Transfer Pricing Insider
Volume: 3 Number: 2
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COST SHARING ARRANGEMENTS ARE LESS ATTRACTIVE UNDER NEW REGULATIONS
Source: Baker & McKenzie North America Transfer Pricing Group
The Temporary Regulations are conceptually based on the IRS’s “investor model” introduced in the 2005 Proposed Regulations. Under the investor model, the participants in a CSA are considered to make cost contributions (shares of ongoing R&D costs) and “platform contributions” (existing intangible property and other resources, capabilities, and rights) to the CSA to achieve an anticipated return on those contributions appropriate to the risk of the CSA and the exploitation of the intangibles resulting from the CSA . Valuations of these contributions are to be made based on the forecasted revenues and costs of the CSA at the outset of the CSA . Under the investor model, a participant making cost contributions, but no platform contributions, is generally limited to a fixed financial return and receives no share of the residual profits attributable to the intangible property resulting from the arrangement. Instead, the residual profits are allocated entirely to the parties making platform contributions.
Like the 2005 Proposed Regulations, the Temporary Regulations characterize a participant’s commitment of an assembled expert R&D team to a CSA as a platform contribution and require the other participants in the CSA to compensate the contributing participant for that contribution. Thus, the participant actually performing the R&D services under the CSA may effectively be required to earn not simply a reimbursement of its costs but also a profit markup on those costs or a share of the residual non-routine profits of the CSA . Temp. Reg. 1.482-7T(c)(5), Example 2.
The Temporary Regulations, like the 2005 Proposed Regulations, permit the IRS (but not the taxpayer) to make periodic adjustments to the compensation received by the participants making platform contributions if actual results differ substantially from forecasted results. The Temporary Regulations allow the IRS to make periodic adjustments using a variation on the Residual Profit-Split Method (RPS M) whereby a party making no platform contributions generally will be limited to a financial return and, if the actual results exceed the forecasted results, will not participate in the unanticipated profits of the CSA . Moreover, the Temporary Regulations significantly narrow the range of deviation from forecasted results permitted before periodic adjustments are imposed. Temp. Reg. 1.482-7T(i)(6).
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