IT Group Urges Withdrawal of Proposed Cost Sharing Regs

From: postoffice@www.qai.irs.gov

Dear Sir or Madam:

[1] On behalf of the Information Technology Industry Council (ITI), I appreciate the opportunity to supplement our initial comments (filed electronically on October 28, 2002), in response to the Notice of Proposed Rulemaking published in the Federal Register on July 29, 2002 (67 Fed. Reg. 48997). The rulemaking addresses the treatment of stock-based compensation for purposes of the rules governing qualified cost sharing arrangements, and for purposes of the comparability factors to be considered under the comparable profits method (the proposed regulations). ITI has serious concerns regarding this proposal.

[2] In our view, the proposed regulations represent a significant departure from the arm's length principle that is used by the United States and many of our trading partners to determine the price of transactions of related foreign entities. The proposal arbitrarily requires related parties to share stock-based compensation costs, even though the Internal Revenue Service (IRS) itself has been unable to find factual evidence that this occurs in cost sharing arrangements between unrelated parties. The result mandated by the proposed regulations ignores the reality that taxpayers regularly enter into cost-sharing arrangements with unrelated parties without sharing stock-based compensation costs.

[3] We are not aware of any instance where any ITI member entered into a cost sharing arrangement with an unrelated party and treated stock options as a shared cost. In fact, the IRS was unable to establish a factual basis for the result that the proposed regulations would require. As such, the proposed regulation's treatment of stock-based compensation as a shared cost is inconsistent with longstanding practice among uncontrolled parties.

[4] In addition, a central tenet of U.S. tax treaty policy is that the results that would have been obtained in unrelated party situations should govern the tax results between related parties. In this regard, the Technical Explanation of Article 9 of the 1996 U.S. Model tax treaty includes the statement that it incorporates the arm's-length principle reflected in the U.S. domestic transfer pricing provisions, particularly Code section 482. We are concerned that any deviation from the arm's-length standard would weaken the U.S. tax treaty network.

[5] The proposed regulations represent a unilateral revision by the United States of the arm's-length standard for cost sharing arrangements, and there is no reason to expect that our treaty partners would accept the proposed treatment of stock-based compensation expenses. For these and other reasons, we urge that the proposal be withdrawn.

[6] We appreciate the opportunity to submit these comments. A hard copy will follow via U.S. Mail.