrative requirements and 
reasonably concluded that its arrangement was a CSA, or a taxpayer 
substantially complied with the CSA administrative requirements and the 
Commissioner determined to apply the CSA rules to the arrangement.
    Commentators suggested broadening the scope of intangible 
development arrangements that meet the CSA definition. Some 
commentators urged the regulations not to define CSA terms and 
conditions but to extend CSA treatment to any arrangement that 
uncontrolled parties might call a cost sharing arrangement, even though 
such arrangement may involve materially different risk allocations and 
provisions than addressed in the cost sharing rules. Still other 
commentators, while accepting that the regulations should define the 
scope of arrangements treated under the cost sharing rules, suggested 
that non-conforming arrangements would be subject only to the general 
principles of Treas. Reg. Sec.  1.482-1 and would not be governed by 
the sections of the regulations addressed to specific transactional 
types. Some commentators also expressed concern that the Commissioner 
might treat a non-conforming arrangement as a CSA even in a situation 
where that result was not warranted.
    Because the cost sharing rules are designed to provide guidance for 
specific types of transactions and arrangements, the Treasury 
Department and the IRS continue to believe that the new rules set forth 
for CSAs should apply only to the transactions intended. From the 
standpoint of the purpose of the cost sharing rules and their 
administrability, it is important that the rules be applicable only to 
the defined scope of intangible development arrangements and apply no 
more broadly or narrowly than intended. In recognition of taxpayer 
concerns, however, the temporary regulations seek to provide taxpayers 
with greater flexibility and scope in the types and provisions of 
arrangements that may qualify as CSAs.
    Under Treas. Reg. Sec.  1.482-1(b)(2)(ii) (Selection of category of 
method applicable to transaction), non-conforming arrangements are 
governed by methods provided in other sections of the regulations under 
section 482, as applied in accordance with Treas. Reg. Sec.  1.482-1. 
See also Treas. Reg. Sec. Sec.  1.482-2(d), 3(a), and 4(a), and Temp. 
Treas. Reg. Sec.  1.482-9T(a). Thus, intangible development 
arrangements, including partnerships, outside the scope of the cost 
sharing rules are governed by the transfer of intangible rules of 
Treas. Reg. Sec.  1.482-4(a), or the controlled services provisions of 
Temp. Treas. Reg. Sec.  1.482-9T, as appropriate. The temporary 
regulations make clarifying amendments to Temp. Treas. Reg. Sec. Sec.  
1.482-1T(b)(2)(i) and (iii), 1.482-4T(g), and 1.482-9T(m)(3). These 
amendments confirm that Treas. Reg. Sec.  1.482-1 provides principles, 
not methods. For methods, reference must be made to the other sections 
of the regulations under section 482. While treatment of a CSA is 
governed by Temp. Treas. Reg. Sec.  1.482-7T, Temp. Treas. Reg. 
Sec. Sec.  1.482-4T(g) and 1.482-9T(m)(3), as appropriate, govern 
intangible development arrangements other than CSAs, including 
partnerships.
    Nevertheless, the methods and best method considerations under the 
cost sharing rules may be adapted for purposes of the evaluation of 
non-conforming intangible development arrangements. Importantly, the 
temporary regulations provide that the analysis under the intangible 
transfer or controlled services provisions, as applicable, should take 
into account the principles, methods, comparability, and reliability 
considerations set forth in Temp. Treas. Reg. Sec.  1.482-7T in 
determining the best method for purposes of those provisions, including 
an unspecified method, as those methods and considerations may be 
appropriately adjusted in light of the differences in the facts and 
circumstances between the non-conforming arrangement and a CSA.
    Finally, Temp. Treas. Reg. Sec.  1.482-7(b)(5) clarifies the 
circumstances under which the Commissioner may treat an arrangement as 
a CSA, notwithstanding a technical failure to meet the substantive 
requirements of a CSA. Namely, the Commissioner must conclude that the 
taxpayer substantially complied with the CSA administrative 
requirements and that application of the CSA rules to such non-
conforming arrangement will provide the most reliable measure of an 
arm's length result. For these purposes, the temporary regulations also 
clarify that applicable contractual provisions will be interpreted by 
reference to economic substance and the parties' actual conduct, and 
the Commissioner may disregard terms lacking economic substance and 
impute terms consistent with the economic substance.
2. Territorial and Other Divisional Interests--Temp. Treas. Reg. Sec.  
1.482-7T(b)(1)(iii) and (4)
    The 2005 proposed regulations required the controlled participants 
in a CSA to receive non-overlapping territorial interests that entitled 
each controlled participant to the perpetual and exclusive right to the 
profits in its territory attributable cost shared intangibles. 
Commentators suggested that requiring territorial divisions of 
interests was overly restrictive and did not align with common business 
models. They also questioned the need for the non-overlapping, 
perpetual, and exclusivity conditions.
    To provide taxpayers with more flexibility in designing qualifying 
divisional interests, the temporary regulations permit use of a new 
basis--the field of use division of interests--in addition to the 
territorial basis. Further, the regulations also authorize other non-
overlapping divisional interests provided that the basis used meets 
four criteria: (1) The basis must clearly and unambiguously divide all 
interests in cost shared intangibles among the controlled participants; 
(2) the consistent use of such basis can be dependably verified from 
the records maintained by the controlled participants; (3) the rights 
of the controlled participants to exploit cost shared intangibles are 
non-overlapping, exclusive, and perpetual; and (4) the resulting 
benefits associated with each controlled participant's interest in cost 
shared intangibles are predictable with reasonable reliability. The 
temporary regulations illustrate instances in which divisional 
interests tied to specific manufacturing facilities, as an example, 
would, and would not, qualify under these criteria. See Temp. Treas. 
Reg. Sec.  1.482-7T(b)(4)(v), Examples 2 and 3.
3. Platform and Other Contributions--Temp. Treas. Reg. Sec.  1.482-
7T(c) and (g)(2)(ii)
    The 2005 proposed regulations described external contributions for 
which compensation was due from other controlled participants, that is, 
preliminary or contemporaneous transactions. A preliminary or 
contemporaneous transaction corresponded to the buy-in pursuant to 
Sec.  1.482-7(g) of the 1995 final regulations. Under the 2005 proposed 
regulations, an external contribution generally consisted of the rights 
in the reference transaction (RT) in any resource or capability 
reasonably anticipated to contribute to developing cost shared 
intangibles. The RT consisted of a transaction, to be designated in the 
CSA documentation, affording the perpetual and exclusive rights in the 
subject resource or capability. While the RT was relevant to valuing 
the compensation obligation under a PCT, the controlled participants 
were not required to actually enter into the RT. Although the RT 
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perpetual and exclusive rights, proration was required to the extent 
that the subject resource or capability was reasonably anticipated to 
contribute both to the CSA Activity and other business activities. 
Evaluation of the preliminary or contemporaneous transaction 
compensation obligation for the subject rights could be in the 
aggregate with preliminary or contemporaneous transaction compensation 
obligation with respect to other external contributions, or in the 
aggregate with the compensation obligations with respect to other 
rights, where valuation on an aggregate basis would provide the most 
reliable measure of an arm's length result for the aggregated 
preliminary or contemporaneous transactions and other transactions.
    Commentators objected to the RT as overbroad. Commentators further 
contended that external contributions included elements such as 
workforce, goodwill or going concern value, or business opportunity, 
which in the commentators' view either do not constitute intangibles, 
or are not being transferred, and so, in the commentators' view, are 
not compensable.
    The temporary regulations replace the term ``external 
contribution'' with the term ``platform contribution'' and replace the 
term ``preliminary or contemporaneous transaction'' with the term 
``platform contribution transaction.'' The temporary regulations, like 
the 2005 proposed regulations, do not limit platform contributions that 
must be compensated in PCTs to the transfer of intangibles defined in 
section 936(h)(3)(B). For example, to the extent a controlled 
participant (the PCT Payee) contributes the services of its research 
team for purposes of developing cost shared intangibles pursuant to the 
CSA, the other controlled participant (the PCT Payor) would owe 
compensation for the services of such team under Temp. Treas. Reg. 
Sec.  1.482-9T, just as would be the case in a contract research 
arrangement. Where there is a combined contribution of research 
services, intangibles in process, or other resources, capabilities, or 
rights, the temporary regulations provide for an aggregate valuation 
where that would provide the most reliable measure of an arm's length 
result for the aggregated PCTs and other transactions. The treatment 
available under the cost sharing rules of the contribution of the 
services of a research team as controlled services is without any 
inference concerning the potential status of workforce in place as an 
intangible within the meaning of section 936(h)(3)(B).
    On the other hand, the temporary regulations only require the PCT 
Payor to compensate the PCT Payee for platform contributions, or cross 
operating contributions, reasonably anticipated to contribute to the 
CSA Activity in the PCT Payor's division as defined in Temp. Treas. 
Reg. Sec.  1.482-7T(j)(1)(i). A PCT Payor is not obligated to 
compensate the PCT Payee for any of the PCT Payee's resources, 
capabilities, or rights that are reasonably anticipated to benefit only 
the PCT Payee's operations. Similarly, under the temporary regulations, 
the PCT Payee is also not entitled to compensation from the PCT Payor 
on account of any of the PCT Payor's own resources, capabilities, or 
rights, including any goodwill or going concern value of the PCT Payor. 
For example, where operations of parties involve undertaking functions 
and risks of scope and duration comparable to those of the PCT Payor, 
an application of the income method based on the comparable profits 
method would retain for the PCT Payor the returns reasonably 
anticipated to its own contributions to operations in its division, 
including any goodwill or going concern value associated with those 
operations, based on the returns to the comparable parties used in the 
CPM analysis. Similarly, the PCT Payor retains the ability to pursue 
its own business opportunities in its division, including through 
operating cost contributions to maintain or develop resources, 
capabilities, or rights to promote its operations.
    In response to comments that the concept of the RT was unnecessary 
and confusing, the temporary regulations do not use that concept. 
Instead, the temporary regulations adopt a presumption that a PCT Payee 
provides any resource, capability, or right to the intangible 
development activity (IDA) pursuant to the CSA on an exclusive basis. A 
taxpayer can rebut the presumption by showing to the satisfaction of 
the Commissioner that the subject resource, capability, or right is 
reasonably anticipated to contribute not just to the CSA, but to other 
business activities as well. For example, if the platform resource is a 
research tool, then the taxpayer could rebut the presumption of 
exclusivity by establishing to the satisfaction of the Commissioner 
that the tool is reasonably anticipated not only to be applied in the 
IDA, but also to be licensed to an uncontrolled taxpayer. The temporary 
regulations provide guidance on proration of PCT payments in cases 
where the taxpayer rebuts the presumption.
4. Intangible Development Activity and Costs--Temp. Treas. Reg. Sec.  
1.482-7T(d)
    Some commentators suggested that taxpayers can limit the 
application of the cost sharing rules by defining the IDA with 
reference only to specifically listed platform contributions. Without 
any inference intended as to the economic substance of such an 
approach, the temporary regulations are clarified to exclude this 
possibility. The scope of the IDA includes all 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, since the IDA is a function of what are the reasonably 
anticipated cost shared intangibles and such a list might 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 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.
    The Treasury Department and the IRS requested in Notice 2005-99, 
2005-52 CB 1214 comments regarding the valuation of stock options and 
other stock-based compensation. The Treasury Department and the IRS 
received comments and continue to consider the technical changes and 
issues described in Notice 2005-99 and intend to address those in a 
subsequent regulations project. See Treas. Reg. Sec.  
601.601(d)(2)(ii)(b).
5. Changes in Participation--Temp. Treas. Reg. Sec.  1.482-7T(f)
    The increased flexibility to adopt a divisional basis other than a 
territorial or field of use basis entails the need for provisions to 
prevent abuse and facilitate compliance. Capability fluctuations, 
whether market-driven or strategic, that materially alter the 
controlled participants' RAB shares as compared with their respective 
divisional interests create the equivalent of a controlled transfer of 
interests and should therefore equally occasion arm's length 
compensation. Accordingly, the temporary regulations modify the change 
of participation provision to classify such a material capability 
variation, in addition to a controlled transfer of interest, as a 
change in

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participation that requires arm's length consideration by the 
controlled participant whose RAB share increases, to the controlled 
participant whose RAB share decreases, as the result of the capability 
variation.

C. Income and Other Specified and Unspecified Methods

1. Best Method Analysis Considerations--Temp. Treas. Reg. Sec.  1.482-
7T(g)(2)
    The 2005 proposed regulations articulated ``general principles''--
such as the realistic alternatives principle--applicable to any method 
to determine the arm's length charge in a PCT. Commentators expressed 
uncertainty about the role intended for these principles. For example, 
they wondered if these principles themselves dictated, or trumped, 
methods or applications of methods.
    The temporary regulations clarify that these principles were 
intended to provide supplementary guidance on the application of the 
best method rule to determine which method, or application of a method, 
provides the most reliable measure of an arm's length result in the CSA 
context. In other words, the principles provide best method 
considerations to aid the competitive evaluation of methods or 
applications, and are not themselves methods or trumping rules.
    a. Consistency with upfront terms and risk allocation--the investor 
model--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(ii).
    The investor model is a core principle of the 2005 proposed 
regulations. A PCT Payor, through cost sharing and payments made 
pursuant to the PCT (PCT Payments), is investing for the term of the 
CSA Activity and expects returns over time consistent with the 
riskiness of that investment.
    The upfront evaluation pursuant to the investor model of expected 
returns to particular risks assumed in intangible development and 
exploitation under the facts and circumstances is key to ensuring 
consistency of the results of a CSA with the arm's length standard. 
Commentators have criticized the investor model for stripping away 
risky returns from the PCT Payor. The temporary regulations provide 
additional guidance to explain that when the PCT Payor assumes risks, 
it accordingly enjoys the returns (or suffers the detriments) that may 
result from such risks.
    For example, in addition to its cost contributions to developing 
cost shared intangibles, a PCT Payor may also commit significant 
operating contributions, such as existing marketing or manufacturing 
process intangibles, to operations in its division as well as make 
significant operating cost contributions towards further developing 
such intangibles. To the extent parties to comparable transactions 
undertake similar risks of similar scope and duration, the PCT Payor 
will be appropriately awarded based on a method that relies in whole or 
part on the returns in such comparable transactions (including 
applications of the income method based on a CUT or the CPM). To the 
extent its operating contributions are nonroutine, that is, not 
reflected in available comparable transactions, then the PCT Payor may 
share in nonroutine divisional profit under the application of the 
residual profit split method (RPSM) provided in the temporary 
regulations.
    Moreover, the temporary regulations provide guidance on discount 
rates and arm's length ranges, so as to further clarify the ability of 
the PCT Payor to achieve results commensurate with its assumption of 
risks.
    b. Aggregation of transactions--Temp. Treas. Reg. Sec.  1.482-7T 
(g)(2)(iv).
    The temporary regulations make conforming changes to the guidance 
included in the 2005 proposed regulations on aggregate evaluation of 
multiple transactions. Thus, if the combined effect of transactions in 
connection with a CSA involving platform, operating, and other 
contributions of resources, capabilities, or rights are reasonably 
anticipated to be interrelated, then determination of the arm's length 
charge for PCTs and other transactions on an aggregate basis may 
provide the most reliable measure of an arm's length result.
    c. Discount rates--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(v).
    The 2005 proposed regulations provided general guidance that, where 
a present value is needed for a purpose in a cost sharing analysis, a 
discount rate should be used that most reliably reflects the risk of 
the particular set of activities or transactions based on all the 
information potentially available at the time for which the present 
value calculation is to be performed. Further, depending on the 
particular facts and circumstances, the discount rate may differ among 
a company's various activities and transactions. As examples, the 
proposed regulations indicated that a weighted average cost of capital 
(WACC) of the taxpayer, or an uncontrolled taxpayer, could provide the 
most reliable basis for a discount rate if the CSA Activity involves 
the same risk as projects undertaken by the taxpayer, or uncontrolled 
taxpayer, as a whole. As another example, in certain appropriate 
conditions, a company's internal hurdle rate for projects of comparable 
risk might provide a reliable basis for a discount rate in a cost 
sharing analysis.
    Commentators offered several criticisms of the discount rate 
guidance. Some comments concluded that the 2005 proposed regulations 
placed an inappropriate emphasis on a taxpayer's WACC as a basis for 
analysis. Other comments suggested a clarification be made that more 
than a single discount rate may be appropriate in a cost sharing 
analysis. Yet other comments addressed whether a discount rate in a 
cost sharing analysis should be before, or after, tax. Some 
commentators asserted that cash flows, rather than items entering into 
income, analytically are the more appropriate amounts to be discounted.
    The temporary regulations revise and elaborate upon the best method 
analysis considerations in regard to discount rates. Guidance is 
provided recognizing that the appropriate discount rate may, depending 
on the facts and circumstances, vary between realistic alternatives and 
forms of payment. As regards discount rate variation between realistic 
alternatives, for example, licensing intangibles needed for its 
operations would ordinarily be less risky for a licensee, and so 
require a lower discount rate, than entering into a CSA which would 
involve the licensee assuming the additional risk of funding its cost 
contributions to the IDA. As regards discount rate variation between 
forms of payment, 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.
    The temporary regulations recognize that, in general, discount 
rates inferred from the operations of the capital markets are post-tax 
rates. An analysis applying post-tax discount rates would be expected 
to treat taxes like any other expense. However, the equivalent result 
may in certain circumstances be achieved by applying a post-tax 
discount rate to pre-tax net income multiplied by the difference of one 
minus the tax rate. If such an approach is adopted in applying the 
income method, 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 (or if reliable 
adjustments may be made for varying tax rates), the mulitiplier (that 
is, one minus the tax rate) may be cancelled from both sides of the 
equation of the cost sharing and

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licensing alternative present values. Accordingly, in such circumstance 
it is sufficient to apply post-tax discount rates to pre-tax items for 
the purpose of equating the cost sharing and licensing alternatives. 
See also the discussion of the income method in this preamble.
    The specific reference to a WACC or to hurdle rates are eliminated 
as unnecessary, but without any inference as to a WACC or a hurdle rate 
being an appropriate discount rate, or an appropriate starting point in 
ascertaining a discount rate, depending on the particular facts.
    Certain methods in the temporary regulations (such as the income 
method under Temp. Treas Reg. Sec.  1.482-7T(g)(4)) are theoretically 
based on valuation techniques that use ``cash flow'' projections rather 
than income projections. While use of cash flow projections is 
permitted under these methods, for a number of practical and 
administrative reasons, detailed guidance on the specific applications 
of the methods are based on income, rather than cash flow, measures. 
The Treasury Department and the IRS considered whether to provide 
guidance on the use of cash flows, rather than income, as the 
appropriate amounts to be discounted in a cost sharing analysis. The 
Treasury Department and the IRS continue to consider, and solicit 
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 and its CWI requirement.
    d. Projections--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(vi).
    The temporary regulations note that the reliability of an estimate 
will often depend upon the reliability of the projections used in 
making the estimate. Projections should reflect the best estimates of 
the items projected (for example, reflecting a probability weighted 
average of possible outcomes).
    e. Arm's length range--Temp. Treas. Reg. Sec.  1.482-7T(g)(2)(ix).
    The 2005 proposed regulations provided supplemental guidance on 
applying arm's length methods in the cost sharing context in accordance 
with the provisions of Treas. Reg. Sec.  1.482-1 including, inter alia, 
the arm's length range of Treas. Reg. Sec.  1.482-1(e). The proposed 
regulations did not, however, provide guidance on how to adapt an arm's 
length range for cost sharing.
    The temporary regulations adapt the guidance in Treas. Reg. Sec.  
1.482-1(e) for use with some of the methods for computing PCT Payments 
that are specified in the temporary regulation. The provisions 
elaborate, where the entire range of results cannot be regarded as of 
sufficient comparability and reliability, how to derive a statistically 
enhanced range of arm's length charges for a PCT.
    The guidance in Treas. Reg. Sec.  1.482-1(e) regarding arm's length 
ranges is most easily understood in the context of a method (for 
example, comparable uncontrolled price, cost plus, resale price, 
comparable uncontrolled transaction, comparable profits), in which the 
result of each comparable transaction directly provides an estimate for 
the result of the controlled transaction. Some of the methods specified 
in the temporary regulations (for example, the income method) have a 
different structure, in which an arm's length result is estimated by 
performing mathematical calculations that depend on two or more input 
parameters (for example, a relevant discount rate, certain financial 
projections, a return for routine activities) that must be determined. 
The additional guidance in this section addresses the arm's length 
range in the context of such methods.
    The temporary regulations distinguish certain input parameters 
(variable input parameters) that, for purposes of determining an arm's 
length range, may be assigned more than one possible value. Such input 
parameters are limited to those whose value is most reliably determined 
by considering two or more observations of market data (for example, 
profit levels or stock betas of two or more companies) that have, or 
with adjustment can be brought to, a similar reliability and 
comparability, as described in Treas. Reg. Sec.  1.482-1(e)(2)(ii). If 
there are two or more variable input parameters, the narrowing effect 
of the interquartile range is used twice: First, to narrow the 
variation of each input parameter, and again to narrow the resulting 
set of PCT Payment values. This double narrowing reflects that the use 
of two or more variable input parameters normally introduces additional 
unreliability into a method, even though that method may be the best 
method.
    Generally, Treas. Reg. Sec.  1.482-1(e)(3) governs the 
Commissioner's ability to make an adjustment to a PCT Payment due to 
the taxpayer's results being outside the arm's length range. Consistent 
with the principles expressed there, adjustment under the temporary 
regulations will normally be to the median, as defined in Treas. Reg. 
Sec.  1.482-1(e)(3). Also, the Commissioner is not required to 
establish an arm's length range prior to making an allocation under 
section 482.
    The Treasury Department and the IRS solicit comments on the design 
and mechanics of the supplemental guidance on determination of an arm's 
length range in paragraph (g)(2)(ix) of the temporary regulations, 
including the limitation of variable input parameters to market-based 
input parameters. Any alternative proposal should specify the design 
and mechanics in detail, and should discuss whether such an approach 
enhances the reliability of the analysis, is administrable, and is not 
so manipulable as to yield unrealistic ranges.
2. Comparable Uncontrolled Transaction Method--Temp. Treas. Reg. Sec.  
1.482-7T(g)(3)
    The 2005 proposed regulations provided for possible use of the 
comparable uncontrolled transaction (CUT) method to determine the arm's 
length charge in a PCT where appropriate in accordance with the 
standards of the intangibles transfer and controlled services 
provisions of the regulations under section 482. Some commentators 
asserted that any arrangement that uncontrolled parties might call a 
cost sharing arrangement could serve as a CUT, even though such 
arrangement may involve materially different risk allocations and 
provisions than addressed in the cost sharing rules.
    In response to these comments, the temporary regulations describe 
the relevant considerations for purposes of evaluating whether a 
putative CUT may, or may not, reflect the most reliable measure of an 
arm's length result. Although all of the factors entering into a best 
method analysis described in Treas. Reg. Sec. Sec.  1.482-1(c) and (d) 
must be considered, comparability and reliability under the CUT method 
in the CSA context 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 the cost sharing 
rules.

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3. Income Method--Temp. Treas. Reg. Sec.  1.482-7T(g)(4)
    The 2005 proposed regulations made the income method a specified 
method for purposes of evaluating the arm's length charge in a PCT. 
Under the general rule, the arm's length charge was an amount that 
equated a controlled participant's present value of entering into a CSA 
with the present value of the controlled participant 's best realistic 
alternative. Also provided were two applications of the income method. 
One, based on a CUT analysis, assumed that a PCT Payee's best realistic 
alternative would be to develop the cost shared intangibles on its own, 
bearing all the intangible development costs (IDCs) itself, and then 
license the cost shared intangibles. A second, based on a comparable 
profits method (CPM) analysis, assumed that the PCT Payor's best 
realistic alternative would be to acquire the rights to external 
contributions (renamed platform contributions under the temporary 
regulations) for payments with a present value equal to the PCT Payor's 
anticipated profit, after reward for its routine contributions to its 
operations, from the CSA Activity in its territory (the only division 
permitted under the 2005 proposed regulations). Both income method 
applications provided for a cost contribution adjustment in order to 
allocate to the PCT Payor the return to its additional risk, as 
compared to its realistic alternative, of bearing its reasonably 
anticipated benefits (RAB) share of the IDCs. As set forth in the 2005 
proposed regulations, both the CUT and CPM based applications of the 
income method built in a conversion to a royalty form of payment, 
either on sales or on operating profit.
    Commentators offered several criticisms with reference to the 
income method. As a general matter, some comments asserted that the 
income method stripped away risky returns from the PCT Payor. Other 
comments focused on technical aspects of the method and the 
applications. In particular, comments pointed to the potential risk 
differentials between cost sharing and the alternative arrangements. 
For example, cost sharing would generally be more risky than licensing 
for the PCT Payor as the result of its sharing with the PCT Payee the 
risks of the IDA. As a corollary, cost sharing would generally be less 
risky for the PCT Payee than licensing. The comments observed that 
these risk differentials would ordinarily be reflected in different 
discount rates being appropriate under the cost sharing and licensing 
alternatives. Other comments suggested the possible use of different 
discounts for different financial flows (sales, cost of sales, 
operating expenses, cost contributions, etc.).
    The temporary regulations provide further guidance on the income 
method and its applications. In general, they provide that 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 
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.
    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 
subsequently 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 the 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 
the cost sharing rules. 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 the temporary regulations.
    The temporary regulations, like the 2005 proposed regulations, 
describe both CUT-based applications and CPM-based applications of the 
Income Method. However, they differ from the applications described in 
the 2005 proposed regulations by equating the cost sharing and 
licensing alternatives of the PCT Payor using discount rates 
appropriate to those 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. 
Otherwise, as recognized in the best method considerations concerning 
discount rates, realistic alternatives having the same reasonably 
anticipated present value may nevertheless involve varying risk 
exposure and, thus, generally are more reliably evaluated using 
different discount rates. 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 (or 
reliable adjustments may be made for varying tax rates), it is 
appropriate to apply post-tax discount rates to pre-tax items for 
purpose of equating the cost sharing and licensing alternatives. The 
discount rate for the cost sharing alternative will generally depend on 
the form of PCT Payments assumed (for example, lump sum, royalty on 
sales, royalty on divisional profit).
    The income method may be applied to determine PCT Payments in any 
form of payment (for example, lump sum, royalty on sales, royalty on 
divisional profit). If an income method application is used to 
determine arm's length PCT Payments in a particular form, then the PCT 
Payments in that form may be converted to an alternative form in 
accordance with Temp. Treas. Reg. Sec.  1.482-7(h) (Form of payment 
rules).
    The temporary regulations clarify the opportunities, depending on 
the facts and circumstances, for the PCT Payor to assume risks and, 
accordingly, to enjoy the returns (or suffer the detriments) that may 
result from such risks. For example, in addition to its cost 
contributions to developing cost shared intangibles, a PCT Payor may 
also commit significant operating contributions, such as existing 
marketing or manufacturing process intangibles, to operations in its 
division as well as make significant operating cost contributions 
towards further developing such intangibles. To the extent parties to 
comparable transactions undertake risks of similar scope and duration, 
the PCT Payor will be appropriately rewarded based on a method that 
relies in whole or part on returns in such comparable transactions 
under an application of the income method whether based on a CUT or the

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CPM. Where its operating contributions are nonroutine, that is, not 
reflected in available comparable transactions, the PCT Payor may share 
in nonroutine divisional profit under the application of the RPSM 
provided in the temporary regulations. Similarly, while the income 
method is limited to cases in which only one of the controlled 
participants provides nonroutine platform contributions as the PCT 
Payee, the RPSM in the temporary regulations addresses the situation 
where more than one controlled participant furnishes nonroutine 
platform contributions.
    Yet other comments criticized the income method as positing an 
unrealistic ``perpetual life.'' The income method is premised on the 
assumption that, at arm's length, an investor will make a risky 
investment (for example, in a platform for developing additional 
technology) only if the investor reasonably anticipates that the 
present value of its reasonably anticipated operational results will be 
increased at least by a present value equal to the platform investment. 
It may be, depending on the facts and circumstances, that the 
technology is reasonably expected to achieve an incremental improvement 
in results for only a finite period (after which period, results are 
reasonably anticipated to return to the levels that would otherwise 
have been expected absent the investment). The period of enhanced 
results that justifies the platform investment in such circumstances 
effectively would correspond to a finite, not a perpetual, life.
4. Acquisition Price and Market Capitalization Methods--Temp. Treas. 
Reg. Sec.  1.482-7T(g)(5) and (6)
    The 2005 proposed regulations included guidance on the acquisition 
price and market capitalization methods for evaluating the arm's length 
charge in a PCT. Under the acquisition price method, the arm's length 
charge for a PCT is the adjusted acquisition price, that is, the 
acquisition price increased by the value of the target's liabilities on 
the date of acquisition, and decreased by the value on that date of 
target's tangible property and any other resources and capabilities not 
covered by the PCT. Under the market capitalization method, the arm's 
length charge for a PCT is the adjusted average market capitalization, 
that is, the average daily market capitalization over the 60 days 
ending with the date of the PCT, increased by the value of the PCT 
Payee's liabilities on such date, and decreased on account of tangible 
property and any other resources and capabilities of the PCT Payee not 
covered by the PCT.
    Commentators questioned the reliability of these methods in light 
of volatility of stock prices and lack of correlation between stock 
price and underlying assets, for example, owing to control premiums or 
economies of integration.
    The Treasury Department and the IRS recognize that these comments 
point to considerations that, depending on the facts and circumstances, 
will need to be taken into account in a best method analysis that 
compares the reliability of the results under application of these 
methods as against the results under application of other methods 
(which may themselves have aspects that reduce their reliability). The 
temporary regulations retain the best method considerations from the 
2005 proposed regulations that observe that reliability is reduced 
under these methods if a substantial portion of the target's, or PCT 
Payor's, nonroutine contributions to business activities is not 
required to be covered by a PCT and, in the case of the market 
capitalization method, if the facts and circumstances demonstrate the 
likelihood of a material divergence between the PCT Payee's average 
market capitalization and the value of its underlying resources, 
capabilities, and rights for which reliable adjustments cannot be made. 
The temporary regulations also provide that proximity in time between 
the acquisition of the target and the PCT Payment is an important 
comparability factor under the acquisition price method.
5. Residual Profit Split Method--Temp. Treas. Reg. Sec.  1.482-7T(g)(7)
    The temporary regulations conform the modified RPSM from the 
proposed regulations to the changes made to the income method.
6. Unspecified Methods--Temp. Treas. Reg. Sec.  1.482-7T(g)(8)
    Under the temporary regulations in order to use an unspecified 
method, a taxpayer must maintain documentation to describe and explain 
the method selected to determine the arm's length payment due in a PCT.

D. Form of Payment

1. Post Formation Acquisitions
    The 2005 proposed regulations generally provided taxpayers 
flexibility to provide for PCT Payments either in fixed amounts 
(whether in lump sums or installment payments with arm's length 
interest) or in contingent amounts. PCT Payments could not be paid in 
shares of stock of the PCT Payor. The form of payment selected for any 
PCT, including the basis and structure of the payments, had to be 
specified no later than the date of the PCT. In the case of a post 
formation acquisition (PFA)--that is, an external contribution (renamed 
platform contribution in the temporary regulations) that is acquired by 
a controlled participant in an uncontrolled transaction (either 
directly, or indirectly through the acquisition of an interest in an 
entity or tier of entities)--the consideration under the PCT for a PFA 
had to be paid in the same form as the consideration in the 
uncontrolled transaction in which the PFA was acquired. An example 
indicates that acquisitions for stock were considered to be for a fixed 
form of payment. One principal rationale for the special rules for PFAs 
was that PFAs stand in the place of IDCs and, therefore, reflect a risk 
allocation equivalent to that in the IDC context, which requires the 
sharing of outlays on a fixed form of payment basis. Another principal 
rationale was the difficulty the IRS has had in examining CSAs using a 
contingent form of payment for PFAs.
    Commentators criticized the same form of payment requirement for 
PFAs, especially the treatment of stock acquisitions as having a fixed 
form of payment. The comments pointed out that a purchaser paying with 
its own stock is selling a part of its business, and thus pays 
consideration that is ultimately contingent on the success of its 
business. Other comments objected to the timing mismatch caused by the 
same form of payment rule, because fixed PCT Payments would be 
immediately includable, but the PFA assets would be amortizable only 
over time. Still other comments asserted that taxpayers may choose 
their form of payment for PFAs, as with other external contributions, 
so long as the price (taking into account the form of payment) is arm's 
length.
    The temporary regulations do not retain the special rules for PFAs. 
Subsequent acquisitions remain an important source of platform 
contributions that occasion the requirement of PCT compensation. 
However, the temporary regulations no longer require a special form of 
payment for such compensation. Therefore, controlled participants may 
choose the form of payment for PCTs regardless of whether the PCTs 
occur at the outset of the CSA or later. Removal of the special rules 
for PFAs moots questions regarding whether stock consideration should 
be treated as contingent or fixed payment and whether (and how) the 
timing mismatch should be addressed. Nonetheless, the IRS will continue 
to

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scrutinize the contractual documentation, pricing, and implementation 
of contingent forms of payment for PFAs.
2. Contingent Payments--Temp. Treas. Reg. Sec.  1.482-7T(h)(2)(iv) and 
(v)
    The temporary regulations incorporate rules to ensure that the 
contingent form for PCT Payments is applied properly by both taxpayers 
and the IRS. In accordance with Treas. Reg. Sec.  1.482-
1(d)(3)(iii)(B), a CSA contractual provision 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. The temporary regulations 
require a contingent payment provision to 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 permit 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 accounting or business management 
purposes).
    The temporary regulations also provide that where a method yields a 
fixed value for PCT Payments, a conversion may be made to a contingent 
form of payments. Guidance is also provided on discount rates for 
purposes of such conversion. 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.

E. Periodic Adjustments

1. Determination of Periodic Adjustments--Temp. Treas. Reg. Sec.  
1.482-7T(i)(6)(v) and (vi)
    The 2005 proposed regulations addressed the CWI principle of the 
second sentence of section 482 in the context of cost sharing. The 
Commissioner could make periodic adjustments for an open taxable year 
(the Adjustment Year) and all subsequent years of the CSA Activity in 
the event of a Periodic Trigger. Under the 2005 proposed regulations, a 
Periodic Trigger arose if the PCT Payor realized, over the period 
beginning with the earliest date on which an IDC occurred through the 
end of the Adjustment Year, an actually experienced return ratio of the 
present value of its total territorial operating profits divided by the 
present value of its investment consisting of the sum of its cost 
contributions plus PCT Payments, outside the periodic return ratio 
range of between .5 and 2. In arriving at these present values, the 
Commissioner would use an applicable discount rate, which in the case 
of certain publicly traded entities would be their weighted average 
cost of capital, unless the Commissioner determines, or the controlled 
participants establish, that another discount rate better reflects the 
degree of risk of the CSA Activity. Periodic adjustments would be 
determined under a modified RPSM. Exceptions were provided, such as for 
an effective CUT or for results due to extraordinary events beyond the 
controlled participants' control and that could not have been 
reasonably anticipated. In determining whether to make any periodic 
adjustments, the Commissioner would consider whether the outcome as 
adjusted more reliably reflects an arm's length result under all the 
relevant facts and circumstances.
    Commentators offered several criticisms of the periodic adjustment 
rules. Some comments considered the periodic adjustment rules to be 
inconsistent with the arm's length standard and, through hindsight, to 
strip away returns to risk. Other comments claimed for taxpayers the 
same ability as the Commissioner to make periodic adjustments to 
implement the CWI principle where subsequent results diverge from 
original expectations. Comments also addressed the exceptions and means 
for taxpayers to demonstrate their results were arm's length so as to 
avoid periodic adjustments.
    The Treasury Department and the IRS reaffirm that the CWI principle 
is consistent, and periodic adjustments are to be administered 
consistently, with the arm's length standard. Congress adopted the CWI 
principle in 1986 out of concern about related-party long-term 
transfers of high-profit potential intangibles for relatively 
insignificant lump sum or royalty consideration justified by reference 
to putatively comparable transactions between unrelated parties that 
differed significantly in terms of the division of functionality and 
risks when compared to the transfers at issue. See H.R. Rep. 99-426, at 
424-25 (1985). See also Notice 88-123 (the White Paper), 1988-2 CB 458, 
472-74, 477-80. Congress intended that taxpayers be able to ``use 
certain bona fide cost-sharing arrangements as an appropriate method of 
allocating income attributable to intangibles among related parties, if 
and to the extent such agreements are consistent with the purposes of 
this provision that the income allocated among the parties reasonably 
reflect the actual economic activity undertaken by each.'' H.R. Conf. 
Rep. No. 99-841, at II-638 (1986). See Treas. Reg. Sec.  
601.601(d)(2)(ii)(b).
    Accordingly, the temporary regulations continue to provide for 
periodic adjustments along lines similar to those in the intangible 
transfer section of the regulations, as adapted for the cost sharing 
context. Compare Treas. Reg. Sec.  1.482-4(f)(2)(Periodic adjustments). 
The temporary regulations, however, adopt a smaller periodic return 
ratio range than the 2005 proposed regulations. Setting a Periodic 
Trigger to occur if the actually experienced return ratio falls outside 
the periodic return ratio range of between .667 and 1.5 (or between 0.8 
and 1.25, if the taxpayer has not substantially complied with the 
documentation requirements of Temp. Treas. Reg. Sec.  1.482-7T(k)) is 
intended to isolate situations in which actual results suggest the 
potential of an absence of arm's length pricing as of the date of the 
PCT. The Treasury Department and the IRS consider that the periodic 
return ratio range under the temporary regulations more realistically 
targets the threshold at which periodic adjustment scrutiny is 
appropriate. In determining whether to make any periodic adjustments, 
the Commissioner considers whether the outcome as adjusted more 
reliably reflects an arm's length result under all the relevant facts 
and circumstances.
    The temporary regulations also make conforming changes to the 
determination of periodic adjustments, in the event of a Periodic 
Trigger, in light of other changes in the temporary regulations, for 
example, in the RPSM and form of payment provisions.
2. Advance Pricing Agreement
    In addition, the Treasury Department and the IRS intend to issue by 
revenue procedure separate published guidance that provides an 
exception to periodic adjustments, similar to exceptions

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provided in Temp. Treas. Reg. Sec.  1.482-7T(i)(6)(vi), in the context 
of an advance pricing agreement (APA) entered into pursuant to Rev. 
Proc. 2006-9, 2006-1 CB 278 (as it may be amended or superseded by 
subsequent administrative pronouncement). The guidance would provide 
that no periodic adjustments will be made in any year based on a 
Trigger PCT that is a covered transaction under the APA. See Treas. 
Reg. Sec.  601.601(d)(2)(ii)(b).
    An APA process generally is contemporaneous with a taxpayer's 
original transactions and involves transparency concerning a taxpayer's 
upfront efforts to conform to the arm's length standard. Thus, the APA 
process may overcome the asymmetry in information addressed by the 
periodic adjustment provisions, eliminating a primary basis for a CWI 
adjustment. See generally 70 FR 51128-51130 (preamble to 2005 proposed 
regulations).
    The Treasury Department and the IRS considered the possibility of a 
further exception to periodic adjustments based on documentation that a 
taxpayer would maintain contemporaneously with a PCT. Compare Treas. 
Reg. Sec.  1.6662-6(d)(2)(iii). Such an exception was not incorporated 
into the temporary regulations in light of the concern that 
documentation prepared only by the taxpayer would not benefit from a 
similar degree of contemporaneous transparency and explanation as 
involved in an APA. The Treasury Department and the IRS continue to 
consider this matter and solicit comments on whether and how a 
documentation exception could be adapted to the purposes of the CWI 
principle.

F. Terminology and Table of Definitions--Temp. Treas. Reg. Sec.  1.482-
7T(j)(1)

    For ease of reference, a comprehensive table of terms is provided. 
The table sets forth, alphabetically, technical terms used in the 
regulations, any applicable abbreviations, definitions (if not 
elsewhere defined in the regulations), and cross references to relevant 
portions of the regulations where the terms are defined or used.

G. Administrative and Transition Rules--Temp. Treas. Reg. Sec.  1.482-
7T(m)

    The 2005 proposed regulations included transition rules for 
existing qualified cost sharing arrangements so as not to disturb 
taxpayers' reliance on the prior regulations, while providing for 
appropriate prospective application of the new regulations. Grandfather 
treatment would have been terminated in certain events, including the 
occasion of a Periodic Trigger as the result of a subsequent PCT 
occurring after the regulations' effective date, a material change in 
the scope of the arrangement, such as a material expansion of the 
activities undertaken beyond the scope of the intangible development 
area, or a 50 percent or greater change in the ownership of interests 
in cost shared intangibles.
    Commentators objected to the grandfather termination events, in 
particular in the case of a subsequent Periodic Trigger or a 50 percent 
change of ownership, as defeating taxpayers' legitimate expectation 
under the prior regulations.
    The temporary regulations do not terminate grandfather treatment 
upon a 50 percent change of ownership or on account of a subsequent 
Periodic Trigger or a material change in scope of the arrangement. The 
temporary regulations instead adopt a targeted provision that applies 
the temporary regulations' periodic adjustment rules to PCTs that occur 
on or after the date of a material change in the scope of the 
grandfathered CSA. 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 Treas. Reg. Sec.  
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.

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 been 
determined also that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
refer to the Special Analyses section of the preamble to the cross-
reference notice of proposed rulemaking