Multiple Reasonably Anticipated Benefit Shares May Coexist

Third Party Communication: None
Date of Communication: Not Applicable

UILC: 482.11-08, 482.11-10, 482.11-12
Release Date: 8/3/2018

Date: July 26, 2018

CC:INTL - POSTN-119796-18

to:
Jennifer Best
Director, Treaty and Transfer Pricing Operations
(Large Business & International)

from:
Marjorie Rollinson
Associate Chief Counsel
(International)

Kenneth Wood
Deputy Associate Chief Counsel
(International)

subject:
Multiple RAB Shares and Subsequent PCTs

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

ISSUES

CONCLUSIONS

FACTS

You requested legal advice regarding the recurring issue of whether the cost sharing regulations in § 1.482-7 prohibit the use of multiple RAB shares within a single CSA. Your request arose specifically in response to a case in which a taxpayer determined an arm's length price for a subsequent PCT¹ that was a different percentage (of an acquisition price) than the RAB share used to determine current CSTs.

LAW AND ANALYSIS

I. The cost sharing regulations — RAB Shares and PCTs

Under a CSA, cost sharing participants share the costs and risks of developing intangibles by engaging in CSTs, resulting in CST Payments that are required to be determined by reference to RAB shares. Treas. Reg. § 1.482-7(a)(1), (b) (first sentence), and (g)(1). For this purpose, “reasonably anticipated benefits” are defined as:

the benefits that reasonably may be anticipated to be derived from exploiting cost shared intangibles. For purposes of this definition, benefits mean the sum of additional revenue generated, plus cost savings, minus any cost increases from exploiting cost shared intangibles.

Treas. Reg. § 1.482-7(j)(1)(i).

“RAB share” is defined as follows:

A controlled participant's share of reasonably anticipated benefits is equal to its reasonably anticipated benefits divided by the sum of the reasonably anticipated benefits, as defined in paragraph (j)(1)(i) of this section, of all the controlled participants. RAB shares must be updated to account for changes in economic conditions, the business operations and practices of the participants, and the ongoing development of intangibles under the CSA. For purposes of determining RAB shares at any given time, reasonably anticipated benefits must be estimated over the entire period, past and future, of exploitation of the cost shared intangibles, and must reflect appropriate updates to take into account the most reliable data regarding past and projected future results available at such time. RAB shares determined for a particular purpose shall not be further updated for that purpose based on information not available at the time that determination needed to be made. For example, RAB shares determined in order to determine IDC shares for a particular taxable year (as set forth in paragraphs (b)(1)(i) and (d)(4) of this section) shall not be recomputed based on information not available at that time. Similarly, RAB shares determined for the purpose of using a particular method such as the acquisition price method (as set forth in paragraph (g)(5)(ii) of this section) to evaluate the arm's length amount charged in a PCT shall not be recomputed based on information not available at the date of that PCT. However, nothing in this paragraph (e)(1)(i) shall limit the Commissioner's use of subsequently available information for purposes of its allocation determinations in accordance with the provisions of paragraph (i) (Allocations by the Commissioner in connection with a CSA) of this section.

Treas. Reg. § 1.482-7(e)(1)(i).

The regulations further explain:

A controlled participant's RAB share must be determined by using the most reliable estimate. In determining which of two or more available estimates is most reliable, the quality of the data and assumptions used in the analysis must be taken into account, consistent with § 1.482-1(c)(2)(ii) (Data and assumptions). Thus, the reliability of an estimate will depend largely on the completeness and accuracy of the data, the soundness of the assumptions, and the relative effects of particular deficiencies in data or assumptions on different estimates. If two estimates are equally reliable, no adjustment should be made based on differences between the estimates. The following factors will be particularly relevant in determining the reliability of an estimate of RAB shares:

(A) The basis used for measuring benefits, as described in paragraph (e)(2)(ii) of this section.

(B) The projections used to estimate benefits, as described in paragraph (e)(2)(iii) of this section.

Treas. Reg. § 1.482-7(e)(1)(ii).

For this purpose, RAB “must be measured on a basis that is consistent for all” cost sharing participants. Treas. Reg. § 1.482-7(e)(2)(i). Such basis may be either “direct” or “indirect.” Id. Examples of indirect bases include, but are not limited to, (1) units used, produced, or sold; (2) sales; and (3) operating profit. Treas. Reg. § 1.482-7(e)(2)(ii).

Units used, produced or sold will generally provide a more reliable measure of anticipated benefit to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to the covered intangibles per unit of the item or items used, produced, or sold. Similarly, sales by each controlled participant in the business activities in which covered intangibles are exploited will generally provide a more reliable measure to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to covered intangibles per dollar of sales. Further, operating profit of each controlled participant from the activities in which covered intangibles are exploited will generally provide a more reliable measure to the extent that such profit is largely attributable to the use of covered intangibles, or if the share of profits attributable to the use of covered intangibles is expected to be similar for each controlled participant.

Other bases for measuring anticipated benefits may, in some circumstances, be appropriate, but only to the extent that there is expected to be a reasonably identifiable relationship between the basis of measurement used and additional income generated or costs saved by the use of covered intangibles. The regulations do not describe direct bases for measuring RAB.

RAB shares are, inherently, a forward-looking, projections-based concept:

Treas. Reg. § 1.482-7(e)(2)(iii)(A).

If a controlled participant makes a platform contribution to a CSA, arm's length compensation must be paid to that controlled participant. The regulations define “platform contribution” as follows:

A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity (whether prior to or during the course of the CSA) that is reasonably anticipated to contribute to developing cost shared intangibles. The determination whether a resource, capability, or right is reasonably anticipated to contribute to developing cost shared intangibles is ongoing and based on the best available information. Therefore, a resource, capability, or right reasonably determined not to be a platform contribution as of an earlier point in time, may be reasonably determined to be a platform contribution at a later point in time. The PCT obligation regarding a resource or capability or right once determined to be a platform contribution does not terminate merely because it may later be determined that such resource or capability or right has not contributed, and no longer is reasonably anticipated to contribute, to developing cost shared intangibles. Notwithstanding the other provisions of this paragraph (c), platform contributions do not include rights in land or depreciable tangible property, and do not include rights in other resources acquired by IDCs. See paragraph (d)(1) of this section.

Treas. Reg. § 1.482-7(c)(1).

The arm's length amount due for PCTs is “determined under the method or methods applicable under the other section or sections of the section 482 regulations, as supplemented by paragraph (g) of this section.” Treas. Reg. § 1.482-7(a)(2). CSA participants “must enter into a PCT as of the earliest date on or after the CSA is entered into on which a platform contribution is reasonably anticipated to contribute to developing cost shared intangibles.” Treas. Reg. § 1.482-7(b)(3). Treas. Reg. § 1.482-7(g) provides guidance regarding transfer pricing methods applicable to PCTs. Each such method

Treas. Reg. § 1.482-7(g)(1).

Cost sharing participants generally may choose the form of PCT Payments as fixed (including spread over a period of time), contingent, or a combination of both, “provided that such form and period of payment are consistent with an arm's length charge as of the date of the PCT.” Treas. Reg. § 1.482-7(h)(2)(i).

The regulations contain specific guidance with respect to PCTs that occur after a CSA has gone into effect (“subsequent PCTs”):

The date of a PCT may occur subsequent to the inception of the CSA. For example, an intangible initially developed outside the IDA may only subsequently become a platform contribution because that later time is the earliest date on which it is reasonably anticipated to contribute to developing cost shared intangibles within the IDA. In such case, the date of the PCT, and the analysis of the arm's length amount charged in the subsequent PCT, is as of such later time.

Treas. Reg. § 1.482-7(g)(2)(viii)(A). For this purpose,

the determination of the arm's length amount charged, respectively, in the prior and subsequent PCTs must be coordinated in a manner that provides the most reliable measure of an arm's length result.

In some circumstances, a subsequent PCT may be reliably evaluated independently of other PCTs, as may be possible for example, under the acquisition price method. In other circumstances, the results of prior and subsequent PCTs may be interrelated and so a subsequent PCT may be most reliably evaluated under the residual profit split method of paragraph (g)(7) of this section.

Treas. Reg. § 1.482-7(g)(2)(viii)(B).

II. Discussion

A. Issue 1

As the name suggests, RAB shares are based on future benefits expected to result from the activity of developing and exploiting cost shared intangibles (“CSA Activity”). Treas. Reg. § 1.482-7(e)(1)(i) and (j)(1)(i). For this purpose, future benefits “must be estimated over the entire period, past and future, of exploitation of the cost shared intangibles and must reflect appropriate updates to take into account the most reliable data regarding past and projected future results available at such time.” Treas. Reg. § 1.482-7(e)(1)(i). Accordingly, when controlled participants determine their RAB shares upon the formation of a CSA, they must estimate their RAB into the future over the entire expected duration of the CSA Activity (i.e., the period of developing and exploiting cost shared intangibles) and they must periodically review and update those RAB shares to reflect new information, changing conditions, and actual past results. Such updates by controlled participants apply prospectively. Treas. Reg. § 1.482-7(e)(1)(i).²

A controlled participant's RAB share must be determined by using the most reliable estimate of RAB. Treas. Reg. § 1.482-7(e)(1)(ii). This rule is consistent with the arm's length standard, which requires use of the best method — “the method that, under the facts and circumstances, provides the most reliable measure of an arm's length result.” Treas. Reg. § 1.482-1(c)(1). Whether that requires the use of a single RAB share for all costs covered by a single CSA, or instead requires two or more RAB shares applicable to two or more discrete cost pools covered by a single CSA, will depend on the facts and circumstances. Specifically, there should be a single RAB share if RAB are most reliably estimated on the basis of a single RAB share, and there should be two or more RAB shares if RAB are most reliably estimated with respect to separate cost pools (and their associated platform contributions) on different bases. Accordingly, the Internal Revenue Service may determine in a particular situation that a taxpayer that used a single RAB share for all costs under a single CSA should have used more than one RAB share for separate cost pools, and may determine in another situation that a taxpayer that used more than one RAB share for separate cost pools under a single CSA should have used a single RAB share for those pools collectively.

B. Issue 2

The regulations regarding subsequent PCTs explain that whether a subsequent PCT should be evaluated separately or in combination with prior PCTs depends on which approach provides the most reliable measure of an arm's length result. Treas. Reg. § 1.482-7(g)(2)(viii)(B). That guidance does not specifically address the inter-relationship of RAB shares and subsequent PCTs.

When a platform contribution is made to an existing CSA (for example, intangible property is acquired by a controlled participant after the inception of the CSA and is required to be contributed in a PCT to the CSA for further development), an arm's length amount must be paid to the contributing controlled participant by the other controlled participant(s). The platform contribution may relate to the current CSA Activity or expand the scope of that activity. The RAB expected to be derived from the platform contribution may come from existing product lines covered by the current CSA Activity, or from new product lines that do not currently exist (in which case there would be no correlation between existing RAB shares and the arm's length price for the subsequent PCT), or both. Accordingly, a separate determination must be made in each case as to whether the method used to determine the arm's length amount to be paid for a subsequent PCT should take into account the method used to determine current RAB shares. In addition, after a subsequent PCT has been entered into, the determination of appropriate RAB shares for intangible development costs that will be incurred going forward must be determined for the IDA connected with each PCT upon which a separate RAB share was determined. As in the case of Issue 1, above, a key consideration is whether the use of one (or more) RAB shares within a single CSA will provide a more (or less) reliable result under the facts and circumstances.

III. Illustrative examples

Please call Matthew A. Nieters of the Office of Associate Chief Counsel (International) at (202) 317-6939 if you have any further questions.

By: Marjorie Rollinson
Associate Chief Counsel (International)