Clarification of the Coordination of the Transfer Pricing Rules With Other Code Provisions, 55538-55543 [2015-23278]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 80, Number 179 (Wednesday, September 16, 2015)]
[Rules and Regulations]
[Pages 55538-55543]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-23278]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9738]
RIN 1545-BM72


Clarification of the Coordination of the Transfer Pricing Rules 
With Other Code Provisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that clarify the 
coordination of the application of the arm's length standard and the 
best method rule under section 482 of the Internal Revenue Code (Code) 
in conjunction with other provisions of the Code. The text of the 
temporary regulations also serves in part as the text of the proposed 
regulations (REG-139483-13) published in the Proposed Rules section of 
this issue of the Federal Register. This document also contains final 
regulations that add cross-references in the existing final regulations 
under section 482 to relevant sections of these temporary regulations.

DATES: Effective date: These regulations are effective on September 14, 
2015.
    Applicability date: For dates of applicability, see Sec.  1.482-
1T(j)(7)(i).

FOR FURTHER INFORMATION CONTACT: Frank W. Dunham III, (202) 317-6939 
(not a toll-free call).

SUPPLEMENTARY INFORMATION: 

Background

    Regulations under section 482 published in the Federal Register (33 
FR 5848) on April 16, 1968, provided guidance on methods for applying 
the arm's length standard to evaluate controlled transactions, 
including transfers of tangible and intangible property, the provision 
of services, and loans or advances. Subsequent revisions and updates of 
the transfer pricing regulations were published in the Federal Register 
on July 8, 1994, Dec. 20, 1995, May 13, 1996, Aug. 26, 2003, Aug. 4, 
2009, Dec. 22, 2011, and Aug. 27, 2013 (59 FR 34971, 60 FR 65553, 61 FR 
21955, 68 FR 51171, 74 FR 38830, 76 FR 80082, and 78 FR 52854, 
respectively).

[[Page 55539]]

Explanation of Provisions

I. Overview--Consistent Valuation of Controlled Transactions for All 
Code Purposes

    Section 482 authorizes the Secretary, and the regulations under 
section 482 authorize the IRS, to adjust the results of controlled 
transactions to clearly reflect the income of commonly controlled 
taxpayers in accordance with the arm's length standard and, in the case 
of the transfer of intangible property (within the meaning of section 
936(h)(3)(B)), so as to be commensurate with the income attributable to 
the intangible. While the determination of arm's length prices for 
controlled transactions is governed by section 482, the tax treatment 
of controlled transactions is also governed by other Code and 
regulatory rules applicable to both controlled and uncontrolled 
transactions. Controlled transactions always remain subject to section 
482 in addition to these generally applicable provisions. These 
temporary regulations clarify the coordination of section 482 and the 
regulations thereunder with such other Code and regulatory provisions.
    The coordination rules in these temporary regulations apply to 
controlled transactions, including controlled transactions that are 
subject in whole or part to both sections 367 and 482. Transfers of 
property subject to section 367 that occur between controlled taxpayers 
require a consistent and coordinated application of sections 367 and 
482 to the controlled transfer of property and any related transactions 
between controlled taxpayers. The controlled transactions may include 
transfers of property subject to section 367(a) or (e), transfers of 
intangible property subject to section 367(d) or (e), and the provision 
of services that contribute significantly to maintaining, exploiting, 
or further developing the transferred properties. All of the 
transactions (and any elements thereof) must be analyzed and valued on 
a consistent basis under section 482 in order to achieve the intended 
purposes of sections 367 and 482.
    The consistent analysis and valuation of transactions subject to 
multiple Code and regulatory provisions is required under the best 
method rule described in Sec.  1.482-1(c). A best method analysis under 
section 482 begins with a consideration of the facts and circumstances 
related to the functions performed, the resources employed, and the 
risks assumed in the actual transaction or transactions among the 
controlled taxpayers, as well as in any uncontrolled transactions used 
as comparables. See Sec.  1.482-1(c)(2)(i) and (d)(3). For example, if 
consideration of the facts and circumstances reveals synergies among 
interrelated transactions, an aggregate evaluation under section 482 
may provide a more reliable measure of an arm's length result than a 
separate evaluation of the transactions. In contrast, an inconsistent 
or uncoordinated application of section 482 to interrelated controlled 
transactions that are subject to tax under different Code and 
regulatory provisions may lead to inappropriate conclusions.
    The best method rule requires a determination of the arm's length 
result of controlled transactions under the method, and particular 
application of that method, that provides the most reliable measure of 
an arm's length result. Under the regulations, the reliability of the 
measure depends on the economics of the controlled transactions, not 
their formal character. See, e.g., Sec. Sec.  1.482-2A(e)(3)(vii) and 
1.482-3(c)(3)(ii)(D) (use of sales agent's commission as comparable for 
reseller's appropriate markup under the resale price method); 
Sec. Sec.  1.482-2A(e)(4)(iv) and 1.482-3(d)(3)(ii)(D) (use of 
purchasing agent's commission as comparable for producer's appropriate 
gross profit percentage under the cost-plus method); and Sec.  1.482-
9(i)(4) and (5), Examples 1 and 3 (reference to charges for transfers 
of property as relevant to the determination of a contingent-payment 
services charge). Realistic alternative transactions that, on a risk-
adjusted basis, reflect arrangements that are economically equivalent 
to those in the controlled transactions may provide the basis for 
application of unspecified methods to determine the most reliable 
measure of an arm's length result in the controlled transactions. See, 
e.g., Sec. Sec.  1.482-1(f)(2)(ii)(A), 1.482-3(e)(1), 1.482-4(d)(1), 
1.482-7(g)(8), and 1.482-9(h). Thus, although a taxpayer may choose 
among different transactional forms--for example, a long-term license, 
research and development services, a cost sharing arrangement, or a 
transfer subject to section 367--specified and unspecified methods 
applicable to each form will provide consistent arm's length results 
for economically equivalent transactions.
    Based upon taxpayer positions that the IRS has encountered in 
examinations and controversy, the Treasury Department and the IRS are 
concerned that certain results reported by taxpayers reflect an 
asserted form or character of the parties' arrangement that involves an 
incomplete assessment of relevant functions, resources, and risks and 
an inappropriately narrow analysis of the scope of the transfer pricing 
rules. In particular, the Treasury Department and the IRS are concerned 
about situations in which controlled groups evaluate economically 
integrated transactions involving economically integrated 
contributions, synergies, and interrelated value on a separate basis in 
a manner that results in a misapplication of the best method rule and 
fails to reflect an arm's length result. Taxpayers may assert that, for 
purposes of section 482, separately evaluating interrelated 
transactions is appropriate simply because different statutes or 
regulations apply to the transactions (for example, where section 367 
and the regulations thereunder apply to one transaction and the general 
recognition rules of the Code apply to another related transaction). 
These positions are often combined with inappropriately narrow 
interpretations of Sec.  1.482-4(b)(6), which provides guidance on when 
an item is considered similar to the other items identified as 
constituting intangibles for purposes of section 482. The 
interpretations purport to have the effect, contrary to the arm's 
length standard, of requiring no compensation for certain value 
provided in controlled transactions despite the fact that compensation 
would be paid if the same value were provided in uncontrolled 
transactions.
    As discussed in the following portion of this preamble, these 
temporary regulations address the aforementioned concerns by clarifying 
the coordination of the application of section 482 in conjunction with 
other Code and regulatory provisions in determining the proper tax 
treatment of controlled transactions.

II. Detailed Explanation of Provisions

A. Compensation Independent of the Form or Character of Controlled 
Transaction--Sec.  1.482-1T(f)(2)(i)(A)

    New Sec.  1.482-1T(f)(2)(i)(A) provides that arm's length 
compensation must be consistent with, and must account for all of, the 
value provided between the parties in a controlled transaction, without 
regard to the form or character of the transaction. For this purpose, 
it is necessary to consider the entire arrangement between the parties, 
as determined by the contractual terms, whether written or imputed in 
accordance with the economic substance of the arrangement, in light of 
the actual conduct of the parties. This requirement is consistent with 
the principles underlying the arm's length standard, which require 
arm's length compensation in controlled transactions equal to the 
compensation that would have occurred if a similar transaction

[[Page 55540]]

had occurred between similarly situated uncontrolled taxpayers. See 
Sec.  1.482-1(b)(1). Accordingly, no inference may be drawn from any 
provision in the section 482 regulations that any transfer of value may 
be made without arm's length compensation.

B. Aggregate or Separate Analysis, Depending on Economic 
Interrelatedness of Controlled Transactions, Including Synergies--Sec.  
1.482-1T(f)(2)(i)(B)

    Section 1.482-1T(f)(2)(i)(B) clarifies Sec.  1.482-1(f)(2)(i)(A), 
which provided that the combined effect of two or more separate 
transactions (whether before, during, or after the year under review) 
may be considered if such transactions, taken as a whole, are so 
interrelated that an aggregate analysis of such transactions provides 
the most reliable measure of an arm's length result determined under 
the best method rule of Sec.  1.482-1(c). Specifically, a new clause is 
added to clarify that this aggregation principle also applies for 
purposes of an analysis under multiple provisions of the Code or 
regulations. In addition, a new sentence elaborates on the aggregation 
principle by noting that consideration of the combined effect of two or 
more transactions may be appropriate to determine whether the overall 
compensation is consistent with the value provided, including any 
synergies among items and services provided. Finally, Sec.  1.482-
1T(f)(2)(i)(B) does not retain the statement in Sec.  1.482-
1(f)(2)(i)(A) that transactions generally will be aggregated only when 
they involve ``related products or services, as defined in Sec.  
1.6038A-3(c)(7)(vii).'' The eliminated sentence had the unintended 
potential to be misconstrued by taxpayers as limiting the aggregation 
analysis pursuant to the best method rule.

C. Aggregation and Allocation for Purposes of Coordinated Analysis 
Under Multiple Code or Regulatory Provisions--Sec. Sec.  1.482-
1T(f)(2)(i)(C) and 1.482-1T(f)(2)(i)(D)

    Section 1.482-1T(f)(2)(i)(C) provides that, for one or more 
controlled transactions governed by more than one provision of the Code 
and regulations, a coordinated best method analysis and evaluation of 
the transactions may be necessary to ensure that the overall value 
provided (including any synergies) is properly taken into account. A 
coordinated best method analysis of the transactions includes a 
consistent consideration of the facts and circumstances of the 
functions performed, resources employed, and risks assumed, and a 
consistent measure of the arm's length results, for purposes of all 
relevant Code and regulatory provisions. For example, situations in 
which a coordinated best method analysis and evaluation may be 
necessary include (1) two or more interrelated transactions when either 
all such transactions are governed by one regulation under section 482 
or all such transactions are governed by one subsection of section 367, 
(2) two or more interrelated transactions governed by two or more 
regulations under section 482, (3) a transfer of property subject to 
section 367(a) and an interrelated transfer of property subject to 
section 367(d), (4) two or more interrelated transactions where section 
367 applies to one transaction and the general recognition rules of the 
Code apply to another interrelated transaction, and (5) other 
circumstances in which controlled transactions require analysis under 
multiple Code and regulatory provisions.
    Section 1.482-1T(f)(2)(i)(D) provides that it may be necessary to 
allocate the arm's length result that was properly determined under a 
coordinated best method analysis described in Sec.  1.482-
1T(f)(2)(i)(C) among the interrelated transactions. Any such allocation 
must be made using the method that, under the facts and circumstances, 
provides the most reliable measure of an arm's length result for each 
allocated amount.

D. Examples of Coordinated Best Method Analysis Under Multiple Code or 
Regulatory Provisions--Sec.  1.482-1T(f)(2)(i)(E)

    Section 1.482-1T(f)(2)(i)(E) provides eleven examples to illustrate 
the guidance in Sec.  1.482-1T(f)(2)(i)(A) through (D). Examples 1 
through 4 are materially the same as the Examples in Sec.  1.482-
1(f)(2)(i)(B). The Treasury Department and the IRS do not intend for 
the revisions to those examples to be interpreted as substantive. The 
rest of the examples are new.
    Section 1.482-1T(f)(2)(ii)(B) replaces Sec.  1.482-1(f)(2)(ii)(B). 
The Example included in Sec.  1.482-1T(f)(2)(ii)(B) is materially the 
same as the old example and has been updated to replace the term 
``district director'' and to include cross-references to Examples 7 and 
8 in Sec.  1.482-1T(f)(2)(i)(E). The Treasury Department and the IRS do 
not intend for the revisions to this example to be interpreted as 
substantive.
    No inference is intended as to the application of the provisions 
amended by these temporary regulations under current law. The IRS may, 
where appropriate, challenge transactions, including those described in 
these temporary regulations and this preamble, under currently 
applicable Code or regulatory provisions or judicial doctrines.

Effective/Applicability Date

    These regulations apply to taxable years ending on or after 
September 14, 2015.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
this regulation. For applicability of the Regulatory Flexibility Act (5 
U.S.C. chapter 6), refer to the cross-referenced notice of proposed 
rulemaking published elsewhere in this issue of the Federal Register. 
Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on their impact on small 
business.

Drafting Information

    The principal author of these regulations is Frank W. Dunham III of 
the Office of the Associate Chief Counsel (International). However, 
other personnel from the Treasury Department and the IRS participated 
in the development of the regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
    Sections 1.482-1 and 1.482-1T are also issued under 26 U.S.C. 
482. * * *


0
Par. 2. Section 1.482-0 is amended by revising the entries for Sec.  
1.482-1(f)(2)(i) and (f)(2)(ii)(B) to read as follows:


Sec.  1.482-0  Outline of regulations under section 482.

* * * * *


Sec.  1.482-1  Allocation of income and deductions among taxpayers.

* * * * *
    (f) * * *

[[Page 55541]]

    (2) * * *
    (i) [Reserved]
    (ii) * * *
    (B) [Reserved]
* * * * *

0
Par. 3. Section 1.482-1 is amended by revising paragraphs (f)(2)(i) and 
(f)(2)(ii)(B) and adding paragraph (j)(7) to read as follows:


Sec.  1.482-1  Allocation of income and deductions among taxpayers.

* * * * *
    (f) * * *
    (2) * * *
    (i)(A) through (E) [Reserved]. For further guidance see Sec.  
1.482-1T(f)(2)(i)(A) through (E).
    (ii) * * *
    (B) [Reserved]. For further guidance see Sec.  1.482-
1T(f)(2)(ii)(B).
* * * * *
    (j) * * *
    (7) [Reserved]. For further guidance see Sec.  1.482-1T(j)(7).

0
 Par. 4. Section 1.482-1T is added to read as follows:


Sec.  1.482-1T  Allocation of income and deductions among taxpayers 
(temporary).

    (a) through (f)(2) [Reserved]. For further guidance see Sec.  
1.482-1(a) through (f)(2).
    (i) Compensation independent of the form or character of controlled 
transaction--(A) In general. All value provided between controlled 
taxpayers in a controlled transaction requires an arm's length amount 
of compensation determined under the best method rule of Sec.  1.482-
1(c). Such amount must be consistent with, and must account for all of, 
the value provided between the parties in the transaction, without 
regard to the form or character of the transaction. For this purpose, 
it is necessary to consider the entire arrangement between the parties, 
as determined by the contractual terms, whether written or imputed in 
accordance with the economic substance of the arrangement, in light of 
the actual conduct of the parties. See, e.g., Sec.  1.482-
1(d)(3)(ii)(B) (identifying contractual terms) and (f)(2)(ii)(A) 
(regarding reference to realistic alternatives).
    (B) Aggregation. The combined effect of two or more separate 
transactions (whether before, during, or after the year under review), 
including for purposes of an analysis under multiple provisions of the 
Code or regulations, may be considered if the transactions, taken as a 
whole, are so interrelated that an aggregate analysis of the 
transactions provides the most reliable measure of an arm's length 
result determined under the best method rule of Sec.  1.482-1(c). 
Whether two or more transactions are evaluated separately or in the 
aggregate depends on the extent to which the transactions are 
economically interrelated and on the relative reliability of the 
measure of an arm's length result provided by an aggregate analysis of 
the transactions as compared to a separate analysis of each 
transaction. For example, consideration of the combined effect of two 
or more transactions may be appropriate to determine whether the 
overall compensation in the transactions is consistent with the value 
provided, including any synergies among items and services provided.
    (C) Coordinated best method analysis and evaluation. Consistent 
with the principles of paragraphs (f)(2)(i)(A) and (B) of this section, 
a coordinated best method analysis and evaluation of two or more 
controlled transactions to which one or more provisions of the Code or 
regulations apply may be necessary to ensure that the overall value 
provided, including any synergies, is properly taken into account. A 
coordinated best method analysis would include a consistent 
consideration of the facts and circumstances of the functions 
performed, resources employed, and risks assumed in the relevant 
transactions, and a consistent measure of the arm's length results, for 
purposes of all relevant statutory and regulatory provisions.
    (D) Allocations of value. In some cases, it may be necessary to 
allocate one or more portions of the arm's length result that was 
properly determined under a coordinated best method analysis described 
in paragraph (f)(2)(i)(C) of this section. Any such allocation of the 
arm's length result determined under the coordinated best method 
analysis must be made using the method that, under the facts and 
circumstances, provides the most reliable measure of an arm's length 
result for each allocated amount. For example, if the full value of 
compensation due in controlled transactions whose tax treatment is 
governed by multiple provisions of the Code or regulations has been 
most reliably determined on an aggregate basis, then that full value 
must be allocated in a manner that provides the most reliable measure 
of each allocated amount.
    (E) Examples. The following examples illustrate the provisions of 
this paragraph (f)(2)(i). For purposes of the examples in this 
paragraph (E), P is a domestic corporation, and S1, S2, and S3 are 
foreign corporations that are wholly owned by P.

    Example 1. Aggregation of interrelated licensing, manufacturing, 
and selling activities. P enters into a license agreement with S1 
that permits S1 to use a proprietary manufacturing process and to 
sell the output from this process throughout a specified region. S1 
uses the manufacturing process and sells its output to S2, which in 
turn resells the output to uncontrolled parties in the specified 
region. In evaluating whether the royalty paid by S1 to P is an 
arm's length amount, it may be appropriate to evaluate the royalty 
in combination with the transfer prices charged by S1 to S2 and the 
aggregate profits earned by S1 and S2 from the use of the 
manufacturing process and the sale to uncontrolled parties of the 
products produced by S1.
    Example 2. Aggregation of interrelated manufacturing, marketing, 
and services activities. S1 is the exclusive Country Z distributor 
of computers manufactured by P. S2 provides marketing services in 
connection with sales of P computers in Country Z and in this regard 
uses significant marketing intangibles provided by P. S3 administers 
the warranty program with respect to P computers in Country Z, 
including maintenance and repair services. In evaluating whether the 
transfer prices paid by S1 to P, the fees paid by S2 to P for the 
use of P marketing intangibles, and the service fees earned by S2 
and S3 are arm's length amounts, it would be appropriate to perform 
an aggregate analysis that considers the combined effects of these 
interrelated transactions if they are most reliably analyzed on an 
aggregated basis.
    Example 3. Aggregation and reliability of comparable 
uncontrolled transactions. The facts are the same as in Example 2. 
In addition, U1, U2, and U3 are uncontrolled taxpayers that carry 
out functions comparable to those of S1, S2, and S3, respectively, 
with respect to computers produced by unrelated manufacturers. R1, 
R2, and R3 constitute a controlled group of taxpayers (unrelated to 
the P controlled group) that carry out functions comparable to those 
of S1, S2, and S3 with respect to computers produced by their common 
parent. Prices charged to uncontrolled customers of the R group 
differ from the prices charged to customers of U1, U2, and U3. In 
determining whether the transactions of U1, U2, and U3, or the 
transactions of R1, R2, and R3, would provide a more reliable 
measure of the arm's length result, it is determined that the 
interrelated R group transactions are more reliable than the wholly 
independent transactions of U1, U2, and U3, given the 
interrelationship of the P group transactions.
    Example 4. Non-aggregation of transactions that are not 
interrelated. P enters into a license agreement with S1 that permits 
S1 to use a proprietary process for manufacturing product X and to 
sell product X to uncontrolled parties throughout a specified 
region. P also sells to S1 product Y, which is manufactured by P in 
the United States and unrelated to product X. Product Y is resold by 
S1 to uncontrolled parties in the specified region. There is no 
connection

[[Page 55542]]

between product X and product Y other than the fact that they are 
both sold in the same specified region. In evaluating whether the 
royalty paid by S1 to P for the use of the manufacturing process for 
product X and the transfer prices charged for unrelated product Y 
are arm's length amounts, it would not be appropriate to consider 
the combined effects of these separate and unrelated transactions.
    Example 5. Aggregation of interrelated patents. P owns 10 
individual patents that, in combination, can be used to manufacture 
and sell a successful product. P anticipates that it could earn 
profits of $25x from the patents based on a discounted cash flow 
analysis that provides a more reliable measure of the value of the 
patents exploited as a bundle rather than separately. P licenses all 
10 patents to S1 to be exploited as a bundle. Evidence of 
uncontrolled licenses of similar individual patents indicates that, 
exploited separately, each license of each patent would warrant a 
price of $1x, implying a total price for the patents of $10x. Under 
paragraph (f)(2)(i)(B) of this section, in determining the arm's 
length royalty for the license of the bundle of patents, it would 
not be appropriate to use the uncontrolled licenses as comparables 
for the license of the bundle of patents, because, unlike the 
discounted cash flow analysis, the uncontrolled licenses considered 
separately do not reliably reflect the enhancement to value 
resulting from the interrelatedness of the 10 patents exploited as a 
bundle.
    Example 6. Consideration of entire arrangement, including 
imputed contractual terms--(i) P conducts a business (``Business'') 
from the United States, with a worldwide clientele, but until Date X 
has no foreign operations. The success of Business significantly 
depends on intangibles (including marketing, manufacturing, 
technological, and goodwill or going concern value intangibles, 
collectively the ``IP''), as well as ongoing support activities 
performed by P (including related research and development, central 
marketing, manufacturing process enhancement, and oversight 
activities, collectively ``Support''), to maintain and improve the 
IP and otherwise maximize the profitability of Business.
    (ii) On Date X, Year 1, P contributes the foreign rights to 
conduct Business, including the foreign rights to the IP, to newly 
incorporated S1. S1, utilizing the IP of which it is now the owner, 
commences foreign operations consisting of local marketing, 
manufacturing, and back office activities in order to conduct and 
expand Business in the foreign market.
    (iii) Later, on Date Y, Year 1, P and S1 enter into a cost 
sharing arrangement (``CSA'') to develop and exploit the rights to 
conduct the Business. Under the CSA, P is entitled to the U.S. 
rights to conduct the Business, and S1 is entitled to the rest-of-
the-world (``ROW'') rights to conduct the Business. P continues 
after Date Y to perform the Support, employing resources, 
capabilities, and rights that as a factual matter were not 
contributed to S1 in the Date X transaction, for the benefit of the 
Business worldwide. Pursuant to the CSA, P and S1 share the costs of 
P's Support in proportion to their reasonably anticipated benefit 
shares from their respective rights to the Business.
    (iv) P treats the Date X transaction as a transfer described in 
section 351 that is subject to 367 and treats the Date Y transaction 
as the commencement of a CSA subject to section 482 and Sec.  1.482-
7. P takes the position that the only platform contribution 
transactions (``PCTs'') in connection with the Date Y CSA consist of 
P's contribution of the U.S. Business IP rights and S1's 
contribution of the ROW Business IP rights of which S1 had become 
the owner on account of the prior Date X transaction.
    (v) Pursuant to paragraph (f)(2)(i)(A) of this section, in 
determining whether an allocation of income is appropriate in Year 1 
or subsequent years, the Commissioner may consider the economic 
substance of the entire arrangement between P and S1, including the 
parties' actual conduct throughout their relationship, regardless of 
the form or character of the contractual arrangement the parties 
have expressly adopted. The Commissioner determines that the 
parties' formal arrangement fails to reflect the full scope of the 
value provided between the parties in accordance with the economic 
substance of their arrangement. Therefore, the Commissioner may 
impute one or more agreements between P and S1, consistent with the 
economic substance of their arrangement, that fully reflect their 
respective reasonably anticipated commitments in terms of functions 
performed, resources employed, and risks assumed over time. For 
example, because P continues after Date Y to perform the Support, 
employing resources, capabilities, and rights not contributed to S1, 
for the benefit of the Business worldwide, the Commissioner may 
impute another PCT on Date Y pursuant to which P commits to so 
continuing the Support. See Sec.  1.482-7(b)(1)(ii). The taxpayer 
may present additional facts that could indicate whether this or 
another alternative agreement best reflects the economic substance 
of the underlying transactions and course of conduct, provided that 
the taxpayer's position fully reflects the value of the entire 
arrangement consistent with the realistic alternatives principle.
    Example 7. Distinguishing provision of value from 
characterization--(i) P developed a collection of resources, 
capabilities, and rights (``Collection'') that it uses on an 
interrelated basis in ongoing research and development of computer 
code that is used to create a successful line of software products. 
P can continue to use the Collection on such interrelated basis in 
the future to further develop computer code and, thus, further build 
on its successful line of software products. Under Sec.  1.482-
7(g)(2)(ix), P determines that the interquartile range of the net 
present value of its own use of the Collection in future research 
and development and software product marketing is between $1000x and 
$1100x, and this range provides the most reliable measure of the 
value to P of continuing to use the Collection on an interrelated 
basis in future research, development, and exploitation. Instead, P 
enters into an exchange described in section 351 in which it 
transfers certain intangible property related to the Collection to 
S1 for use in future research, development, and exploitation but 
continues to perform the same development functions that it did 
prior to the exchange, now on behalf of S1, under express or implied 
commitments in connection with S1's use of the intangible property. 
P takes the position that a portion of the Collection, consisting of 
computer code and related instruction manuals and similar intangible 
property (Portion 1), was transferrable intangible property and was 
the subject of the section 351 exchange and compensable under 
section 367(d). P claims that another portion of the Collection 
consists of items that either do not constitute property for 
purposes of section 367 or are not transferrable (Portion 2). P then 
takes the position that the value of Portion 2 does not give rise to 
income under section 367(d) or gain under section 367(a).
    (ii) Under paragraphs (f)(2)(i)(A) and (C) of this section, any 
part of the value in Portion 2 that is not taken into account in an 
exchange under section 367 must nonetheless be evaluated under 
section 482 and the regulations thereunder to determine arm's length 
compensation for any value provided to S1. Accordingly, even if P's 
assertion that certain items were either not property or not capable 
of being transferred were correct, arm's length compensation is 
nonetheless required for all of the value associated with P's 
contributions under the section 482 regulations. Alternatively, the 
Commissioner may determine under all the facts and circumstances 
that P's assertion is incorrect and that the transaction in fact 
constitutes an exchange of property subject to, and therefore to be 
taken into account under, section 367. Thus, whether any item that P 
identifies as being within Portion 2 is properly characterized as 
property under section 367 (transferable or otherwise) is irrelevant 
because any value in Portion 2 that is provided to S1 must be 
compensated by S1 in a manner consistent with the $1000x to $1100x 
interquartile range of the overall value.
    Example 8. Arm's length compensation for equivalent provisions 
of intangibles under sections 351 and 482. P owns the worldwide 
rights to manufacturing and marketing intangibles that it uses to 
manufacture and market a product in the United States (``US 
intangibles'') and the rest of the world (``ROW intangibles''). P 
transfers all the ROW intangibles to S1 in an exchange described in 
section 351 and retains the US intangibles. Immediately after the 
exchange, P and S1 entered into a CSA described in Sec.  1.482-7(b) 
that covers all research and development of intangibles conducted by 
the parties. A realistic alternative that was available to P and 
that would have involved the controlled parties performing similar 
functions, employing similar resources, and assuming similar risks 
as in the controlled transaction, was to transfer all ROW 
intangibles to S1 upon entering into the CSA in a platform 
contribution transaction described in Sec.  1.482-7(c), rather than 
in an exchange described in section 351 immediately before entering 
into the CSA. Under paragraph (f)(2)(i)(A) of this section, the 
arm's length compensation for the ROW intangibles must

[[Page 55543]]

correspond to the value provided between the parties, regardless of 
the form of the transaction. Accordingly, the arm's length 
compensation for the ROW intangibles is the same in both scenarios, 
and the analysis of the amount to be taken into account under 
section 367(d) pursuant to Sec. Sec.  1.367(d)-1T(c) and 1.482-4 
should include consideration of the amount that P would have charged 
for the realistic alternative determined under Sec.  1.482-7(g) (and 
Sec.  1.482-4, to the extent of any make-or-sell rights 
transferred). See Sec. Sec.  1.482-1(b)(2)(iii) and 1.482-4(g).
    Example 9. Aggregation of interrelated manufacturing and 
marketing intangibles governed by different statutes and 
regulations. The facts are the same as in Example 8 except that P 
transfers only the ROW intangibles related to manufacturing to S1 in 
an exchange described in section 351 and, upon entering into the 
CSA, then transfers the ROW intangibles related to marketing to S1 
in a platform contribution transaction described in Sec.  1.482-7(c) 
(rather than transferring all ROW intangibles only upon entering 
into the CSA or only in a prior exchange described in section 351). 
The value of the ROW intangibles that P transferred in the two 
transactions is greater in the aggregate, due to synergies among the 
different types of ROW intangibles, than if valued as two separate 
transactions. Under paragraph (f)(2)(i)(B) of this section, the 
arm's length standard requires these synergies to be taken into 
account in determining the arm's length results for the 
transactions.
    Example 10. Services provided using intangibles.--(i) P's 
worldwide group produces and markets Product X and subsequent 
generations of products, which result from research and development 
performed by P's R&D Team. Through this collaboration with respect 
to P's proprietary products, the members of the R&D Team have 
individually and as a group acquired specialized knowledge and 
expertise subject to non-disclosure agreements (collectively, 
``knowhow'').
    (ii) P arranges for the R&D Team to provide research and 
development services to create a new line of products, building on 
the Product X platform, to be owned and exploited by S1 in the 
overseas market. P asserts that the arm's length charge for the 
services is only reimbursement to P of its associated R&D Team 
compensation costs.
    (iii) Even though P did not transfer the platform or the R&D 
Team to S1, P is providing value associated with the use of the 
platform, along with the value associated with the use of the 
knowhow, to S1 by way of the services performed by the R&D Team for 
S1 using the platform and the knowhow. The R&D Team's use of 
intangible property, and any other valuable resources, in P's 
provision of services (regardless of whether the service effects a 
transfer of intangible property or valuable resources and regardless 
of whether the property is relatively high or low value) must be 
evaluated under the section 482 regulations, including the 
regulations specifically applicable to controlled services 
transactions in Sec.  1.482-9, to ensure that P receives arm's 
length compensation for any value (attributable to such property or 
services) provided to S1 in a controlled transaction. See Sec. Sec.  
1.482-4 and 1.482-9(m). Under paragraph (f)(2)(i)(A) of this 
section, the arm's length compensation for the services performed by 
the R&D Team for S1 must be consistent with the value provided to 
S1, including the value of the knowhow and any synergies with the 
platform. Under paragraphs (f)(2)(i)(B) and (C) of this section, the 
best method analysis may determine that the compensation is most 
reliably determined on an aggregate basis reflecting the 
interrelated value of the services and embedded value of the 
platform and knowhow.
    (iv) In the alternative, the facts are the same as above, except 
that P assigns to S1 all or a pertinent portion of the R&D Team and 
the relevant rights in the platform. P takes the position that, 
although the transferred platform rights must be compensated, the 
knowhow does not have substantial value independent of the services 
of any individual on the R&D Team and therefore is not an intangible 
within the meaning of Sec.  1.482-4(b). In P's view, S1 owes no 
compensation to P on account of the R&D Team, as S1 will directly 
bear the cost of the relevant R&D Team compensation. However, in 
assembling and arranging to assign the relevant R&D Team, and 
thereby making available the value of the knowhow to S1, rather than 
other employees without the knowhow, P is performing services for S1 
under imputed contractual terms based on the parties' course of 
conduct. Therefore, even if P's position were correct that the 
knowhow is not an intangible under Sec.  1.482-4(b), a position that 
the Commissioner may challenge, arm's length compensation is 
required for all of the value that P provides to S1 through the 
interrelated provision of platform rights, knowhow, and services 
under paragraphs (f)(2)(i)(A), (B), and (C) of this section.
    Example 11. Allocating arm's length compensation determined 
under an aggregate analysis--(i) P provides services to S1, which is 
incorporated in Country A. In connection with those services, P 
licenses intellectual property to S2, which is incorporated in 
Country B. S2 sublicenses the intellectual property to S1.
    (ii) Under paragraph (f)(2)(i)(B) of this section, if an 
aggregate analysis of the service and license transactions provides 
the most reliable measure of an arm's length result, then an 
aggregate analysis must be performed. Under paragraph (f)(2)(i)(D) 
of this section, if an allocation of the value that results from 
such an aggregate analysis is necessary, for example, for purposes 
of sourcing the services income that P receives from S1 or 
determining deductible expenses incurred by S1, then the value 
determined under the aggregate analysis must be allocated using the 
method that provides the most reliable measure of the services 
income and deductible expenses.

    (ii)(A) [Reserved]. For further guidance see Sec.  1.482-
1(f)(2)(ii)(A).
    (B) Example. The following example illustrates this paragraph 
(f)(2)(ii):

    Example. P and S are controlled taxpayers. P licenses a 
proprietary process to S for S's use in manufacturing product X. 
Using its sales and marketing employees, S sells product X to 
related and unrelated customers outside the United States. If the 
license between P and S has economic substance, the Commissioner 
ordinarily will not restructure the taxpayer's transaction to treat 
P as if it had elected to exploit directly the manufacturing 
process. However, because P could have directly exploited the 
manufacturing process and manufactured product X itself, this 
realistic alternative may be taken into account under Sec.  1.482-
4(d) in determining the arm's length consideration for the 
controlled transaction. For examples of such an analysis, see 
Examples 7 and 8 in paragraph (f)(2)(i)(E) of this section and the 
Example in Sec.  1.482-4(d)(2).

    (iii) through (j)(6) [Reserved]. For further guidance see Sec.  
1.482-1(f)(2)(iii) through (j)(6).
    (7) Certain effective/applicability dates--(i) Paragraphs 
(f)(2)(i)(A) through (E) and (f)(2)(ii)(B) of this section apply to 
taxable years ending on or after September 14, 2015.
    (ii) Expiration date. The applicability of paragraphs (f)(2)(i)(A) 
through (E) and (f)(2)(ii)(B) of this section expires on or before 
September 14, 2018.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: September 10, 2015.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2015-23278 Filed 9-14-15; 11:15 am]
 BILLING CODE 4830-01-P