Bulletin No. 2009-7February 17, 2009

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

T.D. 9441, page 460.REG–144615–02, page 561.Final, temporary, and proposed regulations under section 482of the Code provide guidance with respect to the sharing ofcosts and risks under cost sharing arrangements. The reg-ulations replace the existing guidance under regulations sec-tion 1.482–7 to provide clarification and additional guidanceregarding the scope and valuation of the external inputs forwhich arm’s length consideration must be provided as an entrycondition into cost sharing (“buy-ins” under former regulationssection 1.482–7), as well as to address other technical andprocedural issues that have arisen in the course of administer-ing the cost sharing rules. A public hearing on the proposedregulations is scheduled for April 21, 2009.

Notice 2009–14, page 516.Section 382. This notice provides additional guidance regard-ing the application of section 382 treatment of interest in a losscorporation acquired by the federal government pursuant to theEmergency Economic Stabilization Act of 2008 (EESA). Notice2008–100 amplified and superseded.

Rev. Proc. 2009–17, page 517.Substitute tax forms and schedules. Requirements are setforth for privately designed and printed federal tax forms andconditions under which the Service will accept computer pre-pared and computer-generated tax forms and schedules. Rev.Proc. 2007–68 superseded.

Finding Lists begin on page ii.

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February 17, 2009 2009–7 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 482.—Allocationof Income and DeductionsAmong Taxpayers26 CFR 1.482–7: Methods to determine taxable in-come in connection with a cost sharing arrangement.

T.D. 9441

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 1, 301, and 602

Section 482: Methods toDetermine Taxable Incomein Connection With a CostSharing Arrangement

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final and temporary regula-tions.

SUMMARY: This document containstemporary regulations that provide furtherguidance and clarification regarding meth-ods under section 482 to determine taxableincome in connection with a cost sharingarrangement in order to address issues thathave arisen in administering the currentregulations. The temporary regulationsaffect domestic and foreign entities thatenter into cost sharing arrangements de-scribed in the temporary regulations. Thetext of these temporary regulations alsoserves as the text of the proposed regula-tions (REG–144615–02) set forth in thisissue of the Bulletin.

DATES: Effective Date: These regulationsare effective on January 5, 2009.

Applicability Date: For dates ofapplicability, see §§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), and1.301–7701–1(f).

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

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These temporary regulations are beingissued without prior notice and public pro-cedure pursuant to the Administrative Pro-cedure Act (5 U.S.C. 553). For this reason,the collection of information contained inthese regulations has been reviewed andpending receipt and valuation of publiccomments, approved by the Office of Man-agement and Budget under control number1545–1364.

The collections of information inthese temporary regulations are in§1.482–7T(b)(2) and (k). Responses tothe collections of information are requiredby the IRS to monitor compliance ofcontrolled taxpayers with the provisionsapplicable to cost sharing arrangements.

An agency may not conduct or sponsor,and a person is not required to respondto, a collection of information unless thecollection of information displays a validcontrol number assigned by the Office ofManagement and Budget.

Books or records relating to a collectionof information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as requiredby 26 U.S.C. 6103.

Background

A notice of proposed rulemaking andnotice of public hearing regarding addi-tional guidance to improve compliancewith, and administration of, the rules inconnection with a cost sharing arrange-ment (CSA) were published in the FederalRegister (REG–144615–02, 2005–2 C.B.625 [70 FR 51116]) on (REG–144615–02)August 29, 2005 (the 2005 proposed reg-ulations). A correction to the notice ofproposed rulemaking and notice of pub-lic hearing was published in the FederalRegister (70 FR 56611) on September28, 2005. A public hearing was held onDecember 16, 2005.

The Treasury Department and the IRSreceived substantial comments on a widerange of issues addressed in the 2005 pro-

posed regulations. In response to thesecomments, these temporary regulationsmake several significant changes to therules of the 2005 proposed regulations.The temporary regulations are generallyapplicable for CSAs commencing on orafter January 5, 2009, with transitionrules for certain preexisting arrangements.These regulations are being issued intemporary and proposed form so that tax-payers and the IRS may apply the newcost sharing rules while maintaining theopportunity for further input and refine-ments before the issuance of final rules.

Explanation of Provisions

A. Overview

The temporary regulations generallyprovide guidance regarding the applica-tion of section 482 and the arm’s lengthmethod to cost sharing arrangements.Several comments on the proposed regu-lations questioned whether and how theproposed regulations conform to the arm’slength standard, as well as its corollary,the commensurate with income (CWI)requirement added by the Tax ReformAct of 1986. In response, the temporaryregulations provide further guidance onthe evaluation of the arm’s length resultsof cost sharing transactions (CSTs) andplatform contribution transactions (PCTs).The regulations address the material func-tional and risk allocations in the contextof a CSA, including the reasonably antic-ipated duration of the commitments, theintended scope of the intangible develop-ment, the degree and uncertainty of profitpotential of the intangibles to be devel-oped, and the extent of platform and othercontributions of resources, capabilities,and rights to the development and ex-ploitation of cost shared intangibles (CSAActivity).

Under the temporary regulations, ifavailable data of uncontrolled transactionsreflect, or may be reliably adjusted to re-flect, similar facts and circumstances to aCSA, they may be the basis for applicationof a comparable uncontrolled transactionmethod to value the CST and PCT re-sults. Because of the difficulty of findingdata that reliably reflects such facts and

2009–7 I.R.B. 460 February 17, 2009

circumstances (even after adjustments),the temporary regulations also provide forother methods. These include the newlyspecified income, acquisition price, mar-ket capitalization, and residual profit splitmethods. The temporary regulations alsomake related changes to other sections ofthe regulations, including Temp. Treas.Reg. §§1.482–1T, 1.482–4T, 1.482–8T,and 1.482–9T, and Treas. Reg. §1.6662–6.

B. Flexibility and Scope of CSA Coverage

Commentators criticized the 2005 pro-posed regulations for lack of flexibilityconcerning the types and provisions ofarrangements eligible for CSA treatment.Some comments also addressed non-con-forming intangible development arrange-ments that would not be treated as CSAs.

In response to these comments, the tem-porary regulations provide taxpayers withgreater flexibility in designing certain as-pects of CSAs. The temporary regulationsalso address the treatment of non-conform-ing intangible development arrangements.

1. Intangible Development Arrangementsother than CSAs — Temp. Treas.Reg. §§1.482–1T(b)(2)(i) and (iii),1.482–4T(g), 1.482–7T(b)(5), and1.482–9T(m)(3)

The 2005 proposed regulations definedthe contractual terms, risk allocations,and other material provisions of a CSAcovered by the cost sharing rules. Whileother intangible development arrange-ments might be referred to colloquially ascost sharing arrangements, they were notto be treated as CSAs by the 2005 pro-posed regulations unless either a taxpayersubstantially complied with the CSA ad-ministrative requirements and reasonablyconcluded that its arrangement was a CSA,or a taxpayer substantially complied withthe CSA administrative requirements andthe Commissioner determined to apply theCSA rules to the arrangement.

Commentators suggested broadeningthe scope of intangible development ar-rangements that meet the CSA definition.Some commentators urged the regulationsnot to define CSA terms and conditions butto extend CSA treatment to any arrange-ment that uncontrolled parties might calla cost sharing arrangement, even thoughsuch arrangement may involve materiallydifferent risk allocations and provisions

than addressed in the cost sharing rules.Still other commentators, while accept-ing that the regulations should define thescope of arrangements treated under thecost sharing rules, suggested that non-con-forming arrangements would be subjectonly to the general principles of Treas.Reg. §1.482–1 and would not be gov-erned by the sections of the regulationsaddressed to specific transactional types.Some commentators also expressed con-cern that the Commissioner might treata non-conforming arrangement as a CSAeven in a situation where that result wasnot warranted.

Because the cost sharing rules are de-signed to provide guidance for specifictypes of transactions and arrangements, theTreasury Department and the IRS continueto believe that the new rules set forth forCSAs should apply only to the transac-tions intended. From the standpoint ofthe purpose of the cost sharing rules andtheir administrability, it is important thatthe rules be applicable only to the definedscope of intangible development arrange-ments and apply no more broadly or nar-rowly than intended. In recognition of tax-payer concerns, however, the temporaryregulations seek to provide taxpayers withgreater flexibility and scope in the typesand provisions of arrangements that mayqualify as CSAs.

Under Treas. Reg. §1.482–1(b)(2)(ii)(Selection of category of method appli-cable to transaction), non-conformingarrangements are governed by methodsprovided in other sections of the regu-lations under section 482, as applied inaccordance with Treas. Reg. §1.482–1.See also Treas. Reg. §§1.482–2(d),3(a), and 4(a), and Temp. Treas. Reg.§1.482–9T(a). Thus, intangible devel-opment arrangements, including partner-ships, outside the scope of the cost sharingrules are governed by the transfer of in-tangible rules of Treas. Reg. §1.482–4(a),or the controlled services provisions ofTemp. Treas. Reg. §1.482–9T, as ap-propriate. The temporary regulationsmake clarifying amendments to Temp.Treas. Reg. §§1.482–1T(b)(2)(i) and(iii), 1.482–4T(g), and 1.482–9T(m)(3).These amendments confirm that Treas.Reg. §1.482–1 provides principles, notmethods. For methods, reference must bemade to the other sections of the regula-tions under section 482. While treatment

of a CSA is governed by Temp. Treas.Reg. §1.482–7T, Temp. Treas. Reg.§§1.482–4T(g) and 1.482–9T(m)(3), asappropriate, govern intangible develop-ment arrangements other than CSAs,including partnerships.

Nevertheless, the methods and bestmethod considerations under the cost shar-ing rules may be adapted for purposes ofthe evaluation of non-conforming intan-gible development arrangements. Impor-tantly, the temporary regulations providethat the analysis under the intangible trans-fer or controlled services provisions, asapplicable, should take into account theprinciples, methods, comparability, and re-liability considerations set forth in Temp.Treas. Reg. §1.482–7T in determining thebest method for purposes of those provi-sions, including an unspecified method,as those methods and considerations maybe appropriately adjusted in light of thedifferences in the facts and circumstancesbetween the non-conforming arrangementand a CSA.

Finally, Temp. Treas. Reg.§1.482–7(b)(5) clarifies the circumstancesunder which the Commissioner may treatan arrangement as a CSA, notwithstandinga technical failure to meet the substan-tive requirements of a CSA. Namely, theCommissioner must conclude that thetaxpayer substantially complied with theCSA administrative requirements andthat application of the CSA rules to suchnon-conforming arrangement will providethe most reliable measure of an arm’slength result. For these purposes, thetemporary regulations also clarify thatapplicable contractual provisions will beinterpreted by reference to economic sub-stance and the parties’ actual conduct, andthe Commissioner may disregard termslacking economic substance and imputeterms consistent with the economic sub-stance.

2. Territorial and other DivisionalInterests — Temp. Treas. Reg.§1.482–7T(b)(1)(iii) and (4)

The 2005 proposed regulations requiredthe controlled participants in a CSA toreceive non-overlapping territorial inter-ests that entitled each controlled partici-pant to the perpetual and exclusive right tothe profits in its territory attributable costshared intangibles. Commentators sug-

February 17, 2009 461 2009–7 I.R.B.

gested that requiring territorial divisions ofinterests was overly restrictive and did notalign with common business models. Theyalso questioned the need for the non-over-lapping, perpetual, and exclusivity condi-tions.

To provide taxpayers with more flexi-bility in designing qualifying divisional in-terests, the temporary regulations permituse of a new basis — the field of use di-vision of interests — in addition to the ter-ritorial basis. Further, the regulations alsoauthorize other non-overlapping divisionalinterests provided that the basis used meetsfour criteria: (1) the basis must clearly andunambiguously divide all interests in costshared intangibles among the controlledparticipants; (2) the consistent use of suchbasis can be dependably verified from therecords maintained by the controlled par-ticipants; (3) the rights of the controlledparticipants to exploit cost shared intangi-bles are non-overlapping, exclusive, andperpetual; and (4) the resulting benefits as-sociated with each controlled participant’sinterest in cost shared intangibles are pre-dictable with reasonable reliability. Thetemporary regulations illustrate instancesin which divisional interests tied to spe-cific manufacturing facilities, as an exam-ple, would, and would not, qualify underthese criteria. See Temp. Treas. Reg.§1.482–7T(b)(4)(v), Examples 2 and 3.

3. Platform and other Contributions —Temp. Treas. Reg. §1.482–7T(c) and(g)(2)(ii)

The 2005 proposed regulations de-scribed external contributions for whichcompensation was due from other con-trolled participants, that is, preliminaryor contemporaneous transactions. A pre-liminary or contemporaneous transactioncorresponded to the buy-in pursuant to§1.482–7(g) of the 1995 final regulations.Under the 2005 proposed regulations, anexternal contribution generally consistedof the rights in the reference transac-tion (RT) in any resource or capabilityreasonably anticipated to contribute to de-veloping cost shared intangibles. The RTconsisted of a transaction, to be designatedin the CSA documentation, affording theperpetual and exclusive rights in the sub-ject resource or capability. While the RTwas relevant to valuing the compensationobligation under a PCT, the controlled

participants were not required to actu-ally enter into the RT. Although the RTassumed perpetual and exclusive rights,proration was required to the extent thatthe subject resource or capability wasreasonably anticipated to contribute bothto the CSA Activity and other businessactivities. Evaluation of the preliminaryor contemporaneous transaction compen-sation obligation for the subject rightscould be in the aggregate with preliminaryor contemporaneous transaction compen-sation obligation with respect to otherexternal contributions, or in the aggregatewith the compensation obligations withrespect to other rights, where valuationon an aggregate basis would provide themost reliable measure of an arm’s lengthresult for the aggregated preliminary orcontemporaneous transactions and othertransactions.

Commentators objected to the RT asoverbroad. Commentators further con-tended that external contributions includedelements such as workforce, goodwill orgoing concern value, or business oppor-tunity, which in the commentators’ vieweither do not constitute intangibles, or arenot being transferred, and so, in the com-mentators’ view, are not compensable.

The temporary regulations replace theterm “external contribution” with theterm “platform contribution” and replacethe term “preliminary or contemporane-ous transaction” with the term “platformcontribution transaction.” The temporaryregulations, like the 2005 proposed regu-lations, do not limit platform contributionsthat must be compensated in PCTs to thetransfer of intangibles defined in section936(h)(3)(B). For example, to the extenta controlled participant (the PCT Payee)contributes the services of its researchteam for purposes of developing costshared intangibles pursuant to the CSA,the other controlled participant (the PCTPayor) would owe compensation for theservices of such team under Temp. Treas.Reg. §1.482–9T, just as would be thecase in a contract research arrangement.Where there is a combined contribution ofresearch services, intangibles in process,or other resources, capabilities, or rights,the temporary regulations provide for anaggregate valuation where that would pro-vide the most reliable measure of an arm’slength result for the aggregated PCTs andother transactions. The treatment available

under the cost sharing rules of the contri-bution of the services of a research teamas controlled services is without any in-ference concerning the potential status ofworkforce in place as an intangible withinthe meaning of section 936(h)(3)(B).

On the other hand, the temporary reg-ulations only require the PCT Payor tocompensate the PCT Payee for platformcontributions, or cross operating contribu-tions, reasonably anticipated to contributeto the CSA Activity in the PCT Payor’s di-vision as defined in Temp. Treas. Reg.§1.482–7T(j)(1)(i). A PCT Payor is notobligated to compensate the PCT Payee forany of the PCT Payee’s resources, capabil-ities, or rights that are reasonably antici-pated to benefit only the PCT Payee’s op-erations. Similarly, under the temporaryregulations, the PCT Payee is also not en-titled to compensation from the PCT Payoron account of any of the PCT Payor’s ownresources, capabilities, or rights, includingany goodwill or going concern value of thePCT Payor. For example, where opera-tions of parties involve undertaking func-tions and risks of scope and duration com-parable to those of the PCT Payor, an ap-plication of the income method based onthe comparable profits method would re-tain for the PCT Payor the returns reason-ably anticipated to its own contributionsto operations in its division, including anygoodwill or going concern value associ-ated with those operations, based on the re-turns to the comparable parties used in theCPM analysis. Similarly, the PCT Payorretains the ability to pursue its own busi-ness opportunities in its division, includ-ing through operating cost contributions tomaintain or develop resources, capabili-ties, or rights to promote its operations.

In response to comments that the con-cept of the RT was unnecessary andconfusing, the temporary regulations donot use that concept. Instead, the tem-porary regulations adopt a presumptionthat a PCT Payee provides any resource,capability, or right to the intangible de-velopment activity (IDA) pursuant to theCSA on an exclusive basis. A taxpayercan rebut the presumption by showing tothe satisfaction of the Commissioner thatthe subject resource, capability, or rightis reasonably anticipated to contributenot just to the CSA, but to other businessactivities as well. For example, if the plat-form resource is a research tool, then the

2009–7 I.R.B. 462 February 17, 2009

taxpayer could rebut the presumption ofexclusivity by establishing to the satisfac-tion of the Commissioner that the tool isreasonably anticipated not only to be ap-plied in the IDA, but also to be licensed toan uncontrolled taxpayer. The temporaryregulations provide guidance on prorationof PCT payments in cases where the tax-payer rebuts the presumption.

4. Intangible Development Activity andCosts — Temp. Treas. Reg. §1.482–7T(d)

Some commentators suggested that tax-payers can limit the application of the costsharing rules by defining the IDA with ref-erence only to specifically listed platformcontributions. Without any inference in-tended as to the economic substance ofsuch an approach, the temporary regula-tions are clarified to exclude this possi-bility. The scope of the IDA includesall activities that could reasonably be an-ticipated to contribute to developing thereasonably anticipated cost shared intangi-bles. The IDA cannot be described merelyby a list of particular resources, capabili-ties, or rights that will be used in the CSA,since the IDA is a function of what arethe reasonably anticipated cost shared in-tangibles and such a list might not iden-tify reasonably anticipated cost shared in-tangibles. Also, the scope of the IDA maychange as the nature or identity of the rea-sonably anticipated cost shared intangiblesor the nature of the activities necessary fortheir development become clearer. For ex-ample, the relevance of certain ongoingwork to developing reasonably anticipatedcost shared intangibles or the need for ad-ditional work may only become clear overtime.

The Treasury Department and the IRSrequested in Notice 2005–99, 2005–2 C.B.1214 comments regarding the valuationof stock options and other stock-basedcompensation. The Treasury Departmentand the IRS received comments and con-tinue to consider the technical changesand issues described in Notice 2005–99and intend to address those in a subse-quent regulations project. See Treas. Reg.§601.601(d)(2)(ii)(b).

5. Changes in Participation — Temp.Treas. Reg. §1.482–7T(f)

The increased flexibility to adopt a divi-sional basis other than a territorial or field

of use basis entails the need for provisionsto prevent abuse and facilitate compli-ance. Capability fluctuations, whethermarket-driven or strategic, that materi-ally alter the controlled participants’ RABshares as compared with their respectivedivisional interests create the equivalentof a controlled transfer of interests andshould therefore equally occasion arm’slength compensation. Accordingly, thetemporary regulations modify the changeof participation provision to classify sucha material capability variation, in additionto a controlled transfer of interest, as achange in participation that requires arm’slength consideration by the controlled par-ticipant whose RAB share increases, to thecontrolled participant whose RAB sharedecreases, as the result of the capabilityvariation.

C. Income and other Specified andUnspecified Methods

1. Best Method Analysis Considerations— Temp. Treas. Reg. §1.482–7T(g)(2)

The 2005 proposed regulations articu-lated “general principles” — such as therealistic alternatives principle — applica-ble to any method to determine the arm’slength charge in a PCT. Commentators ex-pressed uncertainty about the role intendedfor these principles. For example, theywondered if these principles themselvesdictated, or trumped, methods or applica-tions of methods.

The temporary regulations clarify thatthese principles were intended to providesupplementary guidance on the applicationof the best method rule to determine whichmethod, or application of a method, pro-vides the most reliable measure of an arm’slength result in the CSA context. In otherwords, the principles provide best methodconsiderations to aid the competitive eval-uation of methods or applications, and arenot themselves methods or trumping rules.

a. Consistency with upfront terms and riskallocation — the investor model — Temp.Treas. Reg. §1.482–7T(g)(2)(ii)

The investor model is a core princi-ple of the 2005 proposed regulations. APCT Payor, through cost sharing and pay-ments made pursuant to the PCT (PCTPayments), is investing for the term of

the CSA Activity and expects returns overtime consistent with the riskiness of thatinvestment.

The upfront evaluation pursuant tothe investor model of expected returnsto particular risks assumed in intangibledevelopment and exploitation under thefacts and circumstances is key to ensur-ing consistency of the results of a CSAwith the arm’s length standard. Commen-tators have criticized the investor modelfor stripping away risky returns from thePCT Payor. The temporary regulationsprovide additional guidance to explainthat when the PCT Payor assumes risks itaccordingly, enjoys the returns (or suffersthe detriments) that may result from suchrisks.

For example, in addition to its costcontributions to developing cost sharedintangibles, a PCT Payor may also commitsignificant operating contributions, suchas existing marketing or manufacturingprocess intangibles, to operations in itsdivision as well as make significant op-erating cost contributions towards furtherdeveloping such intangibles. To the extentparties to comparable transactions under-take similar risks of similar scope andduration, the PCT Payor will be appro-priately awarded based on a method thatrelies in whole or part on the returns insuch comparable transactions (includingapplications of the income method basedon a CUT or the CPM). To the extent itsoperating contributions are nonroutine,that is, not reflected in available compara-ble transactions, then the PCT Payor mayshare in nonroutine divisional profit underthe application of the residual profit splitmethod (RPSM) provided in the tempo-rary regulations.

Moreover, the temporary regulationsprovide guidance on discount rates andarm’s length ranges, so as to further clarifythe ability of the PCT Payor to achieveresults commensurate with its assumptionof risks.

b. Aggregation of transactions — Temp.Treas. Reg. §1.482–7T(g)(2)(iv)

The temporary regulations make con-forming changes to the guidance includedin the 2005 proposed regulations on aggre-gate evaluation of multiple transactions.Thus, if the combined effect of transac-tions in connection with a CSA involving

February 17, 2009 463 2009–7 I.R.B.

platform, operating, and other contribu-tions of resources, capabilities, or rightsare reasonably anticipated to be inter-related, then determination of the arm’slength charge for PCTs and other transac-tions on an aggregate basis may providethe most reliable measure of an arm’slength result.

c. Discount rates — Temp. Treas. Reg.§1.482–7T(g)(2)(v)

The 2005 proposed regulations pro-vided general guidance that, where apresent value is needed for a purpose ina cost sharing analysis, a discount rateshould be used that most reliably reflectsthe risk of the particular set of activitiesor transactions based on all the informa-tion potentially available at the time forwhich the present value calculation is tobe performed. Further, depending on theparticular facts and circumstances, thediscount rate may differ among a com-pany’s various activities and transactions.As examples, the proposed regulationsindicated that a weighted average cost ofcapital (WACC) of the taxpayer, or anuncontrolled taxpayer, could provide themost reliable basis for a discount rate ifthe CSA Activity involves the same riskas projects undertaken by the taxpayer,or uncontrolled taxpayer, as a whole. Asanother example, in certain appropriateconditions, a company’s internal hurdlerate for projects of comparable risk mightprovide a reliable basis for a discount ratein a cost sharing analysis.

Commentators offered several criti-cisms of the discount rate guidance. Somecomments concluded that the 2005 pro-posed regulations placed an inappropriateemphasis on a taxpayer’s WACC as a basisfor analysis. Other comments suggesteda clarification be made that more than asingle discount rate may be appropriatein a cost sharing analysis. Yet other com-ments addressed whether a discount ratein a cost sharing analysis should be before,or after, tax. Some commentators assertedthat cash flows, rather than items enteringinto income, analytically are the more ap-propriate amounts to be discounted.

The temporary regulations revise andelaborate upon the best method analysisconsiderations in regard to discount rates.Guidance is provided recognizing that theappropriate discount rate may, depending

on the facts and circumstances, vary be-tween realistic alternatives and forms ofpayment. As regards discount rate varia-tion between realistic alternatives, for ex-ample, licensing intangibles needed for itsoperations would ordinarily be less riskyfor a licensee, and so require a lower dis-count rate, than entering into a CSA whichwould involve the licensee assuming theadditional risk of funding its cost contri-butions to the IDA. As regards discountrate variation between forms of payment,for example, ordinarily a royalty computedon a profits base would be more volatile,and so require a higher discount rate to dis-count projected payments to present value,than a royalty computed on a sales base.

The temporary regulations recognizethat, in general, discount rates inferredfrom the operations of the capital marketsare post-tax rates. An analysis applyingpost-tax discount rates would be expectedto treat taxes like any other expense. How-ever, the equivalent result may in certaincircumstances be achieved by applying apost-tax discount rate to pre-tax net in-come multiplied by the difference of oneminus the tax rate. If such an approach isadopted in applying the income method, tothe extent that the controlled participants’respective tax rates are not materiallyaffected by whether they enter into thecost sharing or licensing alternative (orif reliable adjustments may be made forvarying tax rates), the mulitiplier (thatis, one minus the tax rate) may be can-celled from both sides of the equation ofthe cost sharing and licensing alternativepresent values. Accordingly, in such cir-cumstance it is sufficient to apply post-taxdiscount rates to pre-tax items for purposeof equating the cost sharing and licensingalternatives. See also the discussion of theincome method in this preamble.

The specific reference to a WACC or tohurdle rates are eliminated as unnecessary,but without any inference as to a WACCor a hurdle rate being an appropriate dis-count rate, or an appropriate starting pointin ascertaining a discount rate, dependingon the particular facts.

Certain methods in the temporary reg-ulations (such as the income method un-der Temp. Treas Reg. §1.482–7T(g)(4))are theoretically based on valuation tech-niques that use “cash flow” projectionsrather than income projections. While useof cash flow projections is permitted un-

der these methods, for a number of prac-tical and administrative reasons, detailedguidance on the specific applications of themethods are based on income, rather thancash flow, measures. The Treasury De-partment and the IRS considered whetherto provide guidance on the use of cashflows, rather than income, as the appro-priate amounts to be discounted in a costsharing analysis. The Treasury Depart-ment and the IRS continue to consider, andsolicit comments, on whether and how thecost sharing rules could be reliably be ad-ministered on the basis of cash flows in-stead of operating income, and whethersuch a basis is consistent with the secondsentence of section 482 and its CWI re-quirement.

d. Projections — Temp. Treas. Reg.§1.482–7T(g)(2)(vi)

The temporary regulations note that thereliability of an estimate will often dependupon the reliability of the projections usedin making the estimate. Projections shouldreflect the best estimates of the items pro-jected (for example, reflecting a proba-bility weighted average of possible out-comes).

e. Arm’s length range — Temp. Treas.Reg. §1.482–7T(g)(2)(ix)

The 2005 proposed regulations pro-vided supplemental guidance on applyingarm’s length methods in the cost sharingcontext in accordance with the provisionsof Treas. Reg. §1.482–1 including, interalia, the arm’s length range of Treas. Reg.§1.482–1(e). The proposed regulationsdid not, however, provide guidance onhow to adapt an arm’s length range forcost sharing.

The temporary regulations adapt theguidance in Treas. Reg. §1.482–1(e) foruse with some of the methods for com-puting PCT Payments that are specified inthe temporary regulation. The provisionselaborate, where the entire range of resultscannot be regarded as of sufficient com-parability and reliability, how to derivea statistically enhanced range of arm’slength charges for a PCT.

The guidance in Treas. Reg.§1.482–1(e) regarding arm’s length rangesis most easily understood in the contextof a method (for example, comparableuncontrolled price, cost plus, resale price,

2009–7 I.R.B. 464 February 17, 2009

comparable uncontrolled transaction,comparable profits), in which the resultof each comparable transaction directlyprovides an estimate for the result of thecontrolled transaction. Some of the meth-ods specified in the temporary regulations(for example, the income method) havea different structure, in which an arm’slength result is estimated by performingmathematical calculations that depend ontwo or more input parameters (for ex-ample, a relevant discount rate, certainfinancial projections, a return for rou-tine activities) that must be determined.The additional guidance in this sectionaddresses the arm’s length range in thecontext of such methods.

The temporary regulations distinguishcertain input parameters (variable inputparameters) that, for purposes of deter-mining an arm’s length range, may beassigned more than one possible value.Such input parameters are limited to thosewhose value is most reliably determinedby considering two or more observationsof market data (for example, profit levelsor stock betas of two or more compa-nies) that have, or with adjustment canbe brought to, a similar reliability andcomparability, as described in Treas. Reg.§1.482–1(e)(2)(ii). If there are two ormore variable input parameters, the nar-rowing effect of the interquartile rangeis used twice: first, to narrow the varia-tion of each input parameter, and again tonarrow the resulting set of PCT Paymentvalues. This double narrowing reflectsthat the use of two or more variable inputparameters normally introduces additionalunreliability into a method, even thoughthat method may be the best method.

Generally, Treas. Reg. §1.482–1(e)(3)governs the Commissioner’s ability tomake an adjustment to a PCT Paymentdue to the taxpayer’s results being out-side the arm’s length range. Consistentwith the principles expressed there, ad-justment under the temporary regulationswill normally be to the median, as definedin Treas. Reg. §1.482–1(e)(3). Also, theCommissioner is not required to establishan arm’s length range prior to making anallocation under section 482.

The Treasury Department and the IRSsolicit comments on the design and me-chanics of the supplemental guidance ondetermination of an arm’s length range inparagraph (g)(2)(ix) of the temporary reg-

ulations, including the limitation of vari-able input parameters to market-based in-put parameters. Any alternative proposalshould specify the design and mechanicsin detail, and should discuss whether suchan approach enhances the reliability of theanalysis, is administrable, and is not so ma-nipulable as to yield unrealistic ranges.

2. Comparable Uncontrolled TransactionMethod — Temp. Treas. Reg.§1.482–7T(g)(3)

The 2005 proposed regulations pro-vided for possible use of the comparableuncontrolled transaction (CUT) methodto determine the arm’s length charge ina PCT where appropriate in accordancewith the standards of the intangibles trans-fer and controlled services provisions ofthe regulations under section 482. Somecommentators asserted that any arrange-ment that uncontrolled parties might call acost sharing arrangement could serve as aCUT, even though such arrangement mayinvolve materially different risk alloca-tions and provisions than addressed in thecost sharing rules.

In response to these comments, the tem-porary regulations describe the relevantconsiderations for purposes of evaluatingwhether a putative CUT may, or may not,reflect the most reliable measure of anarm’s length result. Although all of thefactors entering into a best method analysisdescribed in Treas. Reg. §§1.482–1(c) and(d) must be considered, comparability andreliability under the CUT method in theCSA context are particularly dependenton similarity of contractual terms, degreeto which allocation of risks is proportionalto reasonably anticipated benefits fromexploiting the results of intangible devel-opment, similar period of commitment asto the sharing of intangible developmentrisks, and similar scope, uncertainty, andprofit potential of the subject intangibledevelopment, including a similar alloca-tion of the risks of any existing resources,capabilities, or rights, as well as of therisks of developing other resources, capa-bilities, or rights that would be reasonablyanticipated to contribute to exploitationwithin the parties’ divisions, that is con-sistent with the actual allocation of risksbetween the controlled participants as pro-vided in the CSA in accordance with thecost sharing rules.

3. Income Method — Temp. Treas. Reg.§1.482–7T(g)(4)

The 2005 proposed regulations madethe income method a specified method forpurposes of evaluating the arm’s lengthcharge in a PCT. Under the general rule,the arm’s length charge was an amountthat equated a controlled participant’spresent value of entering into a CSA withthe present value of the controlled par-ticipant ’s best realistic alternative. Alsoprovided were two applications of theincome method. One, based on a CUTanalysis, assumed that a PCT Payee’s bestrealistic alternative would be to developthe cost shared intangibles on its own,bearing all the intangible developmentcosts (IDCs) itself, and then license thecost shared intangibles. A second, basedon a comparable profits method (CPM)analysis, assumed that the PCT Payor’sbest realistic alternative would be to ac-quire the rights to external contributions(renamed platform contributions under thetemporary regulations) for payments witha present value equal to the PCT Payor’santicipated profit, after reward for its rou-tine contributions to its operations, fromthe CSA Activity in its territory (the onlydivision permitted under the 2005 pro-posed regulations). Both income methodapplications provided for a cost contribu-tion adjustment in order to allocate to thePCT Payor the return to its additional risk,as compared to its realistic alternative, ofbearing its reasonably anticipated benefits(RAB) share of the IDCs. As set forth inthe 2005 proposed regulations, both theCUT and CPM based applications of theincome method built in a conversion to aroyalty form of payment, either on salesor on operating profit.

Commentators offered several crit-icisms with reference to the incomemethod. As a general matter, some com-ments asserted that the income methodstripped away risky returns from the PCTPayor. Other comments focused on tech-nical aspects of the method and the appli-cations. In particular, comments pointedto the potential risk differentials betweencost sharing and the alternative arrange-ments. For example, cost sharing wouldgenerally be more risky than licensing forthe PCT Payor as the result of its sharingwith the PCT Payee the risks of the IDA.As a corollary, cost sharing would gener-

February 17, 2009 465 2009–7 I.R.B.

ally be less risky for the PCT Payee thanlicensing. The comments observed thatthese risk differentials would ordinarily bereflected in different discount rates beingappropriate under the cost sharing andlicensing alternatives. Other commentssuggested the possible use of different dis-counts for different financial flows (sales,cost of sales, operating expenses, costcontributions, etc.).

The temporary regulations provide fur-ther guidance on the income method andits applications. In general, they providethat the best realistic alternative of the PCTPayor to entering into the CSA would beto license intangibles to be developed byan uncontrolled licensor that undertakesthe commitment to bear the entire risk ofintangible development that would other-wise have been shared under the CSA.Similarly, the best realistic alternative ofthe PCT Payee to entering into the CSAwould be to undertake the commitment tobear the entire risk of intangible devel-opment that would otherwise have beenshared under the CSA and license the re-sulting intangibles to an uncontrolled li-censee.

The licensing alternative is derived onthe basis of a functional and risk analy-sis of the cost sharing alternative, but witha shift of the risk of cost contributions tothe licensor. Accordingly, the PCT Payor’slicensing alternative consists of enteringinto a license with an uncontrolled party,for a term extending for what would be theduration of the CSA Activity, to license themake-or-sell rights in subsequently to bedeveloped resources, capabilities, or rightsof the licensor. Under such license, the li-censor would undertake the commitmentto bear the entire risk of intangible devel-opment that would otherwise have beenshared under the CSA. Apart from the dif-ference in the allocation of the risks of theIDA, the licensing alternative should as-sume contractual provisions with regard tonon-overlapping divisional intangible in-terests, and with regard to allocations ofother risks, that are consistent with the ac-tual CSA in accordance with the cost shar-ing rules. For example, the analysis underthe licensing alternative should assume asimilar allocation of the risks of any ex-isting resources, capabilities, or rights, aswell as of the risks of developing other re-sources, capabilities, or rights that would

be reasonably anticipated to contribute toexploitation within the parties’ divisions,that is consistent with the actual allocationof risks between the controlled participantsas provided in the CSA in accordance withthe temporary regulations.

The temporary regulations, like the2005 proposed regulations, describe bothCUT-based applications and CPM-basedapplications of the Income Method. How-ever, they differ from the applicationsdescribed in the 2005 proposed regula-tions by equating the cost sharing andlicensing alternatives of the PCT Payorusing discount rates appropriate to thosealternatives. In circumstances where themarket-correlated risks as between thecost sharing and licensing alternatives arenot materially different, a reliable anal-ysis may be possible by using the samediscount rate with respect to both alter-natives. Otherwise, as recognized in thebest method considerations concerningdiscount rates, realistic alternatives havingthe same reasonably anticipated presentvalue may nevertheless involve varyingrisk exposure and, thus, generally are morereliably evaluated using different discountrates. To the extent that the controlledparticipants’ respective tax rates are notmaterially affected by whether they enterinto the cost sharing or licensing alterna-tive (or reliable adjustments may be madefor varying tax rates), it is appropriate toapply post-tax discount rates to pre-taxitems for purpose of equating the costsharing and licensing alternatives. Thediscount rate for the cost sharing alter-native will generally depend on the formof PCT Payments assumed (for example,lump sum, royalty on sales, royalty ondivisional profit).

The income method may be applied todetermine PCT Payments in any form ofpayment (for example, lump sum, royaltyon sales, royalty on divisional profit). Ifan income method application is used todetermine arm’s length PCT Payments ina particular form, then the PCT Paymentsin that form may be converted to an al-ternative form in accordance with Temp.Treas. Reg. §1.482–7(h) (Form of pay-ment rules).

The temporary regulations clarify theopportunities, depending on the facts andcircumstances, for the PCT Payor to as-sume risks and, accordingly, to enjoy the

returns (or suffer the detriments) that mayresult from such risks. For example, inaddition to its cost contributions to de-veloping cost shared intangibles, a PCTPayor may also commit significant operat-ing contributions, such as existing market-ing or manufacturing process intangibles,to operations in its division as well as makesignificant operating cost contributions to-wards further developing such intangibles.To the extent parties to comparable trans-actions undertake risks of similar scopeand duration, the PCT Payor will be appro-priately rewarded based on a method thatrelies in whole or part on returns in suchcomparable transactions under an applica-tion of the income method whether basedon a CUT or the CPM. Where its operatingcontributions are nonroutine, that is, notreflected in available comparable transac-tions, the PCT Payor may share in nonrou-tine divisional profit under the applicationof the RPSM provided in the temporaryregulations. Similarly, while the incomemethod is limited to cases in which onlyone of the controlled participants providesnonroutine platform contributions as thePCT Payee, the RPSM in the temporaryregulations addresses the situation wheremore than one controlled participant fur-nishes nonroutine platform contributions.

Yet other comments criticized the in-come method as positing an unrealistic“perpetual life.” The income method ispremised on the assumption that, at arm’slength, an investor will make a risky in-vestment (for example, in a platform fordeveloping additional technology) only ifthe investor reasonably anticipates that thepresent value of its reasonably anticipatedoperational results will be increased atleast by a present value equal to the plat-form investment. It may be, depending onthe facts and circumstances, that the tech-nology is reasonably expected to achievean incremental improvement in results foronly a finite period (after which period,results are reasonably anticipated to returnto the levels that would otherwise havebeen expected absent the investment). Theperiod of enhanced results that justifiesthe platform investment in such circum-stances effectively would correspond to afinite, not a perpetual, life.

2009–7 I.R.B. 466 February 17, 2009

4. Acquisition Price and MarketCapitalization Methods — Temp. Treas.Reg. §1.482–7T(g)(5) and (6)

The 2005 proposed regulations in-cluded guidance on the acquisition priceand market capitalization methods forevaluating the arm’s length charge in aPCT. Under the acquisition price method,the arm’s length charge for a PCT is theadjusted acquisition price, that is, the ac-quisition price increased by the value ofthe target’s liabilities on the date of ac-quisition, and decreased by the value onthat date of target’s tangible property andany other resources and capabilities notcovered by the PCT. Under the marketcapitalization method, the arm’s lengthcharge for a PCT is the adjusted averagemarket capitalization, that is, the averagedaily market capitalization over the 60days ending with the date of the PCT, in-creased by the value of the PCT Payee’sliabilities on such date, and decreasedon account of tangible property and anyother resources and capabilities of the PCTPayee not covered by the PCT.

Commentators questioned the reliabil-ity of these methods in light of volatilityof stock prices and lack of correlation be-tween stock price and underlying assets,for example, owing to control premiums oreconomies of integration.

The Treasury Department and the IRSrecognize that these comments point toconsiderations that, depending on the factsand circumstances, will need to be takeninto account in a best method analysisthat compares the reliability of the re-sults under application of these methodsas against the results under applicationof other methods (which may themselvesmay have aspects that reduce their reliabil-ity). The temporary regulations retain thebest method considerations from the 2005proposed regulations that observe that re-liability is reduced under these methodsif a substantial portion of the target’s, orPCT Payor’s, nonroutine contributionsto business activities is not required tobe covered by a PCT and, in the case ofthe market capitalization method, if thefacts and circumstances demonstrate thelikelihood of a material divergence be-tween the PCT Payee’s average marketcapitalization and the value of its under-lying resources, capabilities, and rightsfor which reliable adjustments cannot be

made. The temporary regulations alsoprovide that proximity in time betweenthe acquisition of the target and the PCTPayment is an important comparabilityfactor under the acquisition price method.

5. Residual Profit Split Method — Temp.Treas. Reg. §1.482–7T(g)(7)

The temporary regulations conform themodified RPSM from the proposed regu-lations to the changes made to the incomemethod.

6. Unspecified Methods — Temp. Treas.Reg. §1.482–7T(g)(8)

Under the temporary regulations in or-der to use an unspecified method, a tax-payer must maintain documentation to de-scribe and explain the method selected todetermine the arm’s length payment due ina PCT.

D. Form of Payment

1. Post Formation Acquisitions

The 2005 proposed regulations gen-erally provided taxpayers flexibility toprovide for PCT Payments either in fixedamounts (whether in lump sums or install-ment payments with arm’s length interest)or in contingent amounts. PCT Paymentscould not be paid in shares of stock ofthe PCT Payor. The form of paymentselected for any PCT, including the basisand structure of the payments, had to bespecified no later than the date of the PCT.In the case of a post formation acquisition(PFA) — that is, an external contribu-tion (renamed platform contribution in thetemporary regulations) that is acquired bya controlled participant in an uncontrolledtransaction (either directly, or indirectlythrough the acquisition of an interest inan entity or tier of entities) — the con-sideration under the PCT for a PFA hadto be paid in the same form as the con-sideration in the uncontrolled transactionin which the PFA was acquired. An ex-ample indicates that acquisitions for stockwere considered to be for a fixed form ofpayment. One principal rationale for thespecial rules for PFAs was that PFAs standin the place of IDCs and, therefore, reflecta risk allocation equivalent to that in theIDC context, which requires the sharingof outlays on a fixed form of payment

basis. Another principal rationale was thedifficulty the IRS has had in examiningCSAs using a contingent form of paymentfor PFAs.

Commentators criticized the same formof payment requirement for PFAs, espe-cially the treatment of stock acquisitions ashaving a fixed form of payment. The com-ments pointed out that a purchaser payingwith its own stock is selling a part of itsbusiness, and thus pays consideration thatis ultimately contingent on the success ofits business. Other comments objected tothe timing mismatch caused by the sameform of payment rule, because fixed PCTPayments would be immediately includ-able, but the PFA assets would be amortiz-able only over time. Still other commentsasserted that taxpayers may choose theirform of payment for PFAs, as with otherexternal contributions, so long as the price(taking into account the form of payment)is arm’s length.

The temporary regulations do not retainthe special rules for PFAs. Subsequentacquisitions remain an important sourceof platform contributions that occasionthe requirement of PCT compensation.However, the temporary regulations nolonger require a special form of paymentfor such compensation. Therefore, con-trolled participants may choose the formof payment for PCTs regardless of whetherthe PCTs occur at the outset of the CSAor later. Removal of the special rules forPFAs moots questions regarding whetherstock consideration should be treated ascontingent or fixed payment and whether(and how) the timing mismatch shouldbe addressed. Nonetheless, the IRS willcontinue to scrutinize the contractual doc-umentation, pricing, and implementationof contingent forms of payment for PFAs.

2.Contingent Payments — Temp. Treas.Reg. §1.482–7T(h)(2)(iii) and (iv)

The temporary regulations incorporaterules to ensure that the contingent formfor PCT Payments is applied properly byboth taxpayers and the IRS. In accordancewith Treas. Reg. §1.482–1(d)(3)(iii)(B),a CSA contractual provision that providesfor payments for a PCT (or group of PCTs)to be contingent on the exploitation of costshared intangibles will be respected asconsistent with economic substance onlyif the allocation between the controlled

February 17, 2009 467 2009–7 I.R.B.

participants of the risks attendant on suchform of payment is determinable beforethe outcomes of such allocation that wouldhave materially affected the PCT pricingare known or reasonably knowable. Thetemporary regulations require a contingentpayment provision to clearly and unam-biguously specify the basis on which thecontingent payment obligations are to bedetermined. In particular, the contingentpayment provision must clearly and un-ambiguously specify the events that giverise to an obligation to make PCT Pay-ments, the royalty base (such as sales orrevenues), and the computation used todetermine the PCT Payments. The royaltybase specified must permit verification ofits proper use by reference to books andrecords maintained by the controlled par-ticipants in the normal course of business(for example, books and records main-tained for financial accounting or businessmanagement purposes).

The temporary regulations also providethat where a method yields a fixed valuefor PCT Payments, a conversion may bemade to a contingent form of payments.Guidance is also provided on discountrates for purposes of such conversion.Certain forms of payment may involvedifferent risks than others. For example,ordinarily a royalty computed on a prof-its base would be more volatile, and sorequire a higher discount rate to discountprojected payments to present value, thana royalty computed on a sales base.

E. Periodic Adjustments

1. Determination of Periodic Adjustments— Temp. Treas. Reg. §1.482–7T(i)(6)(v)and (vi)

The 2005 proposed regulations ad-dressed the CWI principle of the secondsentence of section 482 in the context ofcost sharing. The Commissioner couldmake periodic adjustments for an opentaxable year (the Adjustment Year) andall subsequent years of the CSA Activityin the event of a Periodic Trigger. Underthe 2005 proposed regulations, a PeriodicTrigger arose if the PCT Payor realized,over the period beginning with the earliestdate on which an IDC occurred throughthe end of the Adjustment Year, an actu-ally experienced return ratio of the presentvalue of its total territorial operating prof-

its divided by the present value of itsinvestment consisting of the sum of its costcontributions plus PCT Payments, outsidethe periodic return ratio range of between.5 and 2. In arriving at these presentvalues, the Commissioner would use anapplicable discount rate, which in the caseof certain publicly traded entities wouldbe their weighted average cost of capital,unless the Commissioner determines, orthe controlled participants establish, thatanother discount rate better reflects thedegree of risk of the CSA Activity. Pe-riodic adjustments would be determinedunder a modified RPSM. Exceptions wereprovided, such as for an effective CUTor for results due to extraordinary eventsbeyond the controlled participants’ controland that could not have been reasonablyanticipated. In determining whether tomake any periodic adjustments, the Com-missioner would consider whether theoutcome as adjusted more reliably reflectsan arm’s length result under all the rele-vant facts and circumstances.

Commentators offered several criti-cisms of the periodic adjustment rules.Some comments considered the periodicadjustment rules to be inconsistent withthe arm’s length standard and, throughhindsight, to strip away returns to risk.Other comments claimed for taxpayers thesame ability as the Commissioner to makeperiodic adjustments to implement theCWI principle where subsequent resultsdiverge from original expectations. Com-ments also addressed the exceptions andmeans for taxpayers to demonstrate theirresults were arm’s length so as to avoidperiodic adjustments.

The Treasury Department and the IRSreaffirm that the CWI principle is consis-tent, and periodic adjustments are to beadministered consistently, with the arm’slength standard. Congress adopted theCWI principle in 1986 out of concernabout related-party long-term transfers ofhigh-profit potential intangibles for rela-tively insignificant lump sum or royaltyconsideration justified by reference to pu-tatively comparable transactions betweenunrelated parties that differed significantlyin terms of the division of functionalityand risks when compared to the transfersat issue. See H.R. Rep. 99–426, at 424–25(1985). See also Notice 88–123 (the WhitePaper), 1988–2 C.B. 458, 472–74, 477–80.Congress intended that taxpayers be able

to “use certain bona fide cost-sharing ar-rangements as an appropriate method ofallocating income attributable to intan-gibles among related parties, if and tothe extent such agreements are consistentwith the purposes of this provision thatthe income allocated among the partiesreasonably reflect the actual economicactivity undertaken by each.” H.R. Conf.Rep. No. 99–841, at II–638 (1986). SeeTreas. Reg. §601.601(d)(2)(ii)(b).

Accordingly, the temporary regulationscontinue to provide for periodic adjust-ments along lines similar to those in the in-tangible transfer section of the regulations,as adapted for the cost sharing context.Compare Treas. Reg. §1.482–4(f)(2) (Pe-riodic adjustments). The temporary reg-ulations, however, adopt a smaller peri-odic return ratio range than the 2005 pro-posed regulations. Setting a Periodic Trig-ger to occur if the actually experienced re-turn ratio falls outside the periodic returnratio range of between .667 and 1.5 (orbetween 0.8 and 1.25, if the taxpayer hasnot substantially complied with the docu-mentation requirements of Temp. Treas.Reg. §1.482–7T(k)) is intended to iso-late situations in which actual results sug-gest the potential of an absence of arm’slength pricing as of the date of the PCT.The Treasury Department and the IRS con-sider that the periodic return ratio rangeunder the temporary regulations more real-istically targets the threshold at which peri-odic adjustment scrutiny is appropriate. Indetermining whether to make any periodicadjustments, the Commissioner considerswhether the outcome as adjusted more re-liably reflects an arm’s length result underall the relevant facts and circumstances.

The temporary regulations also makeconforming changes to the determinationof periodic adjustments, in the event of aPeriodic Trigger, in light of other changesin the temporary regulations, for example,in the RPSM and form of payment provi-sions.

2. Advance Pricing Agreement

In addition, the Treasury Departmentand the IRS intend to issue by revenue pro-cedure separate published guidance thatprovides an exception to periodic adjust-ments, similar to exceptions provided inTemp. Treas. Reg. §1.482–7T(i)(6)(vi),in the context of an advance pricing agree-

2009–7 I.R.B. 468 February 17, 2009

ment (APA) entered into pursuant to Rev.Proc. 2006–9, 2006–1 C.B. 278 (as it maybe amended or superseded by subsequentadministrative pronouncement). The guid-ance would provide that no periodic ad-justments will be made in any year basedon a Trigger PCT that is a covered trans-action under the APA. See Treas. Reg.§601.601(d)(2)(ii)(b).

An APA process generally is contempo-raneous with a taxpayer’s original transac-tions and involves transparency concern-ing a taxpayer’s upfront efforts to conformto the arm’s length standard. Thus, theAPA process may overcome the asymme-try in information addressed by the peri-odic adjustment provisions, eliminating aprimary basis for a CWI adjustment. Seegenerally 70 FR 51128–51130 (preambleto 2005 proposed regulations).

The Treasury Department and theIRS considered the possibility of a fur-ther exception to periodic adjustmentsbased on documentation that a tax-payer would maintain contemporane-ously with a PCT. Compare Treas. Reg.§1.6662–6(d)(2)(iii). Such an exceptionwas not incorporated into the temporaryregulations in light of the concern thatdocumentation prepared only by the tax-payer would not benefit from a similardegree of contemporaneous transparencyand explanation as involved in an APA.The Treasury Department and the IRScontinue to consider this matter and solicitcomments on whether and how a docu-mentation exception could be adapted tothe purposes of the CWI principle.

F. Terminology and Table of Definitions— Temp. Treas. Reg. §1.482–7T(j)(1)

For ease of reference, a comprehensivetable of terms is provided. The table setsforth, alphabetically, technical terms usedin the regulations, any applicable abbrevia-tions, definitions (if not elsewhere definedin the regulations), and cross references torelevant portions of the regulations wherethe terms are defined or used.

G. Administrative and Transition Rules —Temp. Treas. Reg. §1.482–7T(m)

The 2005 proposed regulations in-cluded transition rules for existing quali-fied cost sharing arrangements so as notto disturb taxpayers’ reliance on the prior

regulations, while providing for appro-priate prospective application of the newregulations. Grandfather treatment wouldhave been terminated in certain events,including the occasion of a Periodic Trig-ger as the result of a subsequent PCToccurring after the regulations’ effectivedate, a material change in the scope of thearrangement, such as a material expan-sion of the activities undertaken beyondthe scope of the intangible developmentarea, or a 50 percent or greater change inthe ownership of interests in cost sharedintangibles.

Commentators objected to the grandfa-ther termination events, in particular in thecase of a subsequent Periodic Trigger or a50 percent change of ownership, as defeat-ing taxpayers’ legitimate expectation un-der the prior regulations.

The temporary regulations do not ter-minate grandfather treatment upon a 50percent change of ownership or on accountof a subsequent Periodic Trigger or a ma-terial change in scope of the arrangement.The temporary regulations instead adopta targeted provision that applies the tem-porary regulations’ periodic adjustmentrules to PCTs that occur on or after thedate of a material change in the scope ofthe grandfathered CSA. A material changein scope would include a material expan-sion of the activities undertaken beyondthe scope of the intangible developmentarea, as described in former Treas. Reg.§1.482–7(b)(4)(iv). For this purpose, acontraction of the scope of a CSA, absenta material expansion into one or morelines of research and development beyondthe scope of the intangible developmentarea, does not constitute a material changein scope of the CSA. Whether a materialchange in scope has occurred is deter-mined on a cumulative basis. Therefore,a series of expansions, any one of whichis not a material expansion by itself, maycollectively constitute a material expan-sion.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It has been determinedalso that section 553(b) of the Adminis-trative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations. Forthe applicability of the Regulatory Flexi-bility Act (5 U.S.C. chapter 6) refer to theSpecial Analyses section of the preambleto the cross-referenced notice of proposedrulemaking published in this issue of theBulletin. Pursuant to section 7805(f) of theInternal Revenue Code, these regulationswill be submitted to the Chief Counsel forAdvocacy of the Small Business Adminis-tration for comment on its impact on smallbusiness.

Drafting Information

The principal author of these tempo-rary regulations is Kenneth P. Christmanof the Office of Chief Counsel (Interna-tional). However, other personnel from theTreasury Department and the IRS partici-pated in their development.

* * * * *

Amendment to the Regulations

Accordingly, 26 CFR parts 1, 301, and602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.482–7A also issued under

26 U.S.C. 482. * * *Par. 2. Section 1.367(a)–1 is added to

read as follows:

§1.367(a)–1 Transfers to foreigncorporations subject to section 367(a):In general.

(a) through (d)(2) [Reserved].(3) [Reserved] For further guidance, see

§1.367(a)–1T(d)(3).(d)(4) through (g) [Reserved].Par 3. Section 1.367(a)–1T is amended

by revising the second sentence of para-graph (d)(3) to read as follows:

§1.367(a)–1T Transfers to foreigncorporations subject to section 367(a): Ingeneral (temporary).

* * * * *(d) * * *(3) * * * A person’s entering into a cost

sharing arrangement under §1.482–7T or

February 17, 2009 469 2009–7 I.R.B.

acquiring rights to intangible property un-der such an arrangement shall not be con-sidered a transfer of property described insection 367(a)(1). * * *

* * * * *Par. 4. Section 1.482–0 is amended by

adding the entries for §§1.482–1(b)(2)(iii),1.482–2(e) and (f), 1.482–4(g) and (h) andrevising the entries for §1.482–7 to read asfollows:

§1.482–0 Outline of regulations undersection 482 .

* * * * *

§1.482–1 Allocation of income anddeductions among taxpayers.

* * * * *(b) * * *(2)* * *(iii) [Reserved]. For further guid-

ance, see §1.482–0T, the entry for§1.482–1T(b)(2)(iii).

* * * * *

§1.482–2 Determination of taxableincome in specific situations.

* * * * *(e) and (f) [Reserved]. For further

guidance, see §1.482–0T, the entries for§1.482–2T(e) and (f).

* * * * *

§1.482–4 Methods to determine taxableincome in connection with a transfer ofintangible property.

* * * * *(g) and (h) [Reserved]. For further

guidance, see §1.482–0T, the entries for§1.482–4T(g) and (h).

* * * * *

§1.482–7 Methods to determine taxableincome in connection with a cost sharingarrangement.

[Reserved]. For further guidance, see§1.482–0T, the entries for §1.482–7T.

* * * * *Par. 5. Section 1.482–0T is amended as

follows:1. The entries for

§§1.482–1T(b)(2)(iii), (c), (d)(1), (d)(2),(d)(3)(ii)(A), and (d)(3)(ii)B are revised.

2. A new entry for §1.482–1T(b)(2)(iii)is added.

3. The entries for §1.482–2T(e) are re-vised, and new entries for §1.482–2T(f)are added.

4. The entries for §1.482–4T(f)(7) areremoved, and the entries for §1.482–4T(g)and (h) are added.

5. The entries for §1.482–7T are added.6. The entries for §1.482–9T(m)(3) and

(n) are revised.The additions and revisions read as fol-

lows:

§1.482–0T Outline of regulations undersection 482 (temporary).

* * * * *

§1.482–1T Allocation of income anddeductions among taxpayers (temporary).

* * * * *(b) * * *(2)* * *(ii) [Reserved]. For further guid-

ance, see §1.482–0, the entry for§1.482–1(b)(2)(ii).

(iii) Coordination of methods applica-ble to certain intangible development ar-rangements.

(c) through (d)(3)(ii)(B) [Reserved].For further guidance, see §1.482–0,the entries for §1.482–1(c) through(d)(3)(iii)(B).

* * * * *

§1.482–2T Determination of taxableincome in specific situations (temporary).

* * * * *(e) Cost sharing arrangement.(f) Effective/applicability Date.(1) In general.(2) Election to apply paragraph (b) to

earlier taxable years.(3) Expiration date.

* * * * *

§1.482–4T Methods to determine taxableincome in connection with a transfer ofintangible property (temporary).

* * * * *(g) Coordination with rules governing

cost sharing arrangements.(h) Effective/applicability date.

(1) In general.(2) Election to apply regulation to ear-

lier taxable years.(3) Expiration date.

* * * * *

§1.482–7T Methods to determine taxableincome in connection with a cost sharingarrangement (temporary).

(a) In general.(1) RAB share method for cost sharing

transactions (CSTs).(2) Methods for platform contribution

transactions (PCTs).(3) Methods for other controlled trans-

actions.(i) Contribution to a CSA by a con-

trolled taxpayer that is not a controlled par-ticipant.

(ii) Transfer of interest in a cost sharedintangible.

(iii) Other controlled transactions inconnection with a CSA.

(iv) Controlled transactions in the ab-sence of a CSA.

(4) Coordination with the arm’s lengthstandard.

(b) Cost sharing arrangement.(1) Substantive requirements.(i) CSTs.(ii) PCTs.(iii) Divisional interests.(iv) Examples.(2) Administrative requirements.(3) Date of a PCT.(4) Divisional interests.(i) In general.(ii) Territorial based divisional inter-

ests.(iii) Field of use based divisional inter-

ests.(iv) Other divisional bases.(v) Examples.(5) Treatment of certain arrangements

as CSAs.(i) Situation in which Commissioner

must treat arrangement as a CSA.(ii) Situation in which Commissioner

may treat arrangement as a CSA.(iii) Examples.(6) Entity classification of CSAs.(c) Platform contributions.(1) In general.(2) Terms of platform contributions.(i) Presumed to be exclusive.(ii) Rebuttal of Exclusivity.

2009–7 I.R.B. 470 February 17, 2009

(iii) Proration of PCT Payments to theextent allocable to other business activi-ties.

(A) In general.(B) Determining the proration of PCT

Payments.(3) Categorization of the PCT.(4) Certain make-or-sell rights ex-

cluded.(i) In general.(ii) Examples.(5) Examples.(d) Intangible development costs.(1) Determining whether costs are

IDCs.(i) Definition and scope of the IDA.(ii) Reasonably anticipated cost shared

intangible.(iii) Costs included in IDCs.(iv) Examples.(2) Allocation of costs.(3) Stock-based compensation.(i) In general.(ii) Identification of stock-based com-

pensation with the IDA.(iii) Measurement and timing of stock-

based compensation IDC.(A) In general.(1) Transfers to which section 421 ap-

plies.(2) Deductions of foreign controlled

participants.(3) Modification of stock option.(4) Expiration or termination of CSA.(B) Election with respect to options on

publicly traded stock.(1) In general.(2) Publicly traded stock.(3) Generally accepted accounting prin-

ciples.(4) Time and manner of making the

election.(C) Consistency.(4) IDC share.(5) Examples.(e) Reasonably anticipated benefits

share.(1) Definition.(i) In general.(ii) Examples.(2) Measure of benefits.(i) In general.(ii) Indirect bases for measuring antici-

pated benefits.(A) Units used, produced, or sold.(B) Sales.(C) Operating profit.

(D) Other bases for measuring antici-pated benefits.

(E) Examples.(iii) Projections used to estimate bene-

fits.(A) In general.(B) Examples.(f) Changes in participation under a

CSA.(1) In general.(2) Controlled transfer of interests.(3) Capability variation.(4) Arm’s length consideration for a

change in participation.(5) Examples.(g) Supplemental guidance on methods

applicable to PCTs.(1) In general.(2) Best method analysis applicable for

evaluation of a PCT pusuant to a CSA.(i) In general.(ii) Consistency with upfront contrac-

tual terms and risk allocations — the in-vestor model.

(A) In general.(B) Examples.(iii) Consistency of evaluation with re-

alistic alternatives.(A) In general.(B) Examples.(iv) Aggregation of transactions.(v) Discount rate.(A) In general.(B) Considerations in best method anal-

ysis of discount rates.(1) Discount rate variation between re-

alistic alternatives.(2) Discount rate variation between

forms of payment.(3) Post-tax rate.(C) Example.(vi) Financial projections.(vii) Accounting principles.(A) In general.(B) Examples.(viii) Valuations of subsequent PCTs.(A) Date of subsequent PCT.(B) Best method analysis for subse-

quent PCT.(ix) Arm’s length range.(A) In general.(B) Methods based on two or more in-

put parameters.(C) Variable input parameters.(D) Determination of arm’s length PCT

Payment.(1) No variable input parameters.(2) One variable input parameter.

(3) More than one variable input param-eter.

(E) Adjustments.(x) Valuation undertaken on a pre-tax

basis.(3) Comparable uncontrolled transac-

tion method.(4) Income method.(i) In general.(A) Equating cost sharing and licensing

alternatives.(B) Cost sharing alternative.(C) Licensing alternative.(D) Only one controlled participant

with nonroutine platform contributions.(E) Income method payment forms.(F) Discount rates appropriate to cost

sharing and licensing alternatives.(G) The effect of taxation on determin-

ing the arm’s length amount.(ii) Evaluation of PCT Payor’s cost

sharing alternative.(iii) Evaluation of PCT Payor’s licens-

ing alternatives.(A) Evaluation based on CUT.(B) Evaluation based on CPM.(iv) Lump sum payment form.(v) Best method analysis considera-

tions.(vi) Routine platform and operating

contributions.(vii) Examples.(5) Acquisition Price Method.(i) In general.(ii) Determination of arm’s length

charge.(iii) Adjusted acquisition price.(iv) Best method analysis considera-

tion.(v) Examples.(6) Market capitalization method.(i) In general.(ii) Determination of arm’s length

charge.(iii) Average market capitalization.(iv) Adjusted average market capital-

ization.(v) Best method analysis consideration.(vi) Examples.(7) Residual profit split method.(i) In general.(ii) Appropriate share of profits and

losses.(iii) Profit split.(A) In general.(B) Determine nonroutine residual divi-

sional profit or loss.

February 17, 2009 471 2009–7 I.R.B.

(C) Allocate nonroutine residual divi-sional profit or loss.

(1) In general.(2) Relative value determination.(3) Determination of PCT Payments.(4) Routine platform and operating con-

tributions.(iv) Best method analysis considera-

tions.(A) In general.(B) Comparability.(C) Data and assumptions.(D) Other factors affecting reliability.(v) Examples.(8) Unspecified methods.(h) Form of payment rules.(1) CST Payments.(2) PCT Payments.(i) In general.(ii) No PCT Payor stock.(iii) Specified form of payment.(A) In general.(B) Contingent payments.(C) Examples.(iv) Conversion from fixed to contin-

gent form of payment.(3) Coordination of best method rule

and form of payment.(i) Allocations by the Commissioner in

connection with a CSA.(1) In general.(2) CST allocations.(i) In general.(ii) Adjustments to improve the relia-

bility of projections used to estimate RABshares.

(A) Unreliable projects.(B) Foreign-to-foreign adjustments.(C) Correlative adjustments to PCTs.(D) Examples.(iii) Timing of CST allocations.(3) PCT allocations.(4) Allocations regarding changes in

participation under CSA.(5) Allocations when CSTs are consis-

tently and materially disproportionate toRAB shares.

(6) Periodic adjustments.(i) In general.(ii) PRRR.(iii) AERR.(A) In general.(B) PVTP.(C) PVI.(iv) ADR.(A) In general.(B) Publicly traded companies.

(C) Publicly traded.(D) PCT Payor WACC.(E) Generally accepted accounting

principles.(v) Determination of periodic adjust-

ments.(A) In general.(B) Adjusted RPSM as of Determina-

tion Date.(vi) Exceptions to periodic adjustments.(A) Controlled participants establish

periodic adjustment not warranted.(1) Transactions involving the same

platform contribution as in the TriggerPCT.

(2) Results not reasonably anticipated.(3) Reduced AERR does not cause Pe-

riodic Trigger.(4) Increased AERR does not cause Pe-

riodic Trigger.(B) Circumstances in which Periodic

Trigger deemed not to occur.(1) 10-year period.(2) 5-year period.(vii) Examples.(j) Definitions and special rules.(1) Definitions.(i) In general.(ii) Examples.(2) Special rules.(i) Consolidated group.(ii) Trade or business.(iii) Partnership.(3) Character.(i) CST Payments.(ii) PCT Payments.(iii) Examples.(k) CSA administrative requirements.(1) CSA contractual requirements.(i) In general.(ii) Contractual provisions.(iii) Meaning of contemporaneous.(A) In general.(B) Example.(iv) Interpretation of contractual provi-

sions.(A) In general.(B) Examples.(2) CSA documentation requirements.(i) In general.(ii) Additional CSA documentation re-

quirements.(iii) Coordination rules and production

of documents.(A) Coordination with penalty regula-

tions.(B) Production of documentation.

(3) CSA accounting requirements.(i) In general.(ii) Reliance on financial accounting.(4) CSA reporting requirements.(i) CSA Statement.(ii) Content of CSA Statement.(iii) Time for filing CSA Statement.(A) 90-day rule.(B) Annual return requirement.(1) In general.(2) Special filing rule for annual return

requirement.(iv) Examples.(l) Effective/applicability date.(m) Transition rule.(1) In general.(2) Transitional modification of appli-

cable provisions.(3) Special rule for certain periodic ad-

justments.(n) Expiration date.

* * * * *

§1.482–9T Methods to determine taxableincome in connection with a controlledservices transaction (temporary).

* * * * *(m) * * *(3) Coordination with rules governing

cost sharing arrangements.

* * *(n) Effective/applicability dates.Par. 6. Section 1.482–1 is amended

by revising the last sentence of paragraph(c)(1) to read as follows:

§1.482–1 Allocation of income anddeductions among taxpayers.

* * * * *(c) * * *(1) * * * See §1.482–7T for the appli-

cable methods in the case of a cost sharingarrangement.

* * * * *Par. 7. Section 1.482–1T is amended

by:1. Revising paragraphs (b)(2)(i),

(b)(2)(ii), (c), (d)(1), (d)(2), (d)(3)(i),(d)(3)(ii) and (j)(6)(iii).

2. Adding a new paragraph (b)(2)(iii).3. Adding a new sentence to the end of

paragraph (j)(6)(i).The additions and revisions read as fol-

lows:

2009–7 I.R.B. 472 February 17, 2009

§1.482–1T Allocation of income anddeductions among taxpayers (temporary).

* * * * *(b) * * *(2) Arm’s length methods—(i) Meth-

ods. Sections 1.482–2 through 1.482–6,1.482–7T, and 1.482–9T provide specificmethods to be used to evaluate whethertransactions between or among membersof the controlled group satisfy the arm’slength standard, and if they do not, to de-termine the arm’s length result. Section1.482–1 and this section provide generalprinciples applicable in determining arm’slength results of such controlled trans-actions, but do not provide methods, forwhich reference must be made to thoseother sections in accordance with para-graphs (b)(2)(ii) and (iii) of this section.Section 1.482–7T provides the specificmethods to be used to evaluate whethera cost sharing arrangement as defined in§1.482–7T produces results consistentwith an arm’s length result.

(ii) [Reserved]. For further guidance,see §1.482–1(c) through (d)(3)(ii)(C) Ex-ample 1 and 2.

(iii) Coordination of methods applica-ble to certain intangible development ar-rangements. Section 1.482–7T providesthe specific methods to be used to de-termine arm’s length results of controlledtransactions in connection with a cost shar-ing arrangement as defined in §1.482–7T.Sections 1.482–4 and 1.482–9T, as appro-priate, provide the specific methods to beused to determine arm’s length results ofarrangements, including partnerships, forsharing the costs and risks of developingintangibles, other than a cost sharing ar-rangement covered by §1.482–7T. See also§§1.482–4T(g) (Coordination with rulesgoverning cost sharing arrangements) and1.482–9T(m)(3) (Coordination with rulesgoverning cost sharing arrangements).

(c) through (d)(3)(ii)(C) Examples 1and 2. [Reserved]. For further guidance,see §1.482–1(c) through (d)(3)(ii)(C) Ex-ample 1 and 2.

* * * * *(j) * * *(6) * * *(i) * * * The provision of paragraph

(b)(2)(iii) of this section is generally appli-cable on January 5, 2009.

* * * * *

(iii) Except as noted in the succeedingsentence, the applicability of §1.482–1Texpires on or before July 31, 2009. Theapplicability of paragraph (b)(2)(iii) of thissection expires on or before December 30,2011.

* * * * *Par. 8. Section 1.482–2T is amended as

follows:1. Paragraph (e) is redesignated as para-

graph (f) and newly-designated paragraph(f) is revised.

2. New paragraph (e) is added.The addition and revision reads as fol-

lows:

§1.482–2T Determination of taxableincome in specific situations (temporary)..

* * * * *(e) Cost sharing arrangement. For

rules governing allocations under section482 to reflect an arm’s length considera-tion for controlled transactions involving acost sharing arrangement, see §1.482–7T.

(f) Effective/applicability date—(1) Ingeneral. The provision of paragraph (b) ofthis section is generally applicable for taxyears beginning after December 31, 2006.The provision of paragraph (e) of this sec-tion is generally applicable on January 5,2009.

(2) Election to apply paragraph (b)to earlier taxable years. A person mayelect to apply the provisions of paragraph(b) of this section to earlier taxable yearsin accordance with the rules set forth in§1.482–9T(n)(2).

(3) Expiration date. The applicabilityof paragraph (b) of this section expires onor before July 31, 2009. The applicabilityof paragraph (e) of this section expires onor before December 30, 2011.

Par. 9. Section 1.482–4T is amended asfollows:

1. Paragraph (f)(3)(i)(B) is revised.2. Paragraph (f)(7) is removed.3. New paragraphs (g) and (h) are

added.The additions and revision reads as fol-

lows:

§1.482–4T Methods to determine taxableincome in connection with a transfer ofintangible property (temporary).

* * * * *(f) * * *

(3) * * *(i) * * *(B) Cost sharing arrangements. The

rules in this paragraph (f)(3) regardingownership with respect to cost shared in-tangibles and cost sharing arrangementswill apply only as provided in §1.482–7T.

* * * * *(g) Coordination with rules govern-

ing cost sharing arrangements. Section1.482–7T provides the specific methods tobe used to determine arm’s length resultsof controlled transactions in connectionwith a cost sharing arrangement. This sec-tion provides the specific methods to beused to determine arm’s length results ofa transfer of intangible property, includingin an arrangement for sharing the costsand risks of developing intangibles otherthan a cost sharing arrangement coveredby §1.482–7T. In the case of such an ar-rangement, consideration of the principles,methods, comparability, and reliabilityconsiderations set forth in §1.482–7T isrelevant in determining the best method,including an unspecified method, underthis section, as appropriately adjusted inlight of the differences in the facts andcircumstances between such arrangementand a cost sharing arrangement.

(h) Effective/applicability date—(1) Ingeneral. Except as provided in the suc-ceeding sentence, the provisions of para-graphs (f)(3) and (4) of this section aregenerally applicable for taxable years be-ginning after December 31, 2006. The pro-visions of paragraphs (f)(3)(i)(B) and (g)of this section are generally applicable onJanuary 5, 2009.

(2) Election to apply regulation to ear-lier taxable years. A person may elect toapply the provisions of paragraphs (f)(3)and (4) of this section to earlier taxableyears in accordance with the rules set forthin §1.482–9T(n)(2).

(3) Expiration date. The applicabilityof this section expires on or before Decem-ber 30, 2011.

Par. 10. Section 1.482–5 is amendedby revising the last sentence of paragraph(c)(2)(iv) to read as follows:

§1.482–5 Comparable profits method.

* * * * *(c) * * *(2) * * *

February 17, 2009 473 2009–7 I.R.B.

(iv) * * * As another example, it may beappropriate to adjust the operating profitof a party to account for material differ-ences in the utilization of or accountingfor stock-based compensation (as definedby §1.482–7T(d)(3)(i)) among the testedparty and comparable parties.

* * * * *Par. 11. Section 1.482–7 is redesig-

nated §1.482–7A, and an undesignatedcenterheading preceding §1.482–7A isadded to read as follows:

Regulations applicable on or beforeJanuary 4, 2009.

Par. 12. Section 1.482–7T is added toread as follows:

§1.482–7T Methods to determine taxableincome in connection with a cost sharingarrangement (temporary).

(a) In general. The arm’s lengthamount charged in a controlled transactionreasonably anticipated to contribute todeveloping intangibles pursuant to a costsharing arrangement (CSA), as describedin paragraph (b) of this section, must bedetermined under a method described inthis section. Each method must be ap-plied in accordance with the provisions of§1.482–1, except as those provisions aremodified in this section.

(1) RAB share method for cost shar-ing transactions (CSTs). See paragraph(b)(1)(i) of this section regarding the re-quirement that controlled participants, asdefined in section (j)(1)(i) of this section,share intangible development costs (IDCs)in proportion to their shares of reason-ably anticipated benefits (RAB shares)by entering into cost sharing transactions(CSTs).

(2) Methods for platform contributiontransactions (PCTs). The arm’s lengthamount charged in a platform contribu-tion transaction (PCT) described in para-graph (b)(1)(ii) of this section must be de-termined under the method or methods ap-plicable under the other section or sec-tions of the section 482 regulations, as sup-plemented by paragraph (g) of this sec-tion. See §1.482–1(b)(2)(ii) (Selection ofcategory of method applicable to transac-tion), §1.482–1T(b)(2)(iii) (Coordinationof methods applicable to certain intangi-ble development arrangements), and para-graph (g) of this section (Supplementalguidance on methods applicable to PCTs).

(3) Methods for other controlled trans-actions—(i) Contribution to a CSA by acontrolled taxpayer that is not a controlledparticipant. If a controlled taxpayer thatis not a controlled participant contributesto developing a cost shared intangible,as defined in section (j)(1)(i) of this sec-tion, it must receive consideration fromthe controlled participants under the rulesof §1.482–4T(f)(4) (Contribution to thevalue of an intangible owned by another).Such consideration will be treated as anintangible development cost for purposesof paragraph (d) of this section.

(ii) Transfer of interest in a cost sharedintangible. If at any time (during the term,or upon or after the termination, of a CSA)a controlled participant transfers an inter-est in a cost shared intangible to anothercontrolled taxpayer, the controlled partici-pant must receive an arm’s length amountof consideration from the transferee un-der the rules of §§1.482–1 and 1.482–4through 1.482–6 as supplemented by para-graph (f)(4) of this section regarding arm’slength consideration for a change in par-ticipation. For this purpose, a capabilityvariation described in paragraph (f)(3) ofthis section is considered to be a controlledtransfer of interests in cost shared intangi-bles.

(iii) Other controlled transactions inconnection with a CSA. Controlled trans-actions between controlled participantsthat are not PCTs or CSTs (for example,provision of a cross operating contribu-tion, as defined in paragraph (j)(1)(i) ofthis section, or make-or-sell rights) requirearm’s length consideration from the lattercontrolled participant under the rules of§§1.482–1, 1.482–4 through 1.482–6, and1.482–9T as supplemented by paragraph(g)(2)(iv) of this section.

(iv) Controlled transactions in the ab-sence of a CSA. If a controlled transac-tion is reasonably anticipated to contributeto developing intangibles pursuant to anarrangement that is not a CSA describedin paragraph (b)(1) or (5) of this section,whether the results of any such controlledtransaction are consistent with an arm’slength result must be determined under theapplicable rules of the other sections ofthe regulations under section 482. Forexample, an arrangement for developingintangibles in which one controlled tax-payer’s costs of developing the intangi-bles significantly exceeds its share of rea-

sonably anticipated benefits from exploit-ing the developed intangibles would not insubstance be a CSA, as described in para-graphs (b)(1)(i) through (iii) of this sectionor paragraph (b)(5)(i) of this section. Insuch a case, unless the rules of this sec-tion are applicable by reason of paragraph(b)(5) of this section, the arrangement mustbe analyzed under other applicable sec-tions of regulations under section 482 todetermine whether it achieves arm’s lengthresults, and if not, to determine any alloca-tions by the Commissioner that are consis-tent with such other regulations under sec-tion 482. See §§1.482–1(b)(2)(ii) (Selec-tion of category of method applicable totransaction) and 1.482–1T(b)(2)(iii) (Co-ordination of methods applicable to certainintangible development arrangements).

(4) Coordination with the arm’s lengthstandard. A CSA produces results thatare consistent with an arm’s length resultwithin the meaning of §1.482–1(b)(1) if,and only if, each controlled participant’sIDC share (as determined under paragraph(d)(4) of this section) equals its RABshare, each controlled participant com-pensates its RAB share of the value of allplatform contributions by other controlledparticipants, and all other requirements ofthis section are satisfied.

(b) Cost sharing arrangement. A costsharing arrangement is an arrangementby which controlled participants share thecosts and risks of developing cost sharedintangibles in proportion to their RABshares. An arrangement is a CSA if andonly if the requirements of paragraphs(b)(1) through (4) of this section are met.

(1) Substantive requirements—(i)CSTs. All controlled participants mustcommit to, and in fact, engage in cost shar-ing transactions. In CSTs, the controlledparticipants make payments to each other(CST Payments) as appropriate, so that ineach taxable year each controlled partic-ipant’s IDC share is in proportion to itsrespective RAB share.

(ii) PCTs. All controlled participantsmust commit to, and in fact, engage inplatform contributions transactions to theextent that there are platform contributionspursuant to paragraph (c) of this section.In a PCT, each other controlled participant(PCT Payor) is obligated to, and must infact, make arm’s length payments (PCTPayments) to each controlled participant(PCT Payee) that provides a platform con-

2009–7 I.R.B. 474 February 17, 2009

tribution. For guidance on determiningsuch arm’s length obligation, see para-graph (g) of this section.

(iii) Divisional interests. Eachcontrolled participant must receive anon-overlapping interest in the cost sharedintangibles without further obligation tocompensate another controlled participantfor such interest.

(iv) Examples. The following examplesillustrate the principles of this paragraph(b)(1):

Example 1. Company A and Company B, whoare members of the same controlled group, executean agreement to jointly develop vaccine X and ownthe exclusive rights to commercially exploit vaccineX in their respective territories, which together com-prise the whole world. The agreement provides thatthey will share some, but not all, of the costs fordeveloping Vaccine X in proportion to RAB share.Such agreement is not a CSA because Company Aand Company B have not agreed to share all of theIDCs in proportion to their respective RAB shares.

Example 2. Company A and Company B agreeto share all the costs of developing Vaccine X. Theagreement also provides for employing certain re-sources and capabilities of Company A in this pro-gram including a skilled research team and certainresearch facilities, and provides for Company B tomake payments to Company A in this respect. How-ever, the agreement expressly provides that the pro-gram will not employ, and so Company B is expresslyrelieved of the payments in regard to, certain softwaredeveloped by Company A as a medical research toolto model certain cellular processes expected to be im-plicated in the operation of Vaccine X even thoughsuch software would reasonably be anticipated to berelevant to developing Vaccine X and, thus, would bea platform contribution. See paragraph (c) of this sec-tion. Such agreement is not a CSA because CompanyA and Company B have not engaged in a necessaryPCT for purposes of developing Vaccine X.

Example 3. Companies C and D, who are mem-bers of the same controlled group, enter into a CSA.In the first year of the CSA, C and D conduct the in-tangible development activity, as described in para-graph (d)(1) of this section. The total IDCs in re-gard to such activity are $3,000,000 of which C andD pay $2,000,000 and $1,000,000, respectively, di-rectly to third parties. As between C and D, how-ever, their CSA specifies that they will share all IDCsin accordance with their RAB shares (as describedin paragraph (e)(1) of this section), which are 60%for C and 40% for D. It follows that C should bear$1,800,000 of the total IDCs (60% of total IDCs of$3,000,000) and D should bear $1,200,000 of the totalIDCs (40% of total IDCs of $3,000,000). D makes aCST payment to C of $200,000, that is, the amount bywhich D’s share of IDCs in accordance with its RABshare exceeds the amount of IDCs initially borne byD ($1,200,000 - $1,000,000), and which also equalsthe amount by which the total IDCs initially borne byC exceeds its share of IDCS in accordance with itsRAB share ($2,000,000 - $1,800,000). As a result ofD’s CST payment to C, the IDC shares of C and D arein proportion to their respective RAB shares.

(2) Administrative requirements. TheCSA must meet the requirements of para-graph (k) of this section.

(3) Date of a PCT. The controlled par-ticipants must enter into a PCT as of theearliest date on or after the CSA is enteredinto on which a platform contribution isreasonably anticipated to contribute to de-veloping cost shared intangibles.

(4) Divisional interests—(i) In general.Pursuant to paragraph (b)(1)(iii) of thissection, each controlled participant mustreceive a non-overlapping interest in thecost shared intangibles without furtherobligation to compensate another con-trolled participant for such interest. Eachcontrolled participant must be entitled tothe perpetual and exclusive right to theprofits from transactions of any memberof the controlled group that includes thecontrolled participant with uncontrolledtaxpayers to the extent that such profitsare attributable to such interest in the costshared intangibles.

(ii) Territorial based divisional inter-ests. The CSA may divide all interestsin cost shared intangibles on a territorialbasis as follows. The entire world must bedivided into two or more non-overlappinggeographic territories. Each controlledparticipant must receive at least one suchterritory, and in the aggregate all the par-ticipants must receive all such territories.Each controlled participant will be as-signed the perpetual and exclusive right toexploit the cost shared intangibles throughthe use, consumption, or disposition ofproperty or services in its territories. Thus,compensation will be required if othermembers of the controlled group exploitthe cost shared intangibles in such terri-tory.

(iii) Field of use based divisional inter-ests. The CSA may divide all interests incost shared intangibles on the basis of alluses (whether or not known at the time ofthe division) to which cost shared intangi-bles are to be put as follows. All antici-pated uses of cost shared intangibles mustbe identified. Each controlled participantmust be assigned at least one such antici-pated use, and in the aggregate all the par-ticipants must be assigned all such antic-ipated uses. Each controlled participantwill be assigned the perpetual and exclu-sive right to exploit the cost shared intan-gibles through the use or uses assigned to it

and one controlled participant must be as-signed the exclusive and perpetual right toexploit cost shared intangibles through anyunanticipated uses.

(iv) Other divisional bases. (A) In theevent that the CSA does not divide inter-ests in the cost shared intangibles on thebasis of exclusive territories or fields ofuse as described in paragraphs (b)(4)(ii)and (iii) of this section, the CSA mayadopt some other basis on which to divideall interests in the cost shared intangiblesamong the controlled participants, pro-vided that each of the following criteria ismet:

(1) The basis clearly and unambigu-ously divides all interests in cost sharedintangibles among the controlled partici-pants.

(2) The consistent use of such basisfor the division of all interests in the costshared intangibles can be dependably ver-ified from the records maintained by thecontrolled participants.

(3) The rights of the controlled partici-pants to exploit cost shared intangibles arenon-overlapping, exclusive, and perpetual.

(4) The resulting benefits associatedwith each controlled participant’s interestin cost shared intangibles are predictablewith reasonable reliability.

(B) See paragraph (f)(3) of this sec-tion for rules regarding the requirementof arm’s length consideration for changesin participation in CSAs involving divi-sions of interest described in this para-graph (b)(4)(iv).

(v) Examples. The following examplesillustrate the principles of this paragraph(b)(4):

Example 1. Companies P and S, both membersof the same controlled group, enter into a CSA to de-velop product Z. Under the CSA, P receives the in-terest in product Z in the United States and S receivesthe interest in product Z in the rest of the world, asdescribed in paragraph (b)(4)(ii) of this section. BothP and S have plants for manufacturing product Z lo-cated in their respective geographic territories. How-ever, for commercial reasons, product Z is neverthe-less manufactured by P in the United States for sale tocustomers in certain locations just outside the UnitedStates in close proximity to P’s U.S. manufacturingplant. Because S owns the territorial rights outsidethe United States, P must compensate S to ensure thatS realizes all the cost shared intangible profits fromP’s sales of product Z in S’s territory. The pricingof such compensation must also ensure that P real-izes an appropriate return for its manufacturing ef-forts. Benefits projected with respect to such saleswill be included for purposes of estimating S’s, butnot P’s, RAB share.

February 17, 2009 475 2009–7 I.R.B.

Example 2. The facts are the same as in Exam-ple 1 except that P and S agree to divide their inter-est in product Z based on site of manufacturing. Pwill have exclusive and perpetual rights in productZ manufactured in facilities owned by P. S will haveexclusive and perpetual rights to product Z manufac-tured in facilities owned by S. P and S agree that nei-ther will license manufacturing rights in product Z toany related or unrelated party. Both P and S maintainbooks and records that allow production at all sitesto be verified. Both own facilities that will manu-facture product Z and the relative capacities of thesesites are known. All facilities are currently operatingat near capacity and are expected to continue to oper-ate at near capacity when product Z enters productionso that it will not be feasible to shift production be-tween P’s and S’s facilities. P and S have no plansto build new facilities and the lead time required toplan and build a manufacturing facility precludes thepossibility that P or S will build a new facility duringthe period for which sales of Product Z are expected.Based on these facts, this basis for the division of in-terests in Product Z is a division described in para-graph (b)(4)(iv) of this section. The basis for the di-vision of interest is unambiguous and clearly definedand its use can be dependably verified. P and S bothhave non-overlapping, exclusive and perpetual rightsin Product Z. The division of interest results in theparticipant’s relative benefits being predictable withreasonable reliability.

Example 3. The facts are the same as in Example2 except that P’s and S’s manufacturing facilities arenot expected to operate at full capacity when productZ enters production. Production of Product Z can beshifted at any time between sites owned by P and sitesowned by S, although neither P nor S intends to shiftproduction as a result of the agreement. The divisionof interests in Product Z between P and S based onmanufacturing site is not a division described in para-graph (b)(4)(iv) of this section because their relativeshares of benefits are not predictable with reasonablereliability. The fact that neither P nor S intends toshift production is irrelevant.

(5) Treatment of certain arrangementsas CSAs—(i) Situation in which Commis-sioner must treat arrangement as a CSA.The Commissioner must apply the rules ofthis section to an arrangement among con-trolled taxpayers if the administrative re-quirements of paragraph (b)(2) of this sec-tion are met with respect to such arrange-ment and the controlled taxpayers reason-ably concluded that such arrangement wasa CSA meeting the requirements of para-graphs (b)(1), (3), and (4) of this section.

(ii) Situation in which Commissionermay treat arrangement as a CSA. For ar-rangements among controlled taxpayersnot described in paragraph (b)(5)(i) of thissection, the Commissioner may apply theprovisions of this section if the Commis-sioner concludes that the administrativerequirements of paragraph (b)(2) of thissection are met, and, notwithstandingtechnical failure to meet the substantive

requirements of paragraph (b)(1), (3), or(4) of this section, the rules of this sectionwill provide the most reliable measure ofan arm’s length result. See §1.482–1(c)(1)(the best method rule). For purposes ofapplying this paragraph (b)(5)(ii), anysuch arrangement shall be interpreted byreference to paragraph (k)(1)(iv) of thissection.

(iii) Examples. The following examplesillustrate the principles of this paragraph(b)(5). In the examples, assume that Com-panies P and S are both members of thesame controlled group.

Example 1. (i) P owns the patent on a formula fora capsulated pain reliever, P-Cap. P reasonably antic-ipates, pending further research and experimentation,that the P-Cap formula could form the platform for aformula for P-Ves, an effervescent version of P-Cap.P also owns proprietary software that it reasonablyanticipates to be critical to the research efforts. P andS execute a contract that purports to be a CSA bywhich they agree to proportionally share the costs andrisks of developing a formula for P-Ves. The agree-ment reflects the various contractual requirements de-scribed in paragraph (k)(1) of this section and P andS comply with the documentation, accounting, andreporting requirements of paragraphs (k)(2) through(4) of this section. Both the patent rights for P-Capand the software are reasonably anticipated to con-tribute to the development of P-Ves and therefore areplatform contributions for which compensation is duefrom S as part of PCTs. Though P and S enter into andimplement a PCT for the P-Cap patent rights that sat-isfies the arm’s length standard, they fail to enter intoa PCT for the software.

(ii) In this case, P and S have substantially com-plied with the contractual requirements of paragraph(k)(1) of this section and the documentation, account-ing, and reporting requirements of paragraphs (k)(2)through (4) of this section and therefore have met theadministrative requirements of paragraph (b)(2) ofthis section. However, because they did not enter intoa PCT, as required under paragraphs (b)(1)(ii) and(b)(3) of this section, for the software that was rea-sonably anticipated to contribute to the developmentof P-Ves (see paragraph (c) of this section), they can-not reasonably conclude that their arrangement was aCSA. Accordingly, the Commissioner is not requiredunder paragraph (b)(5)(i) of this section to apply therules of this section to their arrangement.

(iii) Nevertheless, the arrangement between P andS closely resembles a CSA. If the Commissioner con-cludes that the rules of this section provide the mostreliable measure of an arm’s length result for such ar-rangement, then pursuant to paragraph (b)(5)(ii) ofthis section, the Commissioner may apply the rulesof this section and treat P and S as entering into aPCT for the software in accordance with the require-ments of paragraph (b)(1)(ii) of this section, and makeany appropriate allocations under paragraph (i) of thissection. Alternatively, the Commissioner may con-clude that the rules of this section do not provide themost reliable measure of an arm’s length result. Insuch case, the arrangement would be analyzed underthe methods under other sections of the 482 regula-

tions to determine whether the arrangement reachesan arm’s length result.

Example 2. The facts are the same as Example1 except that P and S do enter into and implement aPCT for the software as required under this paragraph(b). The Commissioner determines that the PCT Pay-ments for the software were not arm’s length; never-theless, under the facts and circumstances at the timethey entered into the CSA and PCTs, P and S rea-sonably concluded their arrangement to be a CSA.Because P and S have met the requirements of para-graph (b)(2) of this section and reasonably concludedtheir arrangement is a CSA, pursuant to paragraph(b)(5)(i) of this section, the Commissioner must ap-ply the rules of this section to their arrangement. Ac-cordingly, the Commissioner treats the arrangementas a CSA and makes adjustments to the PCT Pay-ments as appropriate under this section to achieve anarm’s length result for the PCT for the software.

Example 3. (i) The facts are the same as Exam-ple 1 except that P and S do enter into a PCT for thesoftware as required under this paragraph (b). Theagreement entered into by P and S provides for a fixedconsideration of $50 million per year for four years,payable at the end of each year. This agreement sat-isfies the arm’s length standard. However, S actuallypays P consideration at the end of each year in theform of four annual royalties equal to two percent ofsales. While such royalties at the time of the PCTwere expected to be $50 million per year, actual salesduring the first year were less than anticipated and thefirst royalty payment was only $25 million.

(ii) In this case, P and S failed to implement theterms of their agreement. Under these circumstances,P and S could not reasonably conclude that theirarrangement was a CSA, as described in paragraph(b)(1) of this section. Accordingly, the Commis-sioner is not required under paragraph (b)(5)(i) ofthis section to apply the rules of this section to theirarrangement.

(iii) Nevertheless, the arrangement between Pand S closely resembles a CSA. If the Commissionerconcludes that that the rules of this section providethe most reliable measure of an arm’s length resultfor such arrangement, then pursuant to paragraph(b)(5)(ii) of this section, the Commissioner mayapply the rules of this section and make any appro-priate allocations under paragraph (i) of this section.Alternatively, the Commissioner may conclude thatthe rules of this section do not provide the mostreliable measure of an arm’s length result. In suchcase, the arrangement would be analyzed under themethods under other sections of the 482 regulationsto determine whether the arrangement reaches anarm’s length result.

Example 4. (i) The facts are the same as in Exam-ple 1 except that P does not own proprietary softwareand P and S use a method for determining the arm’slength amount of the PCT Payment for the P-Cappatent rights different from the method used in Ex-ample 1.

(ii) P and S determine that the arm’s lengthamount of the PCT Payments for the P-Cap patent is$10 million. However, the IRS determines the bestmethod for determining the arm’s length amount ofthe PCT Payments for the P-Cap patent rights andunder such method the arm’s length amount is $100million. To determine this $10 million present value,P and S assumed a useful life of eight years for

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the platform contribution, because the P-Cap patentrights will expire after eight years. However, useof the P-Cap patent rights in research is expected tolead to benefits attributable to exploitation of the costshared intangibles extending many years beyond theexpiration of the P-Cap patent, because use of theP-Cap patent rights will let P and S bring P-Ves tomarket before the competition, and because P andS expect to apply for additional patents coveringP-Ves, which would bar competitors from selling thatproduct for many future years. The assumption byP and S of a useful life for the platform contributionthat is less than the anticipated period of exploitationof the cost shared intangibles is contrary to paragraph(g)(2)(ii) of this section, and reduces the reliabilityof the method used by P and S.

(iii) The method used by P and S employs a de-clining royalty. The royalty starts at 8% of sales,based on an application of the CUT method in whichthe purported CUTs all involve licenses to manufac-ture and sell the current generation of P-Cap, and de-clines to 0% over eight years, declining by 1% eachyear. Such make-or-sell rights are fundamentally dif-ferent from use of the P-Cap patent rights to gen-erate a new product. This difference raises the is-sue of whether the make-or-sell rights are sufficientlycomparable to the rights that are the subject of thePCT Payment. See §1.482–4(c)(4). While a royaltyrate for make-or-sell rights can form the basis for areliable determination of an arm’s length PCT Pay-ment in the CUT-based implementation of the incomemethod described in paragraph (g)(4) of this section,under that method such royalty rate does not declineto zero. Therefore, the use of a declining royalty ratebased on an initial rate for make-or-sell rights furtherreduces the reliability of the method used by P and S.

(iv) Sales of the next-generation product are notanticipated until after seven years, at which point theroyalty rate will have declined to 1%. The tempo-ral mismatch between the period of the royalty ratedecline and the period of exploitation raises furtherconcerns about the method’s reliability.

(v) For the reasons given in paragraphs (ii)through (iv) of this Example 4, the method used by Pand S is so unreliable and so contrary to provisionsof this section that P and S could not reasonablyconclude that they had contracted to make arm’slength PCT Payments as required by paragraphs(b)(1)(ii) and (b)(3) of this section, and thus couldnot reasonably conclude that their arrangement was aCSA. Accordingly, the Commissioner is not requiredunder paragraph (b)(5)(i) of this section to apply therules of this section to their arrangement.

(vi) Nevertheless, the arrangement between Pand S closely resembles a CSA. If the Commissionerconcludes that that the rules of this section providethe most reliable measure of an arm’s length resultfor such arrangement, then pursuant to paragraph(b)(5)(ii) of this section, the Commissioner may ap-ply the rules of this section and make any appropriateallocations under paragraph (i) of this section. Al-ternatively, the Commissioner may conclude that therules of this section do not provide the most reliablemeasure of an arm’s length result. In such case, thearrangement would be analyzed under the methodsunder other section 482 regulations to determinewhether the arrangement reaches an arm’s lengthresult.

(6) Entity classification of CSAs. See§301.7701–1(c) of this chapter for the clas-sification of CSAs for purposes of the In-ternal Revenue Code.

(c) Platform contributions-(1) In gen-eral. A platform contribution is any re-source, capability, or right that a controlledparticipant has developed, maintained, oracquired externally to the intangible devel-opment activity (whether prior to or dur-ing the course of the CSA) that is rea-sonably anticipated to contribute to devel-oping cost shared intangibles. The deter-mination whether a resource, capability,or right is reasonably anticipated to con-tribute to developing cost shared intangi-bles is ongoing and based on the best avail-able information. Therefore, a resource,capability, or right reasonably determinednot to be a platform contribution as of anearlier point in time, may be reasonably de-termined to be a platform contribution ata later point in time. The PCT obligationregarding a resource or capability or rightonce determined to be a platform contribu-tion does not terminate merely because itmay later be determined that such resourceor capability or right has not contributed,and no longer is reasonably anticipated tocontribute, to developing cost shared in-tangibles. Notwithstanding the other pro-visions of this paragraph (c), platform con-tributions do not include rights in land ordepreciable tangible property, and do notinclude rights in other resources acquiredby IDCs. See paragraph (d)(1) of this sec-tion.

(2) Terms of platform contribu-tions—(i) Presumed to be exclusive. Forpurposes of a PCT, the PCT Payee’s provi-sion of a platform contribution is presumedto be exclusive. Thus, it is presumed thatthe platform resource, capability, or rightis not reasonably anticipated to be com-mitted to any business activities other thanthe CSA Activity, as defined in paragraph(j)(1)(i) of this section, whether carriedout by the controlled participants, othercontrolled taxpayers, or uncontrolled tax-payers.

(ii) Rebuttal of exclusivity. The con-trolled participants may rebut the pre-sumption set forth in paragraph (c)(2)(i)of this section to the satisfaction of theCommissioner. For example, if the plat-form resource is a research tool, then thecontrolled participants could rebut thepresumption by establishing to the satis-

faction of the Commissioner that, as ofthe date of the PCT, the tool is reasonablyanticipated not only to contribute to theCSA Activity but also to be licensed to anuncontrolled taxpayer. In such case, thePCT Payments may need to be prorated asdescribed in paragraph (c)(2)(iii) of thissection.

(iii) Proration of PCT Payments to theextent allocable to other business activi-ties—(A) In general. Some transfer pric-ing methods employed to determine thearm’s length amount of the PCT Paymentsdo so by considering the overall value ofthe platform contributions as opposed to,for example, the value of the anticipateduse of the platform contributions in theCSA Activity. Such a transfer pricingmethod is consistent with the presumptionthat the platform contribution is exclusive(that is, that the resources, capabilities orrights that are the subject of a platformcontribution are reasonably anticipated tocontribute only to the CSA Activity). Seeparagraph (c)(2)(i) of this section (Termsof platform contributions — Presumed tobe exclusive). The PCT Payments deter-mined under such transfer pricing methodmay have to be prorated if the controlledparticipants can rebut the presumption thatthe platform contribution is exclusive tothe satisfaction of the Commissioner asprovided in paragraph (c)(2)(ii) of this sec-tion. In the case of a platform contributionthat also contributes to lines of business ofa PCT Payor that are not reasonably antic-ipated to involve exploitation of the costshared intangibles, the need for explicitproration may in some cases be avoidedthrough aggregation of transactions. Seeparagraph (g)(2)(iv) of this section (Ag-gregation of transactions).

(B) Determining the proration of PCTPayments. Proration will be done on areasonable basis in proportion to the rel-ative economic value, as of the date ofthe PCT, reasonably anticipated to be de-rived from the platform contribution by theCSA Activity as compared to the valuereasonably anticipated to be derived fromthe platform contribution by other busi-ness activities. In the case of an aggre-gate valuation done under the principlesof paragraph (g)(2)(iv) of this section thataddresses payment for resources, capabil-ities, or rights used for business activitiesother than the CSA Activity (for example,the right to exploit an existing intangible

February 17, 2009 477 2009–7 I.R.B.

without further development), the prora-tion of the aggregate payments may haveto reflect the economic value attributableto such resources, capabilities, or rightsas well. For purposes of the best methodrule under §1.482–1(c), the reliability ofthe analysis under a method that requiresproration pursuant to this paragraph is re-duced relative to the reliability of an anal-ysis under a method that does not requireproration.

(3) Categorization of the PCT. For pur-poses of §1.482–1(b)(2)(ii) and paragraph(a)(2) of this section, a PCT must be identi-fied by the controlled participants as a par-ticular type of transaction (for example, alicense for royalty payments). See para-graph (k)(2)(ii)(H) of this section. Suchdesignation must be consistent with theactual conduct of the controlled partici-pants. If the conduct is consistent withdifferent, economically equivalent typesof transaction, then the controlled partici-pants may designate the PCT as being anyof such types of transaction. If the con-trolled participants fail to make such des-ignation in their documentation, the Com-missioner may make a designation con-sistent with the principles of paragraph(k)(1)(iv) of this section.

(4) Certain make-or-sell rights ex-cluded—(i) In general. Any right to ex-ploit an existing intangible without furtherdevelopment, such as the right to make,replicate, license or sell existing products,does not constitute a platform contributionto a CSA, and the arm’s length compen-sation for such rights (make-or-sell rights)does not satisfy the compensation obliga-tion under a PCT.

(ii) Examples. The following examplesillustrate the principles of this paragraph(c)(4):

Example 1. P and S, which are members of thesame controlled group, execute a CSA. Under theCSA, P and S will bear their RAB shares of IDCsfor developing the second generation of ABC, a com-puter software program. Prior to that arrangement,P had incurred substantial costs and risks to developABC. Concurrent with entering into the arrangement,P (as the licensor) executes a license with S (as the li-censee) by which S may make and sell copies of theexisting ABC. Such make-or-sell rights do not consti-tute a platform contribution to the CSA. The rules of§§1.482–1 and 1.482–4 through 1.482–6 must be ap-plied to determine the arm’s length consideration inconnection with the make-or-sell licensing arrange-ment. In certain circumstances, this determinationof the arm’s length consideration may be done onan aggregate basis with the evaluation of compensa-tion obligations pursuant to the PCTs entered into by

P and S in connection with the CSA. See paragraph(g)(2)(iv) of this section.

Example 2. (i) P, a software company, has devel-oped and currently exploits software program ABC.P and S enter into a CSA to develop future genera-tions of ABC. The ABC source code is the platformon which future generations of ABC will be built andis therefore a platform contribution of P for whichcompensation is due from S pursuant to a PCT. Con-current with entering into the CSA, P licenses to S themake-or-sell rights for the current version of ABC.P has entered into similar licenses with uncontrolledparties calling for sales-based royalty payments at arate of 20%. The current version of ABC has an ex-pected product life of three years. P and S enter intoa contingent payment agreement to cover both thePCT Payments due from S for P’s platform contri-bution and payments due from S for the make-or-selllicense. Based on the uncontrolled make-or-sell li-censes, P and S agree on a sales-based royalty rate of20% in Year 1 that declines on a straight line basis to0% over the 3 year product life of ABC.

(ii) The make-or-sell rights for the current versionof ABC are not platform contributions, though para-graph (g)(2)(iv) of this section provides for the possi-bility that the most reliable determination of an arm’slength charge for the platform contribution and themake-or-sell license may be one that values the twotransactions in the aggregate. A contingent paymentschedule based on the uncontrolled make-or-sell li-censes may provide an arm’s length charge for theseparate make-or-sell license between P and S, pro-vided the royalty rates in the uncontrolled licensessimilarly decline, but as a measure of the aggregatePCT and license payments it does not account forthe arm’s length value of P’s platform contributionswhich include the rights in the source code and futuredevelopment rights in ABC.

(5) Examples. The following examplesillustrate the principles of this paragraph(c). In each example, Companies P and Sare members of the same controlled group,and execute a CSA providing that eachwill have the exclusive right to exploit costshared intangibles in its own territory. Seeparagraph (b)(4)(ii) of this section (Terri-torial based divisional interests).

Example 1. Company P has developed and cur-rently markets version 1.0 of a new software appli-cation XYZ. Company P and Company S execute aCSA under which they will share the IDCs for de-veloping future versions of XYZ. Version 1.0 is rea-sonably anticipated to contribute to the developmentof future versions of XYZ and therefore CompanyP’s rights in version 1.0 constitute a platform contri-bution from Company P that must be compensatedby Company S pursuant to a PCT. Pursuant to para-graph (c)(3) of this section, the controlled partici-pants designate the platform contribution as a transferof intangibles that would otherwise be governed by§1.482–4, if entered into by controlled parties. Ac-cordingly, pursuant to paragraph (a)(2) of this sec-tion, the applicable method for determining the arm’slength value of the compensation obligation under thePCT between Company P and Company S will begoverned by §1.482–4 as supplemented by paragraph(g) of this section. Absent a showing to the contrary

by P and S, the platform contribution in this case ispresumed to be the exclusive provision of the bene-fit of all rights in version 1.0, other than the rightsdescribed in paragraph (c)(4) of this section (Certainmake-or-sell rights excluded). This includes the rightto use version 1.0 for purposes of research and theexclusive right in S’s territory to exploit any futureproducts that incorporated the technology of version1.0, and would cover a term extending as long as thecontrolled participants were to exploit future versionsof XYZ or any other product based on the version 1.0platform. The compensation obligation of CompanyS pursuant to the PCT will reflect the full value ofthe platform contribution, as limited by Company S’sRAB share.

Example 2. Company P and Company S executea CSA under which they will share the IDCs for de-veloping Vaccine Z. Company P will commit to theproject its research team that has successfully devel-oped a number of other vaccines. The expertise andexisting integration of the research team is a uniqueresource or capability of Company P which is reason-ably anticipated to contribute to the development ofVaccine Z. Therefore, P’s provision of the capabilitiesof the research team constitute a platform contribu-tion for which compensation is due from Company Sas part of a PCT. Pursuant to paragraph (c)(3) of thissection, the controlled parties designate the platformcontribution as a provision of services that would oth-erwise be governed by §1.482–9T(a) if entered intoby controlled parties. Accordingly, pursuant to para-graph (a)(2) of this section, the applicable method fordetermining the arm’s length value of the compensa-tion obligation under the PCT between Company Pand Company S will be governed by §1.482–9T(a) assupplemented by paragraph (g) of this section. Ab-sent a showing to the contrary by P and S, the plat-form contribution in this case is presumed to be theexclusive provision of the benefits by Company P ofits research team to the development of Vaccine Z.Because the IDCs include the ongoing compensationof the researchers, the compensation obligation un-der the PCT is only for the value of the commitmentof the research team by Company P to the CSA’s de-velopment efforts net of such researcher compensa-tion. The value of the compensation obligation ofCompany S for the PCT will reflect the full value ofthe provision of services, as limited by Company S’sRAB share.

(d) Intangible development costs—(1)Determining whether costs are IDCs.Costs included in IDCs are determined byreference to the scope of the intangibledevelopment activity (IDA).

(i) Definition and scope of the IDA. Forpurposes of this section, the IDA meansthe activity under the CSA of developingor attempting to develop reasonably antici-pated cost shared intangibles. The scope ofthe IDA includes all of the controlled par-ticipants’ activities that could reasonablybe anticipated to contribute to developingthe reasonably anticipated cost shared in-tangibles. The IDA cannot be describedmerely by a list of particular resources,capabilities, or rights that will be used in

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the CSA, because such a list would notidentify reasonably anticipated cost sharedintangibles. Also, the scope of the IDAmay change as the nature or identity of thereasonably anticipated cost shared intan-gibles changes or the nature of the activ-ities necessary for their development be-come clearer. For example, the relevanceof certain ongoing work to developing rea-sonably anticipated cost shared intangiblesor the need for additional work may onlybecome clear over time.

(ii) Reasonably anticipated cost sharedintangible. For purposes of this section,reasonably anticipated cost shared in-tangible means any intangible, withinthe meaning of §1.482–4(b), that, at theapplicable point in time, the controlledparticipants intend to develop under theCSA. Reasonably anticipated cost sharedintangibles may change over the courseof the CSA. The controlled participantsmay at any time change the reasonablyanticipated cost shared intangibles butmust document any such change pursuantto paragraph (k)(2)(ii)(A)(1) of this sec-tion. Removal of reasonably anticipatedcost shared intangibles does not affect thecontrolled participants’ interests in costshared intangibles already developed un-der the CSA. In addition, the reasonablyanticipated cost shared intangibles auto-matically expand to include the intendedresult of any further development of acost shared intangible already developedunder the CSA, or applications of suchan intangible. However, the controlledparticipants may override this automaticexpansion in a particular case if theyseparately remove specified further devel-opment of such intangible (or specifiedapplications of such intangible) from theIDA, and document such separate removalpursuant to paragraph (k)(2)(ii)(A)(3) ofthis section.

(iii) Costs included in IDCs. For pur-poses of this section, IDCs mean all costs,in cash or in kind (including stock-basedcompensation, as described in paragraph(d)(3) of this section), but excluding ac-quisition costs for land or depreciableproperty, in the ordinary course of busi-ness after the formation of a CSA that,based on analysis of the facts and circum-stances, are directly identified with, or arereasonably allocable to, the IDA. Thus,IDCs include costs incurred in attemptingto develop reasonably anticipated cost

shared intangibles regardless of whethersuch costs ultimately lead to developmentof those intangibles, other intangibles de-veloped unexpectedly, or no intangibles.IDCs shall also include the arm’s lengthrental charge for the use of any land ordepreciable tangible property (as deter-mined under §1.482–2(c) (Use of tangibleproperty)) directly identified with, or rea-sonably allocable to, the IDA. Referenceto generally accepted accounting princi-ples or Federal income tax accountingrules may provide a useful starting pointbut will not be conclusive regarding inclu-sion of costs in IDCs. IDCs do not includeinterest expense, foreign income taxes(as defined in §1.901–2(a)), or domesticincome taxes.

(iv) Examples. The following examplesillustrate the principles of this paragraph(d)(1):

Example 1. A contract that purports to be a CSAprovides that the IDA to which the agreement appliesconsists of all research and development activity con-ducted at laboratories A, B, and C but not at other fa-cilities maintained by the controlled participants. Thecontract does not describe the reasonably anticipatedcost shared intangibles with respect to which researchand development is to be undertaken. The contractfails to meet the requirements set forth in paragraph(k)(1)(ii)(B) of this section because it fails to ade-quately describe the scope of the IDA to be under-taken.

Example 2. A contract that purports to be a CSAprovides that the IDA to which the agreement ap-plies consists of all research and development activ-ity conducted by any of the controlled participantswith the goal of developing a cure for a particular dis-ease. Such a cure is thus a reasonably anticipated costshared intangible. The contract also contains a provi-sion that the IDA will exclude any activity that buildson the results of the controlled participants’ prior re-search concerning Enzyme X even though such ac-tivity could reasonably be anticipated to contributeto developing such cure. The contract fails to meetthe requirement set forth in paragraph (d)(1)(i) of thissection that the scope of the IDA include all of thecontrolled participants’ activities that could reason-ably be anticipated to contribute to developing rea-sonably anticipated cost shared intangibles.

(2) Allocation of costs. If a particularcost is directly identified with, or reason-ably allocable to, a function the results ofwhich will benefit both the IDA and otherbusiness activities, the cost must be allo-cated on a reasonable basis between theIDA and such other business activities inproportion to the relative economic valuethat the IDA and such other business ac-tivities are anticipated to derive from suchresults.

(3) Stock-based compensation—(i) Ingeneral. As used in this section, the termstock-based compensation means anycompensation provided by a controlledparticipant to an employee or independentcontractor in the form of equity instru-ments, options to acquire stock (stockoptions), or rights with respect to (or deter-mined by reference to) equity instrumentsor stock options, including but not limitedto property to which section 83 appliesand stock options to which section 421applies, regardless of whether ultimatelysettled in the form of cash, stock, or otherproperty.

(ii) Identification of stock-based com-pensation with the IDA. The determinationof whether stock-based compensation isdirectly identified with, or reasonablyallocable to, the IDA is made as of thedate that the stock-based compensationis granted. Accordingly, all stock-basedcompensation that is granted during theterm of the CSA and, at date of grant,is directly identified with, or reasonablyallocable to, the IDA is included as anIDC under paragraph (d)(1) of this sec-tion. In the case of a repricing or othermodification of a stock option, the deter-mination of whether the repricing or othermodification constitutes the grant of a newstock option for purposes of this paragraph(d)(3)(ii) will be made in accordance withthe rules of section 424(h) and relatedregulations.

(iii) Measurement and timing of stock-based compensation IDC—(A) In general.Except as otherwise provided in this para-graph (d)(3)(iii), the cost attributable tostock-based compensation is equal to theamount allowable to the controlled partic-ipant as a deduction for federal income taxpurposes with respect to that stock-basedcompensation (for example, under section83(h)) and is taken into account as an IDCunder this section for the taxable year forwhich the deduction is allowable.

(1) Transfers to which section 421 ap-plies. Solely for purposes of this paragraph(d)(3)(iii)(A), section 421 does not applyto the transfer of stock pursuant to the ex-ercise of an option that meets the require-ments of section 422(a) or 423(a).

(2) Deductions of foreign controlledparticipants. Solely for purposes of thisparagraph (d)(3)(iii)(A), an amount istreated as an allowable deduction of aforeign controlled participant to the extent

February 17, 2009 479 2009–7 I.R.B.

that a deduction would be allowable to aUnited States taxpayer.

(3) Modification of stock option.Solely for purposes of this paragraph(d)(3)(iii)(A), if the repricing or othermodification of a stock option is deter-mined, under paragraph (d)(3)(ii) of thissection, to constitute the grant of a newstock option not identified with, or reason-ably allocable to, the IDA, the stock optionthat is repriced or otherwise modified willbe treated as being exercised immediatelybefore the modification, provided that thestock option is then exercisable and thefair market value of the underlying stockthen exceeds the price at which the stockoption is exercisable. Accordingly, theamount of the deduction that would be al-lowable (or treated as allowable under thisparagraph (d)(3)(iii)(A)) to the controlledparticipant upon exercise of the stock op-tion immediately before the modificationmust be taken into account as an IDC asof the date of the modification.

(4) Expiration or termination of CSA.Solely for purposes of this paragraph(d)(3)(iii)(A), if an item of stock-basedcompensation identified with, or reason-ably allocable to, the IDA is not exercisedduring the term of a CSA, that item ofstock-based compensation will be treatedas being exercised immediately before theexpiration or termination of the CSA, pro-vided that the stock-based compensationis then exercisable and the fair marketvalue of the underlying stock then exceedsthe price at which the stock-based com-pensation is exercisable. Accordingly, theamount of the deduction that would beallowable (or treated as allowable underthis paragraph (d)(3)(iii)(A)) to the con-trolled participant upon exercise of thestock-based compensation must be takeninto account as an IDC as of the date ofthe expiration or termination of the CSA.

(B) Election with respect to optionson publicly traded stock—(1) In general.With respect to stock-based compensa-tion in the form of options on publiclytraded stock, the controlled participants ina CSA may elect to take into account allIDCs attributable to those stock optionsin the same amount, and as of the sametime, as the fair value of the stock optionsreflected as a charge against income inaudited financial statements or disclosedin footnotes to such financial statements,provided that such statements are prepared

in accordance with United States generallyaccepted accounting principles by or onbehalf of the company issuing the publiclytraded stock.

(2) Publicly traded stock. As used inthis paragraph (d)(3)(iii)(B), the term pub-licly traded stock means stock that is regu-larly traded on an established United Statessecurities market and is issued by a com-pany whose financial statements are pre-pared in accordance with United Statesgenerally accepted accounting principlesfor the taxable year.

(3) Generally accepted accountingprinciples. For purposes of this paragraph(d)(3)(iii)(B), a financial statement pre-pared in accordance with a comprehensivebody of generally accepted accountingprinciples other than United States gen-erally accepted accounting principles isconsidered to be prepared in accordancewith United States generally accepted ac-counting principles provided that either—

(i) The fair value of the stock optionsunder consideration is reflected in the rec-onciliation between such other accountingprinciples and United States generally ac-cepted accounting principles required to beincorporated into the financial statementby the securities laws governing compa-nies whose stock is regularly traded onUnited States securities markets; or

(ii) In the absence of a reconciliationbetween such other accounting principlesand United States generally accepted ac-counting principles that reflects the fairvalue of the stock options under consider-ation, such other accounting principles re-quire that the fair value of the stock op-tions under consideration be reflected asa charge against income in audited finan-cial statements or disclosed in footnotes tosuch statements.

(4) Time and manner of making theelection. The election described in thisparagraph (d)(3)(iii)(B) is made by anexplicit reference to the election in thewritten contract required by paragraph(k)(1) of this section or in a written amend-ment to the CSA entered into with theconsent of the Commissioner pursuant toparagraph (d)(3)(iii)(C) of this section. Inthe case of a CSA in existence on August26, 2003, the election by written amend-ment to the CSA may be made withoutthe consent of the Commissioner if suchamendment is entered into not later thanthe latest due date (with regard to exten-

sions) of a federal income tax return of anycontrolled participant for the first taxableyear beginning after August 26, 2003.

(C) Consistency. Generally, all con-trolled participants in a CSA taking op-tions on publicly traded stock into accountunder paragraph (d)(3)(ii), (d)(3)(iii)(A),or (d)(3)(iii)(B) of this section must usethat same method of identification, mea-surement and timing for all options onpublicly traded stock with respect to thatCSA. Controlled participants may changetheir method only with the consent ofthe Commissioner and only with respectto stock options granted during taxableyears subsequent to the taxable year inwhich the Commissioner’s consent is ob-tained. All controlled participants in theCSA must join in requests for the Com-missioner’s consent under this paragraph(d)(3)(iii)(C). Thus, for example, if thecontrolled participants make the electiondescribed in paragraph (d)(3)(iii)(B) ofthis section upon the formation of theCSA, the election may be revoked onlywith the consent of the Commissioner, andthe consent will apply only to stock op-tions granted in taxable years subsequentto the taxable year in which consent isobtained. Similarly, if controlled partici-pants already have granted stock optionsthat have been or will be taken into ac-count under the general rule of paragraph(d)(3)(iii)(A) of this section, then except incases specified in the last sentence of para-graph (d)(3)(iii)(B)(4) of this section, thecontrolled participants may make the elec-tion described in paragraph (d)(3)(iii)(B)of this section only with the consent of theCommissioner, and the consent will applyonly to stock options granted in taxableyears subsequent to the taxable year inwhich consent is obtained.

(4) IDC share. A controlled partici-pant’s IDC share for a taxable year is equalto the controlled participant’s cost contri-bution for the taxable year, divided by thesum of all IDCs for the taxable year. Acontrolled participant’s cost contributionfor a taxable year means all of the IDCs ini-tially borne by the controlled participant,plus all of the CST Payments that the par-ticipant makes to other controlled partici-pants, minus all of the CST Payments thatthe participant receives from other con-trolled participants.

(5) Examples. The following examplesillustrate this paragraph (d):

2009–7 I.R.B. 480 February 17, 2009

Example 1. Foreign parent (FP) and its U.S. sub-sidiary (USS) enter into a CSA to develop a bettermousetrap. USS and FP share the costs of FP’s R&Dfacility that will be exclusively dedicated to this re-search, the salaries of the researchers at the facility,and overhead costs attributable to the project. Theyalso share the cost of a conference facility that is atthe disposal of the senior executive management ofeach company. Based on the facts and circumstances,the cost of the conference facility cannot be directlyidentified with, and is not reasonably allocable to, theIDA. In this case, the cost of the conference facilitymust be excluded from the amount of IDCs.

Example 2. U.S. parent (USP) and its foreign sub-sidiary (FS) enter into a CSA to develop intangiblesfor producing a new device. USP and FS share thecosts of an R&D facility, the salaries of the facil-ity’s researchers, and overhead costs attributable tothe project. Although USP also incurs costs relatedto field testing of the device, USP does not includethose costs in the IDCs that USP and FS will shareunder the CSA. The Commissioner may determine,based on the facts and circumstances, that the costsof field testing are IDCs that the controlled partici-pants must share.

Example 3. U.S. parent (USP) and its foreignsubsidiary (FS) enter into a CSA to develop a newprocess patent. USP assigns certain employees to per-form solely R&D to develop a new mathematical al-gorithm to perform certain calculations. That algo-rithm will be used both to develop the new processpatent and to develop a new design patent the devel-opment of which is outside the scope of the CSA.During years covered by the CSA, USP compensatessuch employees with cash salaries, stock-based com-pensation, or a combination of both. USP and FSanticipate that the economic value attributable to theR&D will be derived from the process patent andthe design patent in a relative proportion of 75% and25%, respectively. Applying the principles of para-graph (d)(2) of this section, 75% of the compensationof such employees must be allocated to the develop-ment of the new process patent and, thus, treated asIDCs. With respect to the cash salary compensation,the IDC is 75% of the face value of the cash. Withrespect to the stock-based compensation, the IDC is75% of the value of the stock-based compensation asdetermined under paragraph (d)(3)(iii) of this section.

Example 4. Foreign parent (FP) and its U.S. sub-sidiary (USS) enter into a CSA to develop a new com-puter source code. FP has an executive officer whooversees a research facility and employees dedicatedsolely to the IDA. The executive officer also over-sees other research facilities and employees unrelatedto the IDA, and performs certain corporate overheadfunctions. The full amount of the costs of the researchfacility and employees dedicated solely to the IDAcan be directly identified with the IDA and, there-fore, are IDCs. In addition, based on the executiveofficer’s records of time worked on various matters,the controlled participants reasonably allocate 20%of the executive officer’s compensation to supervi-sion of the facility and employees dedicated to theIDA, 50% of the executive officer’s compensationto supervision of the facilities and employees unre-lated to the IDA, and 30% of the executive officer’scompensation to corporate overhead functions. Thecontrolled participants also reasonably determine that

the results of the executive officer’s corporate over-head functions yield equal economic benefit to theIDA and the other business activities of FP. Apply-ing the principles of paragraph (d)(1) of this section,the executive officer’s compensation allocated to su-pervising the facility and employees dedicated to theIDA (amounting to 20% of the executive officer’s to-tal compensation) must be treated as IDCs. Apply-ing the principles of paragraph (d)(2) of this section,half of the executive officer’s compensation allocatedto corporate overhead functions (that is, half of 30%of the executive officer’s total compensation), mustbe treated as IDCs. Therefore, a total of 35% (20%plus 15%) of the executive officer’s total compensa-tion must be treated as IDCs.

(e) Reasonably anticipated benefitsshare—(1) Definition—(i) In general. Acontrolled participant’s share of reason-ably anticipated benefits is equal to itsreasonably anticipated benefits dividedby the sum of the reasonably anticipatedbenefits, as defined in paragraph (j)(1)(i)of this section, of all the controlled par-ticipants. RAB shares must be updated toaccount for changes in economic condi-tions, the business operations and practicesof the participants, and the ongoing de-velopment of intangibles under the CSA.For purposes of determining RAB sharesat any given time, reasonably anticipatedbenefits must be estimated over the entireperiod, past and future, of exploitationof the cost shared intangibles, and mustreflect appropriate updates to take intoaccount the most reliable data regardingpast and projected future results availableat such time. A controlled participant’sRAB share must be determined by usingthe most reliable estimate. In determiningwhich of two or more available estimatesis most reliable, the quality of the dataand assumptions used in the analysis mustbe taken into account, consistent with§1.482–1(c)(2)(ii) (Data and assump-tions). Thus, the reliability of an estimatewill depend largely on the completenessand accuracy of the data, the soundnessof the assumptions, and the relative ef-fects of particular deficiencies in data orassumptions on different estimates. If twoestimates are equally reliable, no adjust-ment should be made based on differencesbetween the estimates. The followingfactors will be particularly relevant in de-termining the reliability of an estimate ofRAB shares:

(A) The basis used for measuring bene-fits, as described in paragraph (e)(2)(ii) ofthis section.

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

(ii) Example. The following exampleillustrates the principles of this paragraph(e)(1):

Example. (i) USP and FS plan to conduct re-search to develop Product Lines A and B. USP and FSreasonably anticipate respective benefits from Prod-uct Line A of 100X and 200X and respective bene-fits from Product Line B, respectively, of 300X and400X. USP and FS thus reasonably anticipate com-bined benefits from Product Lines A and B of 400Xand 600X, respectively.

(ii) USP and FS could enter into a separate CSA todevelop Product Line A with respective RAB sharesof 331/3 percent and 662/3 percent (reflecting a ratioof 100X to 200X), and into a separate CSA to de-velop Product Line B with respective RAB shares of426/7 percent and 571/7 percent (reflecting a ratio of300X to 400X). Alternatively, USP and FS could en-ter into a single CSA to develop both Product LinesA and B with respective RAB shares of 40 percentand 60 percent (in the ratio of 400X to 600X). If theseparate CSAs are chosen, then any costs for activi-ties that contribute to developing both Product LineA and Product Line B will constitute IDCs of the re-spective CSAs as required by paragraphs (d)(1) and(d)(2) of this section.

(2) Measure of benefits—(i) In general.In order to estimate a controlled partic-ipant’s RAB share, the amount of eachcontrolled participant’s reasonably antici-pated benefits must be measured on a ba-sis that is consistent for all such partici-pants. See paragraph (e)(2)(ii)(E) Exam-ple 9 of this section. If a controlled par-ticipant transfers a cost shared intangibleto another controlled taxpayer, other thanby way of a transfer described in para-graph (f) of this section, that controlledparticipant’s benefits from the transferredintangible must be measured by referenceto the transferee’s benefits, disregardingany consideration paid by the transferee tothe controlled participant (such as a roy-alty pursuant to a license agreement). Rea-sonably anticipated benefits are measuredeither on a direct basis, by reference toestimated benefits to be generated by theuse of cost shared intangibles (generallybased on additional revenues plus cost sav-ings less any additional costs incurred), oron an indirect basis, by reference to cer-tain measurements that reasonably can beassumed to relate to benefits to be gen-erated. Such indirect bases of measure-ment of anticipated benefits are describedin paragraph (e)(2)(ii) of this section. Acontrolled participant’s reasonably antici-pated benefits must be measured on the ba-

February 17, 2009 481 2009–7 I.R.B.

sis, whether direct or indirect, that mostreliably determines RAB shares. In de-termining which of two bases of measure-ment is most reliable, the factors set forthin §1.482–1(c)(2)(ii) (Data and assump-tions) must be taken into account. It nor-mally will be expected that the basis thatprovided the most reliable estimate for aparticular year will continue to provide themost reliable estimate in subsequent years,absent a material change in the factors thataffect the reliability of the estimate. Re-gardless of whether a direct or indirect ba-sis of measurement is used, adjustmentsmay be required to account for materialdifferences in the activities that controlledparticipants undertake to exploit their in-terests in cost shared intangibles. See Ex-amples 4 and 7 of paragraph (e)(2)(ii)(E)of this section.

(ii) Indirect bases for measuring antic-ipated benefits. Indirect bases for measur-ing anticipated benefits from participationin a CSA include the following:

(A) Units used, produced, or sold.Units of items used, produced, or sold byeach controlled participant in the businessactivities in which cost shared intangiblesare exploited may be used as an indirectbasis for measuring its anticipated ben-efits. This basis of measurement willmore reliably determine RAB shares tothe extent that each controlled participantis expected to have a similar increase innet profit or decrease in net loss attribut-able to the cost shared intangibles per unitof the item or items used, produced, orsold. This circumstance is most likely toarise when the cost shared intangibles areexploited by the controlled participants inthe use, production, or sale of substantiallyuniform items under similar economicconditions.

(B) Sales. Sales by each controlled par-ticipant in the business activities in whichcost shared intangibles are exploited maybe used as an indirect basis for measur-ing its anticipated benefits. This basis ofmeasurement will more reliably determineRAB shares to the extent that each con-trolled participant is expected to have asimilar increase in net profit or decrease innet loss attributable to cost shared intangi-bles per dollar of sales. This circumstanceis most likely to arise if the costs of exploit-ing cost shared intangibles are not substan-tial relative to the revenues generated, or if

the principal effect of using cost shared in-tangibles is to increase the controlled par-ticipants’ revenues (for example, througha price premium on the products they sell)without affecting their costs substantially.Sales by each controlled participant are un-likely to provide a reliable basis for mea-suring RAB shares unless each controlledparticipant operates at the same marketlevel (for example, manufacturing, distri-bution, etc.).

(C) Operating profit. Operating profitof each controlled participant from the ac-tivities in which cost shared intangibles areexploited, as determined before any ex-pense (including amortization) on accountof IDCs, may be used as an indirect basisfor measuring anticipated benefits. Thisbasis of measurement will more reliablydetermine RAB shares to the extent thatsuch profit is largely attributable to the useof cost shared intangibles, or if the shareof profits attributable to the use of costshared intangibles is expected to be sim-ilar for each controlled participant. Thiscircumstance is most likely to arise whencost shared intangibles are closely asso-ciated with the activity that generates theprofit and the activity could not be carriedon or would generate little profit withoutuse of those intangibles.

(D) Other bases for measuring antic-ipated benefits. Other bases for measur-ing anticipated benefits may in some cir-cumstances be appropriate, but only to theextent that there is expected to be a rea-sonably identifiable relationship betweenthe basis of measurement used and addi-tional income generated or costs saved bythe use of cost shared intangibles. For ex-ample, a division of costs based on em-ployee compensation would be consideredunreliable unless there were a relationshipbetween the amount of compensation andthe expected additional income generatedor costs saved by the controlled partici-pants from using the cost shared intangi-bles.

(E) Examples. The following examplesillustrates this paragraph (e)(2)(ii):

Example 1. Controlled parties A and B enter intoa CSA to develop product and process intangibles foralready existing Product P. Without such intangibles,A and B would each reasonably anticipate revenue,in present value terms, of $100M from sales of Prod-uct P until it becomes obsolete. With the intangibles,A and B each reasonably anticipate selling the samenumber of units each year, but reasonably anticipatethat the price will be higher. Because the particu-

lar product intangible is more highly regarded in A’smarket, A reasonably anticipates an increase of $20Min present value revenue from the product intangible,while B reasonably anticipates an increase of only$10M in present value from the product intangible.Further, A and B each reasonably anticipate spendingan additional amount equal to $5M in present valuein production costs to include the feature embodyingthe product intangible. Finally, A and B each rea-sonably anticipate saving an amount equal to $2M inpresent value in production costs by using the processintangible. A and B reasonably anticipate no othereconomic effects from exploiting the cost shared in-tangibles. A’s reasonably anticipated benefits fromexploiting the cost shared intangibles equal its rea-sonably anticipated increase in revenue ($20M) plusits reasonably anticipated cost savings ($2M) less itsreasonably anticipated increased costs ($5M), whichequals $17M. Similarly, B’s reasonably anticipatedbenefits from exploiting the cost shared intangiblesequal its reasonably anticipated increase in revenue($10M) plus its reasonably anticipated cost savings($2M) less its reasonably anticipated increased costs($5M), which equals $7M. Thus A’s reasonably an-ticipated benefits are $17M and B’s reasonably antic-ipated benefits are $7M.

Example 2. Foreign Parent (FP) and U.S. Sub-sidiary (USS) both produce a feedstock for the manu-facture of various high-performance plastic products.Producing the feedstock requires large amounts ofelectricity, which accounts for a significant portionof its production cost. FP and USS enter into a CSAto develop a new process that will reduce the amountof electricity required to produce a unit of the feed-stock. FP and USS currently both incur an electricitycost of $2 per unit of feedstock produced and ratesfor each are expected to remain similar in the future.The new process, if it is successful, will reduce theamount of electricity required by each company toproduce a unit of the feedstock by 50%. Switching tothe new process would not require FP or USS to in-cur significant investment or other costs. Therefore,the cost savings each company is expected to achieveafter implementing the new process are $1 per unit offeedstock produced. Under the CSA, FP and USS di-vide the costs of developing the new process based onthe units of the feedstock each is anticipated to pro-duce in the future. In this case, units produced is themost reliable basis for measuring RAB shares and di-viding the IDCs because each controlled participant isexpected to have a similar $1 (50% of current chargeof $2) decrease in costs per unit of the feedstock pro-duced.

Example 3. The facts are the same as in Exam-ple 2, except that currently USS pays $3 per unit offeedstock produced for electricity while FP pays $6per unit of feedstock produced. In this case, unitsproduced is not the most reliable basis for measuringRAB shares and dividing the IDCs because the par-ticipants do not expect to have a similar decrease incosts per unit of the feedstock produced. The Com-missioner determines that the most reliable measureof RAB shares may be based on units of the feed-stock produced if FP’s units are weighted relative toUSS’s units by a factor of 2. This reflects the factthat FP pays twice as much as USS for electricityand, therefore, FP’s savings of $3 per unit of the feed-stock (50% reduction of current charge of $6) wouldbe twice USS’s savings of $1.50 per unit of feedstock

2009–7 I.R.B. 482 February 17, 2009

(50% reduction of current charge of $3) from any newprocess eventually developed.

Example 4. The facts are the same as in Ex-ample 3, except that to supply the particular needsof the U.S. market USS manufactures the feedstockwith somewhat different properties than FP’s feed-stock. This requires USS to employ a somewhat dif-ferent production process than does FP. Because ofthis difference, USS would incur significant construc-tion costs in order to adopt any new process that maybe developed under the cost sharing agreement. Inthis case, units produced is not the most reliable ba-sis for measuring RAB shares. In order to reliablydetermine RAB shares, the Commissioner measuresthe reasonably anticipated benefits of USS and FP ona direct basis. USS’s reasonably anticipated benefitsare its reasonably anticipated total savings in elec-tricity costs, less its reasonably anticipated costs ofadopting the new process. FS’s reasonably antici-pated benefits are its reasonably anticipated total sav-ings in electricity costs.

Example 5. U.S. Parent (USP) and Foreign Sub-sidiary (FS) enter into a CSA to develop new anes-thetic drugs. USP obtains the right to market anyresulting drugs in the United States and FS obtainsthe right to market any resulting drugs in the rest ofthe world. USP and FS determine RAB shares onthe basis of their respective total anticipated operatingprofit from all drugs under development. USP antic-ipates that it will receive a much higher profit thanFS per unit sold because the price of the drugs is notregulated in the United States, whereas the price ofthe drugs is regulated in many non-U.S. jurisdictions.In both controlled participants’ territories, the antici-pated operating profits are almost entirely attributableto the use of the cost shared intangibles. In this case,the controlled participants’ basis for measuring RABshares is the most reliable.

Example 6. (i) Foreign Parent (FP) and U.S. Sub-sidiary (USS) manufacture and sell fertilizers. Theyenter into a CSA to develop a new pellet form of acommon agricultural fertilizer that is currently avail-able only in powder form. Under the CSA, USS ob-tains the rights to produce and sell the new form offertilizer for the U.S. market while FP obtains therights to produce and sell the new form of fertilizerin the rest of the world. The costs of developing thenew form of fertilizer are divided on the basis of theanticipated sales of fertilizer in the controlled partic-ipants’ respective markets.

(ii) If the research and development is successful,the pellet form will deliver the fertilizer more effi-ciently to crops and less fertilizer will be required toachieve the same effect on crop growth. The pelletform of fertilizer can be expected to sell at a pricepremium over the powder form of fertilizer based onthe savings in the amount of fertilizer that needs to beused. This price premium will be a similar premiumper dollar of sales in each territory. If the researchand development is successful, the costs of producingpellet fertilizer are expected to be approximately thesame as the costs of producing powder fertilizer andthe same for both FP and USS. Both FP and USS op-erate at approximately the same market levels, sellingtheir fertilizers largely to independent distributors.

(iii) In this case, the controlled participants’ basisfor measuring RAB shares is the most reliable.

Example 7. The facts are the same as in Exam-ple 6, except that FP distributes its fertilizers directly

while USS sells to independent distributors. In thiscase, sales of USS and FP are not the most reliablebasis for measuring RAB shares unless adjustmentsare made to account for the difference in market lev-els at which the sales occur.

Example 8. Foreign Parent (FP) and U.S. Sub-sidiary (USS) enter into a CSA to develop materialsthat will be used to train all new entry-level employ-ees. FP and USS determine that the new materialswill save approximately ten hours of training time peremployee. Because their entry-level employees arepaid on differing wage scales, FP and USS decide thatthey should not measure benefits based on the num-ber of entry-level employees hired by each. Rather,they measure benefits based on compensation paid tothe entry-level employees hired by each. In this case,the basis used for measuring RAB shares is the mostreliable because there is a direct relationship betweencompensation paid to new entry-level employees andcosts saved by FP and USS from the use of the newtraining materials.

Example 9. U.S. Parent (USP), Foreign Sub-sidiary 1 (FS1), and Foreign Subsidiary 2 (FS2) enterinto a CSA to develop computer software that eachwill market and install on customers’ computer sys-tems. The controlled participants measure benefitson the basis of projected sales by USP, FS1, andFS2 of the software in their respective geographicareas. However, FS1 plans not only to sell but alsoto license the software to unrelated customers, andFS1’s licensing income (which is a percentage ofthe licensees’ sales) is not counted in the projectedbenefits. In this case, the basis used for measuringthe benefits of each controlled participant is not themost reliable because all of the benefits received bycontrolled participants are not taken into account.In order to reliably determine RAB shares, FS1’sprojected benefits from licensing must be includedin the measurement on a basis that is the same asthat used to measure its own and the other controlledparticipants’ projected benefits from sales (for exam-ple, all controlled participants might measure theirbenefits on the basis of operating profit).

(iii) Projections used to estimate ben-efits—(A) In general. The reliability ofan estimate of RAB shares also dependsupon the reliability of projections used inmaking the estimate. Projections requiredfor this purpose generally include a deter-mination of the time period between theinception of the research and developmentactivities under the CSA and the receiptof benefits, a projection of the time overwhich benefits will be received, and aprojection of the benefits anticipated foreach year in which it is anticipated thatthe cost shared intangible will generatebenefits. A projection of the relevant basisfor measuring anticipated benefits mayrequire a projection of the factors thatunderlie it. For example, a projection ofoperating profits may require a projectionof sales, cost of sales, operating expenses,and other factors that affect operatingprofits. If it is anticipated that there will

be significant variation among controlledparticipants in the timing of their receipt ofbenefits, and consequently benefit sharesare expected to vary significantly over theyears in which benefits will be received,it normally will be necessary to use thepresent value of the projected benefitsto reliably determine RAB shares. Seeparagraph (g)(2)(v) of this section for bestmethod considerations regarding discountrates used for this purpose. If it is notanticipated that benefit shares will signif-icantly change over time, current annualbenefit shares may provide a reliable pro-jection of RAB shares. This circumstanceis most likely to occur when the CSA is along-term arrangement, the arrangementcovers a wide variety of intangibles, thecomposition of the cost shared intangiblesis unlikely to change, the cost shared in-tangibles are unlikely to generate unusualprofits, and each controlled participant’sshare of the market is stable.

(B) Examples. The following examplesillustrate the principles of this paragraph(e)(2)(iii):

Example 1. (i) Foreign Parent (FP) and U.S. Sub-sidiary (USS) enter into a CSA to develop a newcar model. The controlled participants plan to spendfour years developing the new model and four yearsproducing and selling the new model. USS and FPproject total sales of $4 billion and $2 billion, respec-tively, over the planned four years of exploitation ofthe new model. The controlled participants deter-mine RAB shares for each year of 662/3% for USSand 331/3% for FP, based on projected total sales.

(ii) USS typically begins producing and sellingnew car models a year after FP begins producing andselling new car models. In order to reflect USS’sone-year lag in introducing new car models, a morereliable projection of each participant’s RAB sharewould be based on a projection of all four years ofsales for each participant, discounted to present value.

Example 2. U.S. Parent (USP) and Foreign Sub-sidiary (FS) enter into a CSA to develop new and im-proved household cleaning products. Both controlledparticipants have sold household cleaning productsfor many years and have stable worldwide marketshares. The products under development are unlikelyto produce unusual profits for either controlled par-ticipant. The controlled participants determine RABshares on the basis of each controlled participant’scurrent sales of household cleaning products. In thiscase, the controlled participants’ RAB shares are re-liably projected by current sales of cleaning products.

Example 3. The facts are the same as in Example2, except that FS’s market share is rapidly expandingbecause of the business failure of a competitor in itsgeographic area. The controlled participants’ RABshares are not reliably projected by current sales ofcleaning products. FS’s benefit projections shouldtake into account its growth in market share.

Example 4. Foreign Parent (FP) and U.S. Sub-sidiary (USS) enter into a CSA to develop synthetic

February 17, 2009 483 2009–7 I.R.B.

fertilizers and insecticides. FP and USS share costson the basis of each controlled participant’s currentsales of fertilizers and insecticides. The marketshares of the controlled participants have been stablefor fertilizers, but FP’s market share for insecticideshas been expanding. The controlled participants’projections of RAB shares are reliable with regardto fertilizers, but not reliable with regard to insec-ticides; a more reliable projection of RAB shareswould take into account the expanding market sharefor insecticides.

(f) Changes in participation under aCSA—(1) In general. A change in partic-ipation under a CSA occurs when there iseither a controlled transfer of interests or acapability variation. A change in partici-pation requires arm’s length considerationunder paragraph (a)(3)(ii) of this section,and as more fully described in this para-graph (f).

(2) Controlled transfer of interests.A controlled transfer of interests occurswhen a participant in a CSA transfers allor part of its interests in cost shared in-tangibles under the CSA in a controlledtransaction, and the transferee assumesthe associated obligations under the CSA.After the controlled transfer of interestsoccurs, the CSA will still exist if at leasttwo controlled participants still have inter-ests in the cost shared intangibles. In sucha case, the transferee will be treated assucceeding to the transferor’s prior historyunder the CSA as pertains to the trans-ferred interests, including the transferor’scost contributions, benefits derived, andPCT Payments attributable to such rightsor obligations. A transfer that would oth-erwise constitute a controlled transfer ofinterests for purposes of this paragraph(f)(2) shall not constitute a controlledtransfer of interests if it also constitutes acapability variation for purposes of para-graph (f)(3) of this section.

(3) Capability variation. A capabilityvariation occurs when, in a CSA in whichinterests in cost shared intangibles are di-vided as described in paragraph (b)(4)(iv)of this section, the controlled participants’division of interests or their relative ca-pabilities or capacities to benefit from thecost shared intangibles are materially al-tered. For purposes of paragraph (a)(3)(ii)of this section, a capability variation isconsidered to be a controlled transfer ofinterests in cost shared intangibles, inwhich any controlled participant whoseRAB share decreases as a result of thecapability variation is a transferor, and any

controlled participant whose RAB sharethus increases is the transferee of the in-terests in cost shared intangibles.

(4) Arm’s length consideration for achange in participation. In the event of achange in participation, the arm’s lengthamount of consideration from the trans-feree, under the rules of §§1.482–1 and1.482–4 through 1.482–6 and paragraph(a)(3)(ii) of this section, will be deter-mined consistent with the reasonably an-ticipated incremental change in the returnsto the transferee and transferor resultingfrom such change in participation. Suchchanges in returns will themselves dependon the reasonably anticipated incrementalchanges in the benefits from exploitingthe cost shared intangibles, IDCs borne,and PCT Payments (if any). However,any arm’s length consideration requiredunder this paragraph (f)(4) with respectto a capability variation shall be reducedas necessary to prevent duplication ofan adjustment already performed underparagraph (i)(2)(ii)(A) of this section thatresulted from the same capability varia-tion. If an adjustment has been performedalready under this paragraph (f)(4) withrespect to a capability variation, then forpurposes of any adjustment to be per-formed under paragraph (i)(2)(ii)(A) ofthis section, the controlled participants’projected benefit shares referred to inparagraph (i)(2)(ii)(A) of this section shallbe considered to be the controlled partic-ipants’ respective RAB shares after thecapability variation occurred.

(5) Examples. The following examplesillustrate the principles of this paragraph(f):

Example 1. X, Y, and Z are the only controlledparticipants in a CSA. The CSA divides interests incost shared intangibles on a territorial basis as de-scribed in paragraph (b)(4)(ii) of this section. X isassigned the territories of the Americas, Y is assignedthe territory of the UK and Australia, and Z is as-signed the rest of the world. When the CSA is formed,X has a platform contribution T. Under the PCTs forT, Y and Z are each obligated to pay X royalties equalto five percent of their respective sales. Aside from T,there are no platform contributions. Two years afterthe formation of the CSA, Y transfers to Z its inter-est in cost shared intangibles relating to the UK ter-ritory, and the associated obligations, in a controlledtransfer of interests described in paragraph (f)(2) ofthis section. At that time the reasonably anticipatedbenefits from exploiting cost shared intangibles in theUK have a present value of $11M, the reasonably an-ticipated IDCs to be borne relating to the UK terri-tory have a present value of $3M, and the reasonablyanticipated PCT Payments to be made to X relating

to sales in the UK territory have a present value of$2M. As arm’s length consideration for the change inparticipation due to the controlled transfer of inter-ests, Z must pay Y compensation with an anticipatedpresent value of $11M, less $3M, less $2M, whichequals $6M.

Example 2. As in Example 2 of paragraph(b)(4)(v) of this section, companies P and S, bothmembers of the same controlled group, enter into aCSA to develop product Z. P and S agree to dividetheir interest in product Z based on site of manufac-turing. P will have exclusive and perpetual rights inproduct Z manufactured in facilities owned by P. Swill have exclusive and perpetual rights to productZ manufactured in facilities owned by S. P and Sagree that neither will license manufacturing rightsin product Z to any related or unrelated party. BothP and S maintain books and records that allow pro-duction at all sites to be verified. Both own facilitiesthat will manufacture product Z and the relativecapacities of these sites are known. All facilities arecurrently operating at near capacity and are expectedto continue to operate at near capacity when productZ enters production so that it will not be feasibleto shift production between P’s and S’s facilities. Pand S have no plans to build new facilities and thelead time required to plan and build a manufacturingfacility precludes the possibility that P or S will builda new facility during the period for which sales ofProduct Z are expected. When the CSA is formed,P has a platform contribution T. Under the PCTfor T, S is obligated to pay P sales-based royaltiesaccording to a certain formula. Aside from T, thereare no other platform contributions. Two years afterthe formation of the CSA, owing to a change in plansnot reasonably foreseeable at the time the CSA wasentered into, S acquires additional facilities F for themanufacture of Product Z. Such acquisition consti-tutes a capability variation described in paragraph(f)(3) of this section. Under this capability variation,S’s RAB share increases from 50% to 60%. Accord-ingly, there is a compensable change in participationunder paragraph (f)(3) of this section.

(g) Supplemental guidance on methodsapplicable to PCTs—(1) In general. Thisparagraph (g) provides supplemental guid-ance on applying the methods listed in thisparagraph (g)(1) for purposes of evaluat-ing the arm’s length amount charged in aPCT. Each method will yield a value forthe compensation obligation of each PCTPayor consistent with the product of thecombined pre-tax value to all controlledparticipants of the platform contributionthat is the subject of the PCT and the PCTPayor’s RAB share. The methods are—

(i) The comparable uncontrolled trans-action method described in §1.482–4(c), orthe comparable uncontrolled services pricemethod described in §1.482–9T(c), as fur-ther described in paragraph (g)(3) of thissection;

(ii) The income method, described inparagraph (g)(4) of this section;

2009–7 I.R.B. 484 February 17, 2009

(iii) The acquisition price method, de-scribed in paragraph (g)(5) of this section;

(iv) The market capitalization method,described in paragraph (g)(6) of this sec-tion;

(v) The residual profit split method, de-scribed in paragraph (g)(7) of this section;and

(vi) Unspecified methods, described inparagraph (g)(8) of this section.

(2) Best method analysis applicable forevaluation of a PCT pursuant to a CSA—(i) In general. Each method must be ap-plied in accordance with the provisions of§1.482–1, including the best method ruleof §1.482–1(c), the comparability analysisof §1.482–1(d), and the arm’s length rangeof §1.482–1(e), except as those provisionsare modified in this paragraph (g).

(ii) Consistency with upfront contrac-tual terms and risk allocation — the in-vestor model—(A) In general. Althoughall of the factors entering into a bestmethod analysis described in §1.482–1(c)and (d) must be considered, specific fac-tors may be particularly relevant in thecontext of a CSA. In particular, the rel-ative reliability of an application of anymethod depends on the degree of consis-tency of the analysis with the applicablecontractual terms and allocation of riskunder the CSA and this section among thecontrolled participants as of the date ofthe PCT, unless a change in such termsor allocation has been made in return forarm’s length consideration. In this regard,a CSA involves an upfront division ofthe risks as to both reasonably anticipatedobligations and reasonably anticipatedbenefits over the reasonably anticipatedterm of the CSA Activity. Accordingly,the relative reliability of an applicationof a method also depends on the degreeof consistency of the analysis with theassumption that, as of the date of the PCT,each controlled participant’s aggregate netinvestment in the CSA Activity (attribut-able to platform contributions, operatingcontributions, as such term is defined inparagraph (j)(1)(i) of this section, oper-ating cost contributions, as such term isdefined in paragraph (j)(1)(i) of this sec-tion, and cost contributions) is reasonablyanticipated to earn a rate of return equalto the appropriate discount rate for thecontrolled participant’s CSA Activity overthe entire period of such CSA Activity.

If the cost shared intangibles themselvesare reasonably anticipated to contributeto developing other intangibles, then theperiod described in the preceding sentenceincludes the period, reasonably anticipatedas of the date of the PCT, of developingand exploiting such indirectly benefitedintangibles.

(B) Example. The following exampleillustrates the principles of this paragraph(g)(2)(ii):

Example. (i) P, a U.S. corporation, has developeda software program, DEF, which applies certain algo-rithms to reconstruct complete DNA sequences frompartially-observed DNA sequences. S is a wholly-owned foreign subsidiary of P. On the first day of Year1, P and S enter into a CSA to develop a new gener-ation of genetic tests, GHI, based in part on the useof DEF. DEF is therefore a platform contribution ofP for which compensation is due from S pursuant to aPCT. S makes no platform contributions to the CSA.Sales of GHI are projected to commence two yearsafter the inception of the CSA and then to continuefor eight more years. Based on industry experience,P and S are confident that GHI will be replaced by anew type of genetic testing based on technology un-related to DEF or GHI and that, at that point, GHIwill have no further value. P and S project that thatreplacement will occur at the end of Year 10.

(ii) For purposes of valuing the PCT for P’splatform contribution of DEF to the CSA, P andS apply a type of residual profit split method thatis not described in paragraph (g)(7) of this sectionand which, accordingly, constitutes an unspecifiedmethod. See paragraph (g)(7)(i) (last sentence) ofthis section. The principles of this paragraph (g)(2)apply to any method for valuing a PCT, including theunspecified method used by P and S.

(iii) Under the method employed by P and S, ineach year, a portion of the income from sales of GHIin S’s territory is allocated to certain routine contri-butions made by S. The residual of the profit or lossfrom GHI sales in S’s territory after the routine allo-cation step is divided between P and S pro rata totheir capital stocks allocable to S’s territory. Eachcontrolled participant’s capital stock is computed bycapitalizing, applying a capital growth factor to, andamortizing its historical expenditures regarding DEFallocable to S’s territory (in the case of P), or its on-going cost contributions towards developing GHI (inthe case of S). The amortization of the capital stocksis effected on a straight-line basis over an assumedfour-year life for the relevant expenditures. The cap-ital stocks are grown using an assumed growth factorthat P and S consider to be appropriate.

(iv) The assumption that all expenditures amor-tize on a straight-line basis over four years does notappropriately reflect the principle that as of the dateof the PCT regarding DEF, every contribution to thedevelopment of GHI, including DEF, is reasonablyanticipated to have value throughout the entire periodof exploitation of GHI which is projected to continuethrough Year 10. Under this method as applied by Pand S, the share of the residual profit in S’s territorythat is allocated to P as a PCT Payment from S willdecrease every year. After Year 4, P’s capital stockin DEF will necessarily be $0, so that P will receive

none of the residual profit or loss from GHI sales inS’s territory after Year 4 as a PCT Payment.

(v) As a result of this limitation of the PCTPayments to be made by S, the anticipated returnto S’s aggregate investment in the CSA, over thewhole period of S’s CSA Activity, is at a rate thatis significantly higher than the appropriate discountrate for S’s CSA Activity (as determined by a reliablemethod). This discrepancy is not consistent with theinvestor model principle that S should anticipate arate of return to its aggregate investment in the CSA,over the whole period of its CSA Activity, equal tothe appropriate discount rate for its CSA Activity.The inconsistency of the method with the investormodel materially lessens its reliability for purposesof a best method analysis. See §1.482–1(c)(2)(ii)(B).

(iii) Consistency of evaluation withrealistic alternatives—(A) In general.The relative reliability of an applicationof a method also depends on the degreeof consistency of the analysis with theassumption that uncontrolled taxpayersdealing at arm’s length would have eval-uated the terms of the transaction, andonly entered into such transaction, if noalternative is preferable. This conditionis not met, therefore, where for any con-trolled participant the total anticipatedpresent value of its income attributable toits entering into the CSA, as of the dateof the PCT, is less than the total antic-ipated present value of its income thatcould be achieved through an alternativearrangement realistically available to thatcontrolled participant. In principle, thiscomparison is made on a post-tax basisbut, in many cases, a comparison madeon a pre-tax basis will yield equivalentresults. See also paragraph (g)(2)(v)(B)(1)of this section (Discount rate variationbetween realistic alternatives).

(B) Examples. The following examplesillustrate the principles of this paragraph(g)(2)(iii):

Example 1. (i) P, a corporation, and S, a wholly-owned subsidiary of P, enter into a CSA to developa personal transportation device (the product). Un-der the arrangement, P will undertake all of the R&D,and manufacture and market the product in CountryX. S will make CST Payments to P for its appropriateshare of P’s R&D costs, and manufacture and marketthe product in the rest of the world. P owns existingpatents and trade secrets that are reasonably antici-pated to contribute to the development of the product.Therefore the rights in the patents and trade secretsare platform contributions for which compensation isdue from S as part of a PCT.

(ii) S’s manufacturing and distribution activitiesunder the CSA will be routine in nature, and identicalto the activities it would undertake if it alternativelylicensed the product from P.

(iii) Reasonably reliable estimates indicate that Pcould develop the product without assistance from

February 17, 2009 485 2009–7 I.R.B.

S and license the product outside of Country X fora royalty of 20% of sales. Based on reliable finan-cial projections that include all future developmentcosts and licensing revenue that are allocable to thenon-Country X market, and using a discount rate ap-propriate for the riskiness of P’s role as a licensor(see paragraph (g)(2)(v) of this section), the post-taxpresent value of this licensing alternative to P for thenon-Country X market (measured as of the date ofthe PCT) would be $500 million. Thus, based on thisrealistic alternative, the anticipated post-tax presentvalue under the CSA to P in the non-Country X mar-ket (measured as of the date of the PCT), taking intoaccount anticipated development costs allocable tothe non-Country X market, and anticipated CST Pay-ments and PCT Payments from S, and using a dis-count rate appropriate for the riskiness of P’s role asa participant in the CSA, should not be less than $500million.

Example 2. (i) The facts are the same as in Ex-ample 1, except that there are no reliable estimatesof the value to P from the licensing alternative to theCSA. Further, reasonably reliable estimates indicatethat an arm’s length return for S’s routine manufactur-ing and distribution activities is a 10% mark-up on to-tal costs of goods sold plus operating expenses relatedto those activities. Finally, the Commissioner deter-mines that the respective activities undertaken by Pand S (other than licensing payments, CST Payments,and PCT Payments) would be identical regardless ofwhether the arrangement was undertaken as a CSA(CSA Scenario) or as a long-term licensing arrange-ment (Licensing Scenario). In particular, in both Sce-narios, P would perform all research activities and Swould undertake routine manufacturing and distribu-tion activities associated with its territory.

(ii) P undertakes an economic analysis that de-rives S’s cost contributions under the CSA, based onreliable financial projections. Based on this and fur-ther economic analysis, P determines S’s PCT Pay-ment as a certain lump sum amount to be paid as ofthe date of the PCT (Date D).

(iii) Based on reliable financial projections thatinclude S’s cost contributions and that incorporate S’sPCT Payment, as computed by P, and using a discountrate appropriate for the riskiness of S’s role as a CSAparticipant (see paragraph (g)(2)(v) of this section),the anticipated post-tax net present value to S in theCSA Scenario (measured as of Date D) is $800 mil-lion. Further, based on these same reliable projec-tions (but incorporating S’s licensing payments in-stead of S’s cost contributions and PCT Payment),and using a discount rate appropriate for the riskinessof S’s role as a long-term licensee, the anticipatedpost-tax net present value to S in the Licensing Sce-nario (measured as of Date D) is $100 million. Thus,S’s anticipated post-tax net present value is $700 mil-lion greater in the CSA Scenario than in the Licens-ing Scenario. This result suggests that P’s anticipatedpost-tax present value must be significantly less un-der the CSA Scenario than under the Licensing Sce-nario. This means that the reliability of P’s analysisas described in paragraph (ii) of this Example 2 is re-duced, since P would not be expected to enter into acost sharing arrangement if its alternative of being along-term licensor is preferable.

Example 3. (i) The facts are the same as in para-graphs (i) and (ii) of Example 2. In addition, basedon reliable financial projections that include S’s cost

contributions and S’s PCT Payment, and using a dis-count rate appropriate for the riskiness of S’s role as aCSA participant, the anticipated post-tax net presentvalue to S under the CSA (measured as of the date ofthe PCT) is $50 million. Also, instead of entering theCSA, S has the realistic alternative of manufacturingand distributing product Z unrelated to the personaltransportation device, with the same anticipated 10%mark-up on total costs that it would anticipate for itsroutine activities in Example 2. Under its realistic al-ternative, at a discount rate appropriate for the risk-iness of S’s role with respect to product Z, S antici-pates a present value of $100 million.

(ii) Because the lump sum PCT Payment made byS results in S having a considerably lower anticipatednet present value than S could achieve through analternative arrangement realistically available to it,the reliability of P’s calculation of the lump sum PCTPayment is reduced.

(iv) Aggregation of transactions. Thecombined effect of multiple contempo-raneous transactions, consisting eitherof multiple PCTs, or of one or morePCT and one or more other transactionsin connection with a CSA that are notgoverned by this section (such as trans-actions involving cross operating con-tributions or make-or-sell rights), mayrequire evaluation in accordance withthe principles of aggregation describedin §1.482–1(f)(2)(i). In such cases, itmay be that the multiple transactions arereasonably anticipated, as of the date ofthe PCT(s), to be so interrelated that themethod that provides the most reliablemeasure of an arm’s length charge is amethod under this section applied on anaggregate basis for the PCT(s) and othertransactions. A section 482 adjustmentmay be made by comparing the aggregatearm’s length charge so determined to theaggregate payments actually made for themultiple transactions. In such a case, itgenerally will not be necessary to allo-cate separately the aggregate arm’s lengthcharge as between various PCTs or as be-tween PCTs and such other transactions.However, such an allocation may be nec-essary for other purposes, such as applyingparagraph (i)(6) (Periodic adjustments) ofthis section. An aggregate determinationof the arm’s length charge for multipletransactions will often yield a paymentfor a controlled participant that is equalto the aggregate value of the platformcontributions and other resources, capa-bilities, and rights covered by the multipletransactions multiplied by that controlledparticipant’s RAB share. Because RABshares only include benefits from costshared intangibles, the reliability of an

aggregate determination of payments formultiple transactions may be reduced tothe extent that it includes transactions cov-ering resources, capabilities, and rightsfor which the controlled participants’ ex-pected benefit shares differ substantiallyfrom their RAB shares.

(v) Discount rate—(A) In general. Thebest method analysis in connection withcertain methods or forms of payment maydepend on a rate or rates of return usedto convert projected results of transactionsto present value, or to otherwise convertmonetary amounts at one or more points intime to equivalent amounts at a differentpoint or points in time. For this purpose,a discount rate or rates should be usedthat most reliably reflect the market-corre-lated risks of activities or transactions andshould be applied to the best estimates ofthe relevant projected results, based on allthe information potentially available at thetime for which the present value calcula-tion is to be performed. Depending onthe particular facts and circumstances, themarket-correlated risk involved and thus,the discount rate, may differ among a com-pany’s various activities or transactions.Normally, discount rates are most reliablydetermined by reference to market infor-mation.

(B) Considerations in best methodanalysis of discount rate—(1) Discountrate variation between realistic alterna-tives. Realistic alternatives may involvevarying risk exposure and, thus, may bemore reliably evaluated using differentdiscount rates. In some circumstances, aparty may have less risk as a licensee ofintangibles needed in its operations, and sorequire a lower discount rate, than it wouldhave by entering into a CSA to developsuch intangibles, which may involve theparty’s assumption of additional risk infunding its cost contributions to the IDA.Similarly, self-development of intangiblesand licensing out may be riskier for thelicensor, and so require a higher discountrate, than entering into a CSA to developsuch intangibles, which would relieve thelicensor of the obligation to fund a portionof the IDCs of the IDA.

(2) Discount rate variation betweenforms of payment. Certain forms of pay-ment may involve different risks thanothers. For example, ordinarily a royaltycomputed on a profits base would be morevolatile, and so require a higher discount

2009–7 I.R.B. 486 February 17, 2009

rate to discount projected payments topresent value, than a royalty computed ona sales base.

(3) Post-tax rate. In general, discountrate estimates that may be inferred fromthe operations of the capital markets arepost-tax discount rates. Therefore, an anal-ysis would in principle apply post-tax dis-count rates to income net of expense itemsincluding taxes (post-tax income). How-ever, in certain circumstances the result ofapplying a post-tax discount rate to post-tax income is equivalent to the productof—

(i) The result of applying a post-tax dis-count rate to income net of expense itemsother than taxes (pre-tax income); and

(ii) The difference of one minus the taxrate.

Therefore, in such circumstances, cal-culation of pre-tax income, rather thanpost-tax income, may be sufficient. See,for example, paragraph (g)(4)(i)(G) of thissection.

(C) Example. The following exampleillustrates the principles of this paragraph(g)(2)(v):

Example. (i) P and S form a CSA to develop in-tangible X, which will be used in product Y. P willdevelop X, and S will make CST Payments as its costcontributions. At the start of the CSA, P has a plat-form contribution, for which S commits to make aPCT Payment of 5% of its sales of product Y. Aspart of the evaluation of whether that PCT Payment isarm’s length, the Commissioner considers whether Phad a more favorable realistic alternative (see para-graph (g)(2)(iii) of this section). Specifically, theCommissioner compares P’s anticipated post-tax dis-counted present value of the financial projections un-der the CSA (taking into account S’s PCT Paymentof 5% of its sales of product Y) with P’s anticipatedpost-tax discounted present value of the financial pro-jections under a reasonably available alternative Li-censing Arrangement that consists of developing in-tangible X on its own and then licensing X to S or toan uncontrolled party similar to S. In undertaking theanalysis, the Commissioner determines that, becauseit would be funding the entire development of the in-tangible, P undertakes greater risks in the licensingscenario than in the cost sharing scenario (in the costsharing scenario P would be funding only part of thedevelopment of the intangible).

(ii) The Commissioner determines that, as be-tween the two scenarios, all of the components ofP’s anticipated financial flows are identical, exceptfor the CST and PCT Payments under the CSA,compared to the licensing payments under the Li-censing Alternative. Accordingly, the Commissionerconcludes that the differences in market-correlatedrisks between the two scenarios, and therefore thedifferences in discount rates between the two scenar-ios, relate to the differences in these components ofthe financial projections.

(vi) Financial projections. The reliabil-ity of an estimate of the value of a platformor operating contribution in connectionwith a PCT will often depend upon thereliability of projections used in makingthe estimate. Such projections shouldreflect the best estimates of the items pro-jected (normally reflecting a probabilityweighted average of possible outcomes).Projections necessary for this purpose mayinclude a projection of sales, IDCs, costsof developing operating contributions,routine operating expenses, and costs ofsales. Some method applications directlyestimate projections of items attributableto separate development and exploitationby the controlled participants within theirrespective divisions. Other method ap-plications indirectly estimate projectionsof items from the perspective of the con-trolled group as a whole, rather than fromthe perspective of a particular participant,and then apportion the items so estimatedon some assumed basis. For example, insome applications, sales might be directlyprojected by division, but worldwide pro-jections of other items such as operatingexpenses might be apportioned among di-visions in the same ratio as the divisions’respective sales. Which approach is morereliable depends on which provides themost reliable measure of an arm’s lengthresult, considering the competing perspec-tives under the facts and circumstancesin light of the completeness and accu-racy of the underlying data, the reliabilityof the assumptions, and the sensitivityof the results to possible deficiencies inthe data and assumptions. For these pur-poses, projections that have been preparedfor non-tax purposes are generally morereliable than projections that have beenprepared solely for purposes of meetingthe requirements in this paragraph (g).

(vii) Accounting principles—(A) Ingeneral. Allocations or other valuationsdone for accounting purposes may providea useful starting point but will not be con-clusive for purposes of the best methodanalysis in evaluating the arm’s lengthcharge in a PCT, particularly where theaccounting treatment of an asset is incon-sistent with its economic value.

(B) Examples. The following examplesillustrate the principles of this paragraph(g)(2)(vii):

Example 1. (i) USP, a U.S. corporation and FSub,a wholly-owned foreign subsidiary of USP, enter into

a CSA in Year 1 to develop software programs withapplication in the medical field. Company X is anuncontrolled software company located in the UnitedStates that is engaged in developing software pro-grams that could significantly enhance the programsbeing developed by USP and FSub. Company Xis still in a startup phase, so it has no currently ex-ploitable products or marketing intangibles and itsworkforce consists of a team of software develop-ers. Company X has negligible liabilities and tangibleproperty. In Year 2, USP purchases Company X aspart of an uncontrolled transaction in order to acquireits in-process technology and workforce for purposesof the development activities of the CSA. USP filesa consolidated return that includes Company X. Foraccounting purposes, $50 million of the $100 millionacquisition price is allocated to the in-process tech-nology and workforce, and the residual $50 millionis allocated to goodwill.

(ii) The in-process technology and workforce ofCompany X acquired by USP are reasonably antici-pated to contribute to developing cost shared intangi-bles and therefore the rights in the in-process technol-ogy and workforce of Company X are platform con-tributions for which FSub must compensate USP aspart of a PCT. In determining whether to apply theacquisition price or another method for purposes ofevaluating the arm’s length charge in the PCT, rel-evant best method analysis considerations must beweighed in light of the general principles of para-graph (g)(2) of this section. The allocation for ac-counting purposes raises an issue as to the reliabilityof using the acquisition price method in this case be-cause it suggests that a significant portion of the valueof Company X’s nonroutine contributions to USP’sbusiness activities is allocable to goodwill, which isoften difficult to value reliably and which, dependingon the facts and circumstances, might not be attribut-able to platform contributions that are to be compen-sated by PCTs. See paragraph (g)(5)(iv)(A) of thissection.

(iii) This paragraph (g)(2)(vii) provides that ac-counting treatment may be a starting point, but is notdeterminative for purposes of assessing or applyingmethods to evaluate the arm’s length charge in a PCT.The facts here reveal that Company X has nothing ofeconomic value aside from its in-process technologyand assembled workforce. The $50 million of the ac-quisition price allocated to goodwill for accountingpurposes, therefore, is economically attributable toeither of, or both, the in-process technology and theworkforce. That moots the potential issue under theacquisition price method of the reliability of valua-tion of assets not to be compensated by PCTs, sincethere are no such assets. Assuming the acquisitionprice method is otherwise the most reliable method,the aggregate value of Company X’s in-process tech-nology and workforce is the full acquisition price of$100 million (subject to possible adjustment for dif-ferences in tax liabilities of the type described in para-graph (g)(5)(ii) of this section). Accordingly, the ag-gregate value of the arm’s length PCT Payments duefrom FSub to USP for the platform contributions con-sisting of the rights in Company X’s in-process tech-nology and workforce will equal $100 million (sub-ject to adjustment as per paragraph (g)(5)(ii) of thissection) multiplied by FSub’s RAB share.

Example 2. (i) The facts are the same as in Exam-ple 1, except that Company X is a mature software

February 17, 2009 487 2009–7 I.R.B.

business in the United States with a successful cur-rent generation of software that it markets under arecognized trademark, in addition to having the re-search team and new generation software in processthat could significantly enhance the programs beingdeveloped under USP’s and FSub’s CSA. USP con-tinues Company X’s existing business and integratesthe research team and the in-process technology intothe efforts under its CSA with FSub. For accountingpurposes, the $100 million price for acquiring Com-pany X is allocated $50 million to existing softwareand trademark, $25 million to in-process technologyand research workforce, and the residual $25 millionto goodwill and going concern value.

(ii) In this case an analysis of the facts indicatesa likelihood that, consistent with the allocation un-der the accounting treatment (although not necessar-ily in the same amount), a significant amount of thenonroutine contributions to the USP’s business ac-tivities consist of goodwill and going concern valueeconomically attributable to the existing U.S. soft-ware business rather than to the platform contribu-tions consisting of the rights in the in-process tech-nology and research workforce. In addition, an anal-ysis of the facts indicates that a significant amount ofthe nonroutine contributions to USP’s business activ-ities consist of the make-or-sell rights under the ex-isting software and trademark, which are not platformcontributions and might be difficult to value. Accord-ingly, further consideration must be given to the ex-tent to which these circumstances reduce the relativereliability of the acquisition price method in compar-ison to other potentially applicable methods for eval-uating the PCT Payment.

Example 3. (i) USP, a U.S. corporation, and FSub,a wholly-owned foreign subsidiary of USP, enter intoa CSA in Year 1 to develop Product A. Company Yis an uncontrolled corporation that owns TechnologyX, which is critical to the development of ProductA. Company Y currently markets Product B, whichis dependent on Technology X. USP is solely inter-ested in acquiring Technology X, but is only able todo so through the acquisition of Company Y in its en-tirety for $200 million in an uncontrolled transactionin Year 2. For accounting purposes, the acquisitionprice is allocated as follows: $120 million to ProductB and the underlying Technology X, $30 million totrademark and other marketing intangibles, and theresidual $50 million to goodwill and going concernvalue. After the acquisition of Company Y, Technol-ogy X is used to develop Product A. No other partof Company Y is used in any manner. Immediatelyafter the acquisition, product B is discontinued, and,therefore, the accompanying marketing intangiblesbecome worthless. None of the previous employeesof Company Y is retained.

(ii) The Technology X of Company Y acquired byUSP is reasonably anticipated to contribute to devel-oping cost shared intangibles and is therefore a plat-form contribution for which FSub must compensateUSP as part of a PCT. Although for accounting pur-poses a significant portion of the acquisition price ofCompany Y was allocated to items other than Tech-nology X, the facts demonstrate that USP had no in-tention of using and therefore placed no economicvalue on any part of Company Y other than Technol-ogy X. If USP was willing to pay $200 million forCompany Y solely for purposes of acquiring Tech-nology X, then assuming the acquisition price method

is otherwise the most reliable method, the value ofTechnology X is the full $200 million acquisitionprice. Accordingly, the value of the arm’s length PCTPayment due from FSub to USP for the platform con-tribution consisting of the rights in Technology X willequal the product of $200 million (subject to adjust-ment as described in paragraph (g)(5)(ii) of this sec-tion) and FSub’s RAB share.

(viii) Valuations of subsequentPCTs—(A) Date of subsequent PCT. Thedate of a PCT may occur subsequent tothe inception of the CSA. For example,an intangible initially developed outsidethe IDA may only subsequently becomea platform contribution because that latertime is the earliest date on which it isreasonably anticipated to contribute todeveloping cost shared intangibles withinthe IDA. In such case, the date of thePCT, and the analysis of the arm’s lengthamount charged in the subsequent PCT, isas of such later time.

(B) Best method analysis for subse-quent PCT. In cases where PCTs occur ondifferent dates, the determination of thearm’s length amount charged, respectively,in the prior and subsequent PCTs mustbe coordinated in a manner that providesthe most reliable measure of an arm’slength result. In some circumstances, asubsequent PCT may be reliably evaluatedindependently of other PCTs, as may bepossible for example, under the acquisitionprice method. In other circumstances, theresults of prior and subsequent PCTs maybe interrelated and so a subsequent PCTmay be most reliably evaluated under theresidual profit split method of paragraph(g)(7) of this section. In those cases, forpurposes of allocating the present valueof nonroutine residual divisional profitor loss, and so determining the presentvalue of the subsequent PCT Payments, inaccordance with paragraph (g)(7)(iii)(C)of this section, the PCT Payor’s interestin cost shared intangibles, both alreadydeveloped and in process, are treated asadditional PCT Payor operating contribu-tions as of the date of the subsequent PCT.

(ix) Arm’s length range—(A) In gen-eral. The guidance in §1.482–1(e) re-garding determination of an arm’s lengthrange, as modified by this section, appliesin evaluating the arm’s length amountcharged in a PCT under a transfer pricingmethod provided in this section (appli-cable method). Section 1.482–1(e)(2)(i)provides that the arm’s length range isordinarily determined by applying a single

pricing method selected under the bestmethod rule to two or more uncontrolledtransactions of similar comparability andreliability although use of more than onemethod may be appropriate for the pur-poses described in §1.482–1(c)(2)(iii).The rules provided in §1.482–1(e) and thissection for determining an arm’s lengthrange shall not override the rules providedin paragraph (i)(6) of this section for pe-riodic adjustments by the Commissioner.The provisions in paragraphs (g)(2)(ix)(C)and (D) of this section apply only to ap-plicable methods that are based on twoor more input parameters as described inparagraph (g)(2)(ix)(B) of this section.For an example of how the rules of thissection for determining an arm’s lengthrange of PCT Payments are applied, seeparagraph (g)(4)(vii) of this section.

(B) Methods based on two or more in-put parameters. An applicable methodmay determine PCT Payments based oncalculations involving two or more param-eters whose values depend on the facts andcircumstances of the case (input parame-ters). For some input parameters (market-based input parameters), the value is mostreliably determined by reference to datathat derives from uncontrolled transactions(market data). For example, the value ofthe return to a controlled participant’s rou-tine contributions, as such term is definedin paragraph (j)(1)(i) of this section, to theCSA Activity (which value is used as aninput parameter in the income method de-scribed in paragraph (g)(4) of this section)may in some cases be most reliably deter-mined by reference to the profit level ofa company with rights, resources, and ca-pabilities comparable to those routine con-tributions. See §1.482–5. As another ex-ample, the value for the discount rate thatreflects the riskiness of a controlled par-ticipant’s role in the CSA (which value isused as an input parameter in the incomemethod described in paragraph (g)(4) ofthis section) may in some cases be most re-liably determined by reference to the stockbeta of a company whose overall risk iscomparable to the riskiness of the con-trolled participant’s role in the CSA.

(C) Variable input parameters. Forsome market-based input parameters(variable input parameters), the param-eter’s value is most reliably determinedby considering two or more observa-tions of market data that have, or with

2009–7 I.R.B. 488 February 17, 2009

adjustment can be brought to, a similarreliability and comparability, as describedin §1.482–1(e)(2)(ii) (for example, profitlevels or stock betas of two or more com-panies). See paragraph (g)(2)(ix)(B) ofthis section.

(D) Determination of arm’s length PCTPayment. For purposes of applying thisparagraph (g)(2)(ix), each input parameteris assigned a single most reliable value,unless it is a variable input parameter asdescribed in paragraph (g)(2)(ix)(C) of thissection. The determination of the arm’slength payment depends on the number ofvariable input parameters.

(1) No variable input parameters. Ifthere are no variable input parameters,the arm’s length PCT Payment is a singlevalue determined by using the single mostreliable value determined for each inputparameter.

(2) One variable input parameter. Ifthere is exactly one variable input param-eter, then under the applicable method,the arm’s length range of PCT Paymentsis the interquartile range, as described in§1.482–1(e)(2)(iii)(C), of the set of PCTPayment values calculated by selecting—

(i) Iteratively, the value of the vari-able input parameter that is based on eachobservation as described in paragraph(g)(2)(ix)(C) of this section; and

(ii) The single most reliable values foreach other input parameter.

(3) More than one variable input pa-rameter. If there are two or more vari-able input parameters, then under the ap-plicable method, the arm’s length range ofPCT Payments is the interquartile range, asdescribed in §1.482–1(e)(2)(iii)(C), of theset of PCT Payment values calculated iter-atively using every possible combinationof permitted choices of values for the in-put parameters. For input parameters otherthan a variable input parameter, the onlysuch permitted choice is the single mostreliable value. For variable input param-eters, such permitted choices include anyvalue that is—

(i) Based on one of the observationsdescribed in paragraph (g)(2)(ix)(C) of thissection; and

(ii) Within the interquartile range (asdescribed in §1.482–1(e)(2)(iii)(C)) of theset of all values so based.

(E) Adjustments. Section1.482–1(e)(3), applied as modified by thisparagraph (g)(2)(ix), determines when the

Commissioner may make an adjustmentto a PCT Payment due to the taxpayer’sresults being outside the arm’s lengthrange. Adjustment will be to the median,as defined in §1.482–1(e)(3). Thus, theCommissioner is not required to establishan arm’s length range prior to making anallocation under section 482.

(x) Valuation undertaken on a pre-taxbasis. PCT Payments in general may in-crease the PCT Payee’s tax liability anddecrease the PCT Payor’s tax liability.The arm’s length amount of a PCT Pay-ment determined under the methods inthis paragraph (g) is the value of the PCTPayment itself, without regard to suchtax effects. Therefore, the methods underthis section must be applied, with suitableadjustments if needed, to determine thePCT Payments on a pre-tax basis. Seeparagraphs (g)(2)(v)(B)(3), (g)(4)(i)(G),(g)(5)(ii), and (g)(6)(ii) of this section.

(3) Comparable uncontrolled transac-tion method. The comparable uncontrolledtransaction (CUT) method described in§1.482–4(c), and the comparable uncon-trolled services price (CUSP) methoddescribed in §1.482–9T(c), may be appliedto evaluate whether the amount chargedin a PCT is arm’s length by reference tothe amount charged in a comparable un-controlled transaction. Although all ofthe factors entering into a best methodanalysis described in §1.482–1(c) and (d)must be considered, comparability and re-liability under this method are particularlydependent on similarity of contractualterms, degree to which allocation of risksis proportional to reasonably anticipatedbenefits from exploiting the results ofintangible development, similar periodof commitment as to the sharing of in-tangible development risks, and similarscope, uncertainty, and profit potential ofthe subject intangible development, in-cluding a similar allocation of the risksof any existing resources, capabilities, orrights, as well as of the risks of developingother resources, capabilities, or rights thatwould be reasonably anticipated to con-tribute to exploitation within the parties’divisions, that is consistent with the actualallocation of risks between the controlledparticipants as provided in the CSA in ac-cordance with this section. When appliedin the manner described in §1.482–4(c) or1.482–9T(c), the CUT or CUSP methodwill typically yield an arm’s length total

value for the platform contribution that isthe subject of the PCT. That value mustthen be multiplied by each PCT Payor’srespective RAB share in order to deter-mine the arm’s length PCT Payment duefrom each PCT Payor. The reliability ofa CUT or CUSP that yields a value forthe platform contribution only in the PCTPayor’s division will be reduced to theextent that value is not consistent with thetotal worldwide value of the platform con-tribution multiplied by the PCT Payor’sRAB share.

(4) Income method—(i) In gen-eral—(A) Equating cost sharing and li-censing alternatives. The income methodevaluates whether the amount charged ina PCT is arm’s length by reference to acontrolled participant’s best realistic al-ternative to entering into a CSA. Underthis method, the arm’s length charge for aPCT Payment will be an amount such thata controlled participant’s present value, asof the date of the PCT, of its cost sharingalternative of entering into a CSA equalsthe present value of its best realistic al-ternative. In general, the best realisticalternative of the PCT Payor to enteringinto the CSA would be to license intangi-bles to be developed by an uncontrolledlicensor that undertakes the commitmentto bear the entire risk of intangible devel-opment that would otherwise have beenshared under the CSA. Similarly, the bestrealistic alternative of the PCT Payee toentering into the CSA would be to under-take the commitment to bear the entirerisk of intangible development that wouldotherwise have been shared under theCSA and license the resulting intangiblesto an uncontrolled licensee. Paragraphs(g)(4)(ii) through (iv) of this section de-scribe specific applications of the incomemethod, but do not exclude other possibleapplications of this method.

(B) Cost sharing alternative. The PCTPayor’s cost sharing alternative corre-sponds to the actual CSA in accordancewith this section, with the PCT Payor’sobligation to make the PCT Payments tobe determined and its commitment for theduration of the IDA to bear cost contribu-tions.

(C) Licensing alternative. The licens-ing alternative is derived on the basis ofa functional and risk analysis of the costsharing alternative, but with a shift of therisk of cost contributions to the licensor.

February 17, 2009 489 2009–7 I.R.B.

Accordingly, the PCT Payor’s licensingalternative consists of entering into a li-cense with an uncontrolled party, for aterm extending for what would be the du-ration of the CSA Activity, to license themake-or-sell rights in to-be-developed re-sources, capabilities, or rights of the li-censor. Under such license, the licensorwould undertake the commitment to bearthe entire risk of intangible developmentthat would otherwise have been shared un-der the CSA. Apart from any difference inthe allocation of the risks of the IDA, the li-censing alternative should assume contrac-tual provisions with regard to non-over-lapping divisional intangible interests, andwith regard to allocations of other risks,that are consistent with the actual CSA inaccordance with this section. For exam-ple, the analysis under the licensing alter-native should assume a similar allocationof the risks of any existing resources, capa-bilities, or rights, as well as of the risks ofdeveloping other resources, capabilities, orrights that would be reasonably anticipatedto contribute to exploitation within the par-ties’ divisions, that is consistent with theactual allocation of risks between the con-trolled participants as provided in the CSAin accordance with this section.

(D) Only one controlled participantwith nonroutine platform contributions.This method involves only one of the con-trolled participants providing nonroutineplatform contributions as the PCT Payee.For a method under which more thanone controlled participant may be a PCTPayee, see the application of the residualprofit method pursuant to paragraph (g)(7)of this section.

(E) Income method payment forms. Theincome method may be applied to deter-mine PCT Payments in any form of pay-ment (for example, lump sum, royalty onsales, or royalty on divisional profit). Forconverting to another form of payment, seegenerally §1.482–7T(h) (Form of paymentrules).

(F) Discount rates appropriate to costsharing and licensing alternatives.

(1) The present value of the cost sharingand licensing alternatives, respectively,should be determined using the appro-priate discount rates in accordance withparagraph (g)(2)(v) of this section. See,for example, §1.482–7T(g)(2)(v)(B)(1)(Discount rate variation between realisticalternatives). In circumstances where the

market-correlated risks as between thecost sharing and licensing alternatives arenot materially different, a reliable analysismay be possible by using the same dis-count rate with respect to both alternatives.

(2) The discount rate for the cost shar-ing alternative will generally depend onthe form of PCT Payments assumed (forexample, lump sum, royalty on sales, roy-alty on divisional profit).

(G) The effect of taxation on determin-ing the arm’s length amount. In principle,the present values of the cost sharingand licensing alternatives should be de-termined by applying post-tax discountrates to post-tax income (including thepost-tax value to the controlled participantof the PCT Payments). If such approachis adopted, then the post-tax value of thePCT Payments must be appropriately ad-justed in order to determine the arm’slength amount of the PCT Payments ona pre-tax basis. See paragraph (g)(2)(x)of this section. In certain circumstances,post-tax income may be derived as theproduct of the result of applying a post-taxdiscount rate to pre-tax income, and a fac-tor equal to one minus the tax rate. Seeparagraph (g)(2)(v)(B)(3) of this section.Moreover, to the extent that a controlledparticipant’s tax rate is not materially af-fected by whether it enters into the costsharing or licensing alternative (or reli-able adjustments may be made for varyingtax rates), the factor (that is, one minusthe tax rate) may be cancelled from bothsides of the equation of the cost sharingand licensing alternative present values.Accordingly, in such circumstance it issufficient to apply post-tax discount ratesto projections of pre-tax income for thepurpose of equating the cost sharing andlicensing alternatives. The specific appli-cations of the income method described inparagraphs (g)(4)(ii) through (iv) of thissection and the examples set forth in para-graph (g)(4)(vii) of this section assumethat such circumstance applies.

(ii) Evaluation of PCT Payor’s costsharing alternative. The present value ofthe PCT Payor’s cost sharing alternativeis the present value of the stream of thereasonably anticipated residuals over theduration of the CSA Activity of divisionalprofits or losses, minus operating costcontributions, minus cost contributions,minus PCT Payments.

(iii) Evaluation of PCT Payor’s licens-ing alternative—(A) Evaluation basedon CUT. The present value of the PCTPayor’s licensing alternative may be de-termined using the comparable uncon-trolled transaction method, as described in§1.482–4(c)(1) and (2). In this case, thepresent value of the PCT Payor’s licens-ing alternative is the present value of thestream, over what would be the durationof the CSA Activity under the cost sharingalternative, of the reasonably anticipatedresiduals of the divisional profits or lossesthat would be achieved under the costsharing alternative, minus operating costcontributions that would be made underthe cost sharing alternative, minus thelicensing payments as determined underthe comparable uncontrolled transactionmethod.

(B) Evaluation based on CPM. Thepresent value of the PCT Payor’s licensingalternative may be determined using thecomparable profits method, as describedin §1.482–5. In this case, the present valueof the licensing alternative is determinedas in paragraph (g)(4)(iii)(A) of this sec-tion, except that the PCT Payor’s licensingpayments, as defined in paragraph (j)(1)(i)of this section, are determined to be a lumpsum, as of the date of the PCT, equal tothe present value (using the discount rateappropriate for the licensing alternative)of the stream, over what would be the du-ration of the CSA Activity under the costsharing alternative, of the reasonably an-ticipated residuals of the divisional profitsor losses that would be achieved under thecost sharing alternative, minus operatingcost contributions that would be madeunder the cost sharing alternative, minusmarket returns for routine contributions,as defined in paragraph (j)(1)(i) of thissection.

(iv) Lump sum payment form. Wherethe form of PCT Payment is a lump sum asof the date of the PCT, then, based on para-graphs (g)(4)(i) through (iii) of this sec-tion, the PCT Payment equals the differ-ence between—

(A) The present value, using the dis-count rate appropriate for the cost sharingalternative, of the stream of the reasonablyanticipated residuals over the duration ofthe CSA Activity of divisional profits orlosses, minus cost contributions and oper-ating cost contributions; and

2009–7 I.R.B. 490 February 17, 2009

(B) The present value of the licensingalternative.

(v) Best method analysis considera-tions. (A) Whether results derived fromthis method are the most reliable measureof an arm’s length result is determinedusing the factors described under the bestmethod rule in §1.482–1(c). Thus, com-parability and the quality of data, thereliability of the assumptions, and thesensitivity of the results to possible defi-ciencies in the data and assumptions, mustbe considered in determining whether thismethod provides the most reliable mea-sure of an arm’s length result.

(B) This method will be more reliableto the extent that the controlled partici-pants’ respective tax rates are not mate-rially affected by whether they enter intothe cost sharing or licensing alternative.Even if this assumption of invariant taxrates across alternatives does not hold, thismethod may still be reliable to the extentthat reliable adjustments can be made to re-flect the variation in tax rates.

(C) If the licensing alternative is eval-uated using the comparable uncontrolledtransactions method, as described in para-graph (g)(4)(iii)(A) of this section, any ad-ditional comparability and reliability con-siderations stated in §1.482–4(c)(2) mayapply.

(D) If the licensing alternative is evalu-ated using the comparable profits method,as described in paragraph (g)(4)(iii)(B) ofthis section, any additional comparabil-ity and reliability considerations stated in§1.482–5(c) may apply.

(E) This method may be used even ifthe PCT Payor furnishes significant oper-ating contributions, or commits to assumethe risk of significant operating cost con-tributions, to the PCT Payor’s division.However, in such a case, any compara-ble uncontrolled transactions described inparagraph (g)(4)(iii)(A) of this section,and any comparable transactions usedunder §1.482–5(c) as described in para-graphs (g)(4)(iii)(B) of this section, shouldbe consistent with such contributions (orreliable adjustments must be made formaterial differences).

(vi) Routine platform and operatingcontributions. For purposes of this para-graph (g)(4), any routine contributions thatare platform or operating contributions,

the valuation and PCT Payments for whichare determined and made independentlyof the income method, are treated simi-larly to cost contributions and operatingcost contributions, respectively. Accord-ingly, wherever used in this paragraph,the term “routine contributions” shall notinclude routine platform or operating con-tributions, and wherever the terms “costcontributions” and “operating cost con-tributions” appear in this paragraph, theyshall include net routine platform contri-butions and net routine operating contri-butions, respectively. Net routine platformcontributions are the value of a controlledparticipant’s total reasonably anticipatedroutine platform contributions, plus itsreasonably anticipated PCT Payments toother controlled participants in respect oftheir routine platform contributions, minusthe reasonably anticipated PCT Paymentsit is to receive from other controlled par-ticipants in respect of its routine platformcontributions. Net routine operating con-tributions are the value of a controlledparticipant’s total reasonably anticipatedroutine operating contributions, plus itsreasonably anticipated arm’s length com-pensation to other controlled participantsin respect of their routine operating contri-butions, minus the reasonably anticipatedarm’s length compensation it is to receivefrom other controlled participants in re-spect of its routine operating contributions.

(vii) Examples. The following exam-ples illustrate the principles of this para-graph (g)(4):

Example 1. (i) USP, a software company, has de-veloped version 1.0 of a new software application thatit is currently marketing. In Year 1 USP enters into aCSA with its wholly-owned foreign subsidiary, FS, todevelop future versions of the software application.Under the CSA, USP will have the rights to exploitthe future versions in the United States, and FS willhave the rights to exploit them in the rest of the world.The future rights in version 1.0, and USP’s develop-ment team, are reasonably anticipated to contributeto the development of future versions and thereforethe rights in version 1.0 are platform contributionsfor which compensation is due from FS as part of aPCT. USP does not transfer the current exploitationrights in version 1.0 to FS. FS does not furnish anyplatform contributions nor does it control any operat-ing intangibles at the inception of the CSA that wouldbe relevant to the exploitation of version 1.0 or futureversions of the software. FS agrees to make PCT pay-ments in the form of a single lump sum payment asof the date of the PCT.

(ii) In evaluating the CSA, the Commissionerconcludes that the cost sharing alternative represents

a riskier alternative for FS than the licensing alter-native because, in cost sharing, FS will take on theadditional risks associated with CST Payments andof making the PCT payments as a single lump sum.Consequently, the Commissioner concludes thatthe appropriate discount rate to apply in assessingthe licensing alternative, based on discount ratesof comparable uncontrolled companies undertakingcomparable licensing transactions, would be 13%per year, whereas the appropriate discount rate toapply in assessing the cost sharing alternative wouldbe 15% per year. FS undertakes financial projectionsand anticipates making no sales during the first twoyears of the CSA in its territory with sales in Years3 through Year 8 rapidly increasing to $200 million,$400 million, $600 million, $650 million, $700 mil-lion and $750 million, respectively. After year 8,sales in the rest of the world are expected to remainat $750 million per annum for the foreseeable future.Costs including routine costs and operating costcontributions are anticipated to equal 60% of grosssales from Year 3, onwards. FS anticipates its costcontributions will equal $50 million per year for thefirst four years of the CSA and equal 10% of grosssales in each year, thereafter. The Commissioner ac-cepts the financial projections undertaken by FS. TheCommissioner determines that the arm’s length rateUSP would have charged an uncontrolled licenseefor a license of future versions of the software hadUSP further developed version 1.0 on its own is 35%of the sales price, as determined under the compara-ble uncontrolled transaction method in §1.482–4(c).FS also determines that the tax rate applicable to itwill be the same in the licensing alternative as in theCSA.

(iii) Based on these projections and applyingthe appropriate discount rate, the Commissionerdetermines that under the cost sharing alternative,the present value of its divisional profits (after sub-tracting the present value of the anticipated operatingcost contributions and cost contributions) would be$867 million (for simplicity of calculation in thisexample, all financial flows are assumed to occur atthe beginning of each period). Under the licensingalternative, the present value of the divisional profitsand losses minus the operating cost contributionswould be $1.592 billion, and the present value of thelicensing payments would be $1.393 billion. There-fore, the total value of the licensing alternative wouldbe $199 million. In order for the present value ofthe cost sharing alternative to equal the present valueof the licensing alternative, the present value of thePCT payments must equal $668 million; the arm’slength lump sum PCT payment therefore equals $668million.

Example 2. Arm’s length range. (i) The facts arethe same as in Example 1. The licensing discount rate(13%) and the CUT licensing rate (35%) used by theCommissioner as input parameters in applying the in-come method are the median values of comparableuncontrolled discount rates and license rates, respec-tively. The observations that are in the interquartilerange of the respective input parameters are as fol-lows:

February 17, 2009 491 2009–7 I.R.B.

Observations that are withininterquartile range

Comparable uncontrolleddiscount rate

1 11%

2 12%

3 (Median) 13%

4 15%

5 17%

Observations that are withininterquartile range

Comparable uncontrolledlicensing rate

1 30%

2 32%

3 (Median) 35%

4 37%

5 40%

(ii) The Commissioner concludes that these esti-mates of the appropriate arm’s length discount ratesand licensing rates are independent of each other. Ac-cordingly, the Commissioner undertakes 25 differentapplications of the income method, using each com-

bination of the discount rate and licensing rate pa-rameters. In undertaking this analysis, the Commis-sioner assumes that the ratio of the median discountrate for the cost sharing alternative to the median dis-count rate for the licensing alternative (that is, 15%

to 13%) is maintained. The results of the 25 applica-tions of the income method, sorted in ascending orderof calculated PCT payment, are as follows:

Income methodapplication number:

Comparableuncontrolled

licensing discount rate

Comparableuncontrolled CSA

discount rate

Comparableuncontrolledlicensing rate

Calculated lump sumPCT Payment

Interquartile range ofPCT payments

1 17% 19.6% 30% 291

2 17% 19.6% 32% 347

3 15% 17.3% 30% 367

4 17% 19.6% 35% 431

5 15% 17.3% 32% 433

6 13% 15% 30% 469

7 17% 19.6% 37% 487 LQ = 487

8 15% 17.3% 35% 532

9 12% 13.8% 30% 535

10 13% 15% 32% 549

11 17% 19.6% 40% 571

12 15% 17.3% 37% 598

13 11% 12.7% 30% 614 Median = 614

14 12% 13.8% 32% 623

15 13% 15% 35% 668

16 15% 17.3% 40% 697

17 11% 12.7% 32% 712

18 13% 15% 37% 748

19 12% 13.8% 35% 755 UQ = 755

20 12% 13.8% 37% 844

21 11% 12.7% 35% 860

22 13% 15% 40% 867

2009–7 I.R.B. 492 February 17, 2009

Income methodapplication number:

Comparableuncontrolled

licensing discount rate

Comparableuncontrolled CSA

discount rate

Comparableuncontrolledlicensing rate

Calculated lump sumPCT Payment

Interquartile range ofPCT payments

23 11% 12.7% 37% 959

24 12% 13.8% 40% 976

25 11% 12.7% 40% 1,107

(iii) Accordingly, the Commissioner determinesthat a taxpayer will not be subject to adjustment if itsinitial (ex ante) determination of the PCT payment isbetween $487 million and $755 million. In the eventthat the taxpayer’s determination of the appropriatePCT payment falls outside this range, the adjustmentmade by the Commissioner will ordinarily be to $614.

Example 3. (i) USP, a U.S. software company,has developed version 1.0 of a new software appli-cation, employed to store and retrieve complex datasets in certain types of storage media. Version 1.0is currently being marketed. In Year 1, USP entersinto a CSA with its wholly-owned foreign subsidiary,FS, to develop future versions of the software appli-cation. Under the CSA, USP will have the exclusiverights to exploit the future versions in the U.S., andFS will have the exclusive rights to exploit them inthe rest of the world. USP’s rights in version 1.0, andits development team, are reasonably anticipated tocontribute to the development of future versions ofthe software application and, therefore, the rights inversion 1.0 are platform contributions for which com-pensation is due from FS as part of a PCT. USP alsotransfers the current exploitation rights in version 1.0to FS and the arm’s length amount of the compensa-tion for such transfer is determined in the aggregatewith the arm’s length PCT Payments in this Exam-ple 3. FS does not furnish any platform contribu-tions to the CSA nor does it control any operatingintangibles at the inception of the CSA that wouldbe relevant to the exploitation of version 1.0 or fu-ture versions of the software. It is reasonably an-ticipated that FS will have gross sales of $1000X inits territory for 5 years attributable to its exploitationof version 1.0 and the cost shared intangibles, afterwhich time the software application will be renderedobsolete and unmarketable by the obsolescence of thestorage medium technology to which it relates. FS’scosts reasonably attributable to the CSA, other thancost contributions and operating cost contributions,are anticipated to be $250X per year. Certain oper-ating cost contributions that will be borne by FS arereasonably anticipated to equal $200X per annum for5 years. In addition, FS is reasonably anticipated topay cost contributions of $200X per year as a con-trolled participant in the CSA.

(ii) FS concludes that its realistic alternativewould be to license software from an uncontrolledlicensor that would undertake the commitment tobear the entire risk of software development. Ap-plying CPM using the profit levels experienced byuncontrolled licensees with contractual provisionsand allocations of risk that are comparable to thoseof FS’s licensing alternative, FS determines that itcould, as a licensee, reasonably expect a (pre-tax)routine return equal to 14% of gross sales or $140Xper year for 5 years. The remaining net revenuewould be paid to the uncontrolled licensor as a li-cense fee of $410X per year. FS determines that thediscount rate that would be applied to determine the

present value of income and costs attributable to itsparticipation in the licensing alternative would be12.5% as compared to the 15% discount rate thatwould be applicable in determining the present valu-able of the net income attributable to its participationin the CSA (reflecting the increased risk borne byFS in bearing a share of the R&D costs in the costsharing alternative and the fact that FS intends to paythe PCT payment as a single lump sum). FS alsodetermines that the tax rate applicable to it will bethe same in the licensing alternative as in the CSA.

(iii) On these facts, the present value to FS ofentering into the cost sharing alternative equals thepresent value of the divisional profits ($1,000X minus$250X) minus operating cost contributions ($200X)minus cost contributions ($200X) minus PCT Pay-ments, determined over 5 years by discounting at adiscount rate of 15%(for simplicity of calculation inthis example, all financial flows are assumed to occurat the beginning of each period). Thus, the presentvalue of the residuals, prior to subtracting the valueof the PCT Payments, is $1349X.

(iv) On these facts, the present value to FS of en-tering into the licensing alternative would be $561Xdetermined by discounting, over 5 years, divisionalprofits ($1,000X minus $250X) minus operatingcost contributions ($200X) and licensing payments($410X) at a discount rate of 12.5% per annum.The present value of the cost sharing alternativemust also equal $561X but equals $1349X prior tosubtracting the present value of the PCT payments.Consequently, the PCT payments must have a presentvalue of $788X. Thus, the arm’s length lump sumPCT payment made at the time of the PCT will equal$788X.

(5) Acquisition price method—(i) Ingeneral. The acquisition price methodapplies the comparable uncontrolled trans-action method of §1.482–4(c), or thecomparable uncontrolled services pricemethod described in §1.482–9T(c), toevaluate whether the amount charged ina PCT, or group of PCTs, is arm’s lengthby reference to the amount charged (theacquisition price) for the stock or assetpurchase of an entire organization or por-tion thereof (the target) in an uncontrolledtransaction. The acquisition price methodis ordinarily used where substantially allthe target’s nonroutine contributions, assuch term is defined in paragraph (j)(1)(i)of this section, made to the PCT Payee’sbusiness activities are covered by a PCTor group of PCTs.

(ii) Determination of arm’s lengthcharge. Under this method, the arm’s

length charge for a PCT or group of PCTscovering resources, capabilities, and rightsof the target is equal to the adjusted ac-quisition price, as divided among thecontrolled participants according to theirrespective RAB shares. However, an ad-ditional adjustment may be necessary toreflect the fact that PCT Payee’s tax liabil-ity attributable to the purchase from targetmay differ from the tax liability attribut-able to the PCT Payments. See paragraph(g)(2)(x) of this section.

(iii) Adjusted acquisition price. The ad-justed acquisition price is the acquisitionprice of the target increased by the value ofthe target’s liabilities on the date of the ac-quisition, other than liabilities not assumedin the case of an asset purchase, and de-creased by the value of the target’s tangi-ble property on that date and by the valueon that date of any other resources, capa-bilities, and rights not covered by a PCT orgroup of PCTs.

(iv) Best method analysis considera-tions. The comparability and reliabilityconsiderations stated in §1.482–4(c)(2) ap-ply. Consistent with those considerations,the reliability of applying the acquisitionprice method as a measure of the arm’slength charge for the PCT Payment nor-mally is reduced if—

(A) A substantial portion of the tar-get’s nonroutine contributions to the PCTPayee’s business activities is not requiredto be covered by a PCT or group of PCTs,and that portion of the nonroutine contri-butions cannot reliably be valued;

(B) A substantial portion of the target’sassets consists of tangible property thatcannot reliably be valued; or

(C) The date on which the target is ac-quired and the date of the PCT are not con-temporaneous.

(v) Example. The following exampleillustrates the principles of this paragraph(g)(5):

Example. USP, a U.S. corporation, and its newlyincorporated, wholly-owned foreign subsidiary (FS)enter into a CSA at the start of Year 1 to developGroup Z products. Under the CSA, USP and FS willhave the exclusive rights to exploit the Group Z prod-

February 17, 2009 493 2009–7 I.R.B.

ucts in the U.S. and the rest of the world, respec-tively. At the start of Year 2, USP acquires CompanyX for cash consideration worth $110 million. At thistime USP’s RAB share is 60% and FS’s RAB share is40%. Company X joins in the filing of a U.S. con-solidated income tax return with USP. Under para-graph (j)(2)(i) of this section, Company X and USPare treated as one taxpayer for purposes of this sec-tion. Accordingly, the rights in any of Company X’sresources and capabilities that are reasonably antic-ipated to contribute to the development activities ofthe CSA will be considered platform contributionsfurnished by USP. Company X’s resources and ca-pabilities consist of its workforce, certain technol-ogy intangibles, $15 million of tangible property andother assets and $5 million in liabilities. The tech-nology intangibles, as well as Company X’s work-force, are reasonably anticipated to contribute to thedevelopment of the Group Z products under the CSAand, therefore, the rights in the technology intangi-bles and the workforce are platform contributions forwhich FS must make a PCT Payment to USP. Noneof Company X’s existing intangible assets or any ofits workforce are anticipated to contribute to activi-ties outside the CSA. For purposes of this example, itis assumed that no additional adjustment on accountof tax liabilities (as described in paragraph (g)(5)(ii)of this section) is needed. Applying the acquisitionprice method, the value of USP’s platform contribu-tions is the adjusted acquisition price of $100 million($110 million acquisition price plus $5 million liabil-ities less $15 million tangible property and other as-sets). FS must make a PCT Payment to USP for theseplatform contributions with a reasonably anticipatedpresent value of $40 million, which is the product of$100 million (the value of the platform contributions)and 40% (FS’s RAB share at the time of the PCT).

(6) Market capitalization method—(i)In general. The market capitalizationmethod applies the comparable uncon-trolled transaction method of §1.482–4(c),or the comparable uncontrolled servicesprice method described in §1.482–9T(c),to evaluate whether the amount charged ina PCT, or group of PCTs, is arm’s lengthby reference to the average market capi-talization of a controlled participant (PCTPayee) whose stock is regularly tradedon an established securities market. Themarket capitalization method is ordinarilyused where substantially all of the PCTPayee’s nonroutine contributions to thePCT Payee’s business are covered by aPCT or group of PCTs.

(ii) Determination of arm’s lengthcharge. Under the market capitalizationmethod, the arm’s length charge for a PCTor group of PCTs covering resources, ca-pabilities, and rights of the PCT Payee isequal to the adjusted average market capi-talization, as divided among the controlledparticipants according to their respectiveRAB shares. An increase to reflect the factthat a PCT Payment may increase the PCT

Payee’s tax liability and decrease the PCTPayor’s tax liability may be warranted.See paragraph (g)(2)(x) of this section.

(iii) Average market capitalization. Theaverage market capitalization is the av-erage of the daily market capitalizationsof the PCT Payee over a period of timebeginning 60 days before the date of thePCT and ending on the date of the PCT.The daily market capitalization of the PCTPayee is calculated on each day its stockis actively traded as the total number ofshares outstanding multiplied by the ad-justed closing price of the stock on thatday. The adjusted closing price is the dailyclosing price of the stock, after adjust-ments for stock-based transactions (divi-dends and stock splits) and other pendingcorporate (combination and spin-off) re-structuring transactions for which reliablearm’s length adjustments can be made.

(iv) Adjusted average market capital-ization. The adjusted average market cap-italization is the average market capital-ization of the PCT Payee increased by thevalue of the PCT Payee’s liabilities on thedate of the PCT and decreased by the valueon such date of the PCT Payee’s tangibleproperty and of any other resources, capa-bilities, or rights of the PCT Payee not cov-ered by a PCT or group of PCTs.

(v) Best method analysis considera-tions. The comparability and reliabilityconsiderations stated in §1.482–4(c)(2) ap-ply. Consistent with those considerations,the reliability of applying the comparableuncontrolled transaction method using theadjusted market capitalization of a com-pany as a measure of the arm’s lengthcharge for the PCT Payment normally isreduced if—

(A) A substantial portion of the PCTPayee’s nonroutine contributions to itsbusiness activities is not required to becovered by a PCT or group of PCTs, andthat portion of the nonroutine contribu-tions cannot reliably be valued;

(B) A substantial portion of the PCTPayee’s assets consists of tangible propertythat cannot reliably be valued; or

(C) Facts and circumstances demon-strate the likelihood of a material diver-gence between the average market capi-talization of the PCT Payee and the valueof its resources, capabilities, and rightsfor which reliable adjustments cannot bemade.

(vi) Examples. The following examplesillustrate the principles of this paragraph(g)(6):

Example 1. (i) USP, a publicly traded U.S. com-pany, and its newly incorporated wholly-owned for-eign subsidiary (FS) enter into a CSA on Date 1 to de-velop software. At that time USP has in-process soft-ware but has no software ready for the market. Underthe CSA, USP and FS will have the exclusive rightsto exploit the software developed under the CSA inthe United States and the rest of the world, respec-tively. On Date 1, USP’s RAB share is 70% and FS’sRAB share is 30%. USP’s assembled team of re-searchers and its in-process software are reasonablyanticipated to contribute to the development of thesoftware under the CSA. Therefore, the rights in theresearch team and in-process software are platformcontributions for which compensation is due from FS.Further, these rights are not reasonably anticipated tocontribute to any business activity other than the CSAActivity.

(ii) On Date 1, USP had an average market capi-talization of $205 million, tangible property and otherassets that can be reliably valued worth $5 million,and no liabilities. Aside from those assets, USP hadno assets other than its research team and in-processsoftware. Applying the market capitalization method,the value of USP’s platform contributions is $200million ($205 million average market capitalizationof USP less $5 million of tangible property and otherassets). The arm’s length value of the PCT PaymentsFS must make to USP for the platform contributions,before any adjustment on account of tax liability asdescribed in paragraph (g)(2)(ii) of this section, is$60 million, which is the product of $200 million (thevalue of the platform contributions) and 30% (FS’sRAB share on Date 1).

Example 2. Aggregation with make-or-sell rights.(i) The facts are the same as in Example 1, exceptthat on Date 1 USP also has existing software readyfor the market. USP separately enters into a licenseagreement with FS for make-or-sell rights for all ex-isting software outside the United States. No market-ing has occurred, and USP has no marketing intan-gibles. This license of current make-or-sell rights isa transaction governed by §1.482–4. However, af-ter analysis, it is determined that the arm’s lengthPCT Payments and the arm’s length payments forthe make-or-sell license may be most reliably deter-mined in the aggregate using the market capitaliza-tion method, under principles described in paragraph(g)(2)(iv) of this section, and it is further determinedthat those principles are most reliably implementedby computing the aggregate arm’s length charge asthe product of the aggregate value of the existing andin-process software and FS’s RAB share on Date 1.

(ii) Applying the market capitalization method,the aggregate value of USP’s platform contributionsand the make-or-sell rights in its existing software is$250 million ($255 million average market capital-ization of USP less $5 million of tangible propertyand other assets). The total arm’s length value of thePCT Payments and license payments FS must maketo USP for the platform contributions and currentmake-or-sell rights, before any adjustment on accountof tax liability as described in paragraph (g)(2)(ii)of this section, is $75 million, which is the productof $250 million (the value of the platform contribu-

2009–7 I.R.B. 494 February 17, 2009

tions and the make-or-sell rights) and 30% (FS’s RABshare on Date 1).

Example 3. Reduced reliability. The facts are thesame as in Example 1 except that USP also has sig-nificant nonroutine assets that will be used solely in anascent business division that is unrelated to the sub-ject of the CSA and that cannot themselves be reliablyvalued. Those nonroutine contributions are not plat-form contributions and accordingly are not requiredto be covered by a PCT. The reliability of using themarket capitalization method to determine the valueof USP’s platform contributions to the CSA is sig-nificantly reduced in this case because that methodwould require adjusting USP’s average market cap-italization to account for the significant nonroutinecontributions that are not required to be covered bya PCT.

(7) Residual profit split method—(i) Ingeneral. The residual profit split methodevaluates whether the allocation of com-bined operating profit or loss attributableto one or more platform contributions sub-ject to a PCT is arm’s length by referenceto the relative value of each controlledparticipant’s contribution to that combinedoperating profit or loss. The combinedoperating profit or loss must be derivedfrom the most narrowly identifiable busi-ness activity (relevant business activity) ofthe controlled participants for which dataare available that include the CSA Ac-tivity. The residual profit split methodmay not be used where only one controlledparticipant makes significant nonroutinecontributions (including platform or oper-ating contributions) to the CSA Activity.The provisions of §1.482–6 shall apply toCSAs only to the extent provided and asmodified in this paragraph (g)(7). Anyother application to a CSA of a residualprofit method not described in paragraphs(g)(7)(ii) and (iii) will constitute an un-specified method for purposes of sections482 and 6662(e) and the regulations underthose sections.

(ii) Appropriate share of profits andlosses. The relative value of each con-trolled participant’s contribution to thesuccess of the relevant business activ-ity must be determined in a manner thatreflects the functions performed, risks as-sumed, and resources employed by eachparticipant in the relevant business ac-tivity, consistent with the best methodanalysis described in §1.482–1(c) and (d).Such an allocation is intended to corre-spond to the division of profit or loss thatwould result from an arrangement betweenuncontrolled taxpayers, each performingfunctions similar to those of the various

controlled participants engaged in the rele-vant business activity. The profit allocatedto any particular controlled participant isnot necessarily limited to the total operat-ing profit of the group from the relevantbusiness activity. For example, in a givenyear, one controlled participant may earn aprofit while another controlled participantincurs a loss. In addition, it may not be as-sumed that the combined operating profitor loss from the relevant business activityshould be shared equally, or in any otherarbitrary proportion.

(iii) Profit split—(A) In general. Un-der the residual profit split method, thepresent value of each controlled partic-ipant’s residual divisional profit or lossattributable to nonroutine contributions(nonroutine residual divisional profit orloss) is allocated between the controlledparticipants that each furnish significantnonroutine contributions (including plat-form or operating contributions) to therelevant business activity in that division.

(B) Determine nonroutine residual di-visional profit or loss. The present valueof each controlled participant’s nonroutineresidual divisional profit or loss must bedetermined to reflect the most reliablemeasure of an arm’s length result. Thepresent value of nonroutine residual di-visional profit or loss equals the presentvalue of the stream of the reasonably an-ticipated residuals over the duration of theCSA Activity of divisional profit or loss,minus market returns for routine contribu-tions, minus operating cost contributions,minus cost contributions, using a discountrate appropriate to such residuals in ac-cordance with paragraph (g)(2)(v) of thissection.

(C) Allocate nonroutine residual divi-sional profit or loss—(1) In general. Thepresent value of nonroutine residual di-visional profit or loss in each controlledparticipant’s division must be allocatedamong all of the controlled participantsbased upon the relative values, deter-mined as of the date of the PCTs, of thePCT Payor’s as compared to the PCTPayee’s nonroutine contributions to thePCT Payor’s division. For this purpose,the PCT Payor’s nonroutine contributionconsists of the sum of the PCT Payor’snonroutine operating contributions andthe PCT Payor’s RAB share of the PCTPayor’s nonroutine platform contributions.For this purpose, the PCT Payee’s non-

routine contribution consists of the PCTPayor’s RAB share of the PCT Payee’snonroutine platform contributions.

(2) Relative value determination. Therelative values of the controlled partici-pants’ nonroutine contributions must bedetermined so as to reflect the most re-liable measure of an arm’s length result.Relative values may be measured by exter-nal market benchmarks that reflect the fairmarket value of such nonroutine contribu-tions. Alternatively, the relative value ofnonroutine contributions may be estimatedby the capitalized cost of developing thenonroutine contributions and updates, asappropriately grown or discounted so thatall contributions may be valued on a com-parable dollar basis as of the same date.If the nonroutine contributions by a con-trolled participant are also used in otherbusiness activities (such as the exploitationof make-or-sell rights described in para-graph (c)(4) of this section), an allocationof the value of the nonroutine contribu-tions must be made on a reasonable basisamong all the business activities in whichthey are used in proportion to the relativeeconomic value that the relevant businessactivity and such other business activitiesare anticipated to derive over time as theresult of such nonroutine contributions.

(3) Determination of PCT Payments.Any amount of the present value of a con-trolled participant’s nonroutine residual di-visional profit or loss that is allocated toanother controlled participant representsthe present value of the PCT Payments dueto that other controlled participant for itsplatform contributions to the relevant busi-ness activity in the relevant division. Forpurposes of paragraph (j)(3)(ii) of this sec-tion, the present value of a PCT Payor’sPCT Payments under this paragraph shallbe deemed reduced to the extent of thepresent value of any PCT Payments owedto it from other controlled participants un-der this paragraph (g)(7). The resultingremainder may be converted to a fixedor contingent form of payment in accor-dance with paragraph (h) (Form of pay-ment rules) of this section.

(4) Routine platform and operatingcontributions. For purposes of this para-graph (g)(7), any routine platform oroperating contributions, the valuation andPCT Payments for which are determinedand made independently of the residualprofit split method, are treated similarly

February 17, 2009 495 2009–7 I.R.B.

to cost contributions and operating costcontributions, respectively. Accordingly,wherever used in this paragraph (g)(7),the term “routine contributions” shall notinclude routine platform or operating con-tributions, and wherever the terms “costcontributions” and “operating cost contri-butions” appear in this paragraph (g)(7),they shall include net routine platformcontributions and net routine operatingcontributions, respectively, as defined inparagraph (g)(4)(vi) of this section.

(iv) Best method analysis considera-tions—(A) In general. Whether resultsderived from this method are the mostreliable measure of the arm’s length resultis determined using the factors describedunder the best method rule in §1.482–1(c).Thus, comparability and quality of data,reliability of assumptions, and sensitivityof results to possible deficiencies in thedata and assumptions, must be consid-ered in determining whether this methodprovides the most reliable measure of anarm’s length result. The application ofthese factors to the residual profit split inthe context of the relevant business ac-tivity of developing and exploiting costshared intangibles is discussed in para-graphs (g)(7)(iv)(B), (C) and (D) of thissection.

(B) Comparability. The derivation ofthe present value of nonroutine residualdivisional profit or loss includes a carve-out on account of market returns for rou-tine contributions. Thus, the compara-bility considerations that are relevant forthat purpose include those that are rele-vant for the methods that are used to de-termine market returns for the routine con-tributions.

(C) Data and assumptions. The relia-bility of the results derived from the resid-ual profit split is affected by the quality ofthe data and assumptions used to apply thismethod. In particular, the following fac-tors must be considered:

(1) The reliability of the allocation ofcosts, income, and assets between the rel-evant business activity and the controlledparticipants’ other activities that will af-fect the reliability of the determination ofthe divisional profit or loss and its allo-cation among the controlled participants.See §1.482–6(c)(2)(ii)(C)(1).

(2) The degree of consistency betweenthe controlled participants and uncon-trolled taxpayers in accounting practices

that materially affect the items that deter-mine the amount and allocation of operat-ing profit or loss affects the reliability ofthe result. See §1.482–6(c)(2)(ii)(C)(2).

(3) The reliability of the data used andthe assumptions made in estimating therelative value of the nonroutine contribu-tions by the controlled participants. In par-ticular, if capitalized costs of developmentare used to estimate the relative value ofnonroutine contributions, the reliability ofthe results is reduced relative to the relia-bility of other methods that do not requiresuch an estimate. This is because, in anygiven case, the costs of developing a non-routine contribution may not be related toits market value and because the calcula-tion of the capitalized costs of develop-ment may require the allocation of indirectcosts between the relevant business activ-ity and the controlled participant’s otheractivities, which may affect the reliabilityof the analysis.

(D) Other factors affecting reliability.Like the methods described in §§1.482–3through 1.482–5 and §1.482–9T(c), thecarveout on account of market returns forroutine contributions relies exclusivelyon external market benchmarks. As indi-cated in §1.482–1(c)(2)(i), as the degreeof comparability between the controlledparticipants and uncontrolled transactionsincreases, the relative weight accorded theanalysis under this method will increase.In addition, to the extent the allocationof nonroutine residual divisional profit orloss is not based on external market bench-marks, the reliability of the analysis will bedecreased in relation to an analysis under amethod that relies on market benchmarks.Finally, the reliability of the analysis un-der this method may be enhanced by thefact that all the controlled participants areevaluated under the residual profit split.However, the reliability of the results of ananalysis based on information from all thecontrolled participants is affected by thereliability of the data and the assumptionspertaining to each controlled participant.Thus, if the data and assumptions are sig-nificantly more reliable with respect toone of the controlled participants than withrespect to the others, a different method,focusing solely on the results of that party,may yield more reliable results.

(v) Examples. The following examplesillustrate the principles of this paragraph(g)(7):

Example 1. (i) USP, a U.S. electronic data storagecompany, has partially developed technology for atype of extremely small compact storage devices(nanodisks) which are expected to provide a signifi-cant increase in data storage capacity in various typesof portable devices such as cell phones, MP3 players,laptop computers and digital cameras. At the sametime, USP’s wholly-owned subsidiary, FS, has de-veloped significant marketing intangibles outside theUnited States in the form of customer lists, ongoingrelations with various OEMs, and trademarks that arewell recognized by consumers due to a long historyof marketing successful data storage devices andother hardware used in various types of consumerelectronics. At the beginning of Year 1, USP entersinto a CSA with FS to develop nanodisk technologiesfor eventual commercial exploitation. Under theCSA, USP will have the right to exploit nanodisksin the United States, while FS will have the rightto exploit nanodisks in the rest of the world. Thepartially developed nanodisk technologies owned byUSP are reasonably anticipated to contribute to thedevelopment of commercially exploitable nanodisksand therefore the rights in the nanodisk technologiesconstitute platform contributions of USP for whichcompensation is due under PCTs. FS does not ownany intangible assets that constitute platform contri-butions for the CSA. Due to the fact that nanodisktechnologies have yet to be incorporated into anycommercially available product, neither USP nor FStransfers rights to make or sell current products inconjunction with the CSA.

(ii) Because only in FS’s territory do both con-trolled participants make significant nonroutine con-tributions, USP and FS determine that they need todetermine the relative value of their respective con-tributions to operating profit or loss attributable to theCSA only in FS’s territory (that is, to FS’s divisionalprofit or loss). FS anticipates making no nanodisksales during the first year of the CSA in its territorywith revenues in Years 2 reaching $200 million. Rev-enues through Year 5 are reasonably anticipated to in-crease by 50% per year. The annual growth rate forrevenues is then expected to decline to 30% per an-num in Years 6 and 7, 20% per annum in Years 8 and9 and 10% per annum in Year 10. Revenues are thenexpected to start to decline; declining 10% in Year11 and 5% per annum, thereafter. The routine costs(costs other than cost contributions, operating costcontributions, routine platform and operating contri-butions, and nonroutine contributions) that are alloca-ble to this revenue in calculating FS’s divisional profitor loss, are anticipated to equal 45% of gross salesfrom Year 2, onwards. FS undertakes routine distri-bution activities in its markets that constitute routinecontributions to the relevant business activity of ex-ploiting nanodisk technologies. USP and FS estimatethat the total market return on these routine contri-butions will amount to 6% of the routine costs. FSanticipates that its operating cost contributions willequal $40 million per annum for the first two years ofthe CSA and $65 and $70 million in Years 3 and 4.Thereafter, operating cost contributions are expectedto equal 7% of revenue in each year. FS expects itscost contributions to be $60 million in Year 1, rise to$100 million in Years 2 and 3, and then decline againto $60 million. Thereafter, FS’s cost contributions areexpected to equal 10% of revenues.

2009–7 I.R.B. 496 February 17, 2009

(iii) USP and FS determine the present value ofthe stream of the reasonably anticipated residuals inFS’s territory over the duration of the CSA Activityof the divisional profit or loss (revenues minus rou-tine costs), minus the market returns for routine con-tributions, the operating cost contributions, and thecost contributions. USP and FS determine, based onthe considerations discussed in paragraph (g)(2)(v)of this section, that the appropriate discount rate is17.5% per annum (for simplicity of calculation in thisexample, all financial flows are assumed to occur atthe beginning of each period). Therefore, the presentvalue of the nonroutine residual divisional profit is$1.319 billion.

(iv) After analysis, USP and FS determine thatthe relative value of the nanodisk technologies con-tributed by USP to CSA (giving effect only to itsvalue in FS’s territory) is roughly 150% of the valueof FS’s marketing intangibles (which only havevalue in FS’s territory). Consequently, 60% of thenonroutine residual divisional profit is attributable toUSP’s platform contribution. Therefore, FS’s PCTpayments should have an expected present valueequal to $792 million (.6 x $1.319 billion).

Example 2. (i) USP is a U.S. automobile man-ufacturing company that has completed significantresearch on the development of diesel-electric hy-brid engines that, if they could be successfully man-ufactured, would result in providing a significant in-creased fuel economy for a wide variety of motor ve-hicles. Successful commercialization of the diesel-electric hybrid engine will require the developmentof a new class of advanced battery that will be light,relatively cheap to manufacture and yet capable ofholding a substantial electric charge. FS, a foreignsubsidiary of USP, has completed significant researchon developing lithium-ion batteries that appear likelyto have the requisite characteristics. At the beginningof Year 1, USP enters into a CSA with FS to furtherdevelop diesel-electric hybrid engines and lithium-ion battery technologies for eventual commercial ex-ploitation. Under the CSA, USP will have the right toexploit the diesel-electric hybrid engine and lithium-ion battery technologies in the United States, whileFS will have the right to exploit such technologies inthe rest of the world. The partially developed diesel-electric hybrid engine and lithium-ion battery tech-nologies owned by USP and FS, respectively, are rea-sonably anticipated to contribute to the developmentof commercially exploitable automobile engines andtherefore the rights in both these technologies con-stitute platform contributions of USP and of FS forwhich compensation is due under PCTs. At the timeof inception of the CSA, USP owns operating intangi-bles in the form of self-developed marketing intangi-bles which have significant value in the United States,but not in the rest of the world, and that are rele-vant to exploiting the cost shared intangibles. Sim-ilarly, FS owns self-developed marketing intangibleswhich have significant value in the rest of the world,but not in the United States, and that are relevantto exploiting the cost shared intangibles. Althoughthe new class of diesel-electric hybrid engine usinglithium-ion batteries is not yet ready for commercialexploitation, components based on this technologyare beginning to be incorporated in current-genera-tion gasoline-electric hybrid engines and the rights tomake and sell such products are transferred from USP

to FS and vice-versa in conjunction with the inceptionof the CSA.

(ii) USP’s estimated RAB share is 66.7 percent.During year 1, it is anticipated that sales in USP’s ter-ritory will be $1000X in Year 1. Sales in FS’s terri-tory are anticipated to be $500X. Thereafter, as rev-enue from the use of components in gasoline-electrichybrids is supplemented by revenues from the pro-duction of complete diesel-electric hybrid engines us-ing lithium-ion battery technology, anticipated salesin both territories will increase rapidly at a rate of50% per annum through Year 4. Anticipated salesare then anticipated to increase at a rate of 40% perannum for another 4 years. Sales are then anticipatedto increase at a rate of 30% per annum through year10. Thereafter, sales are anticipated to decrease ata rate of 5% per annum for the foreseeable futureas new automotive drivetrain technologies displacediesel-electric hybrid engines and lithium-ion batter-ies. Total operating expenses attributable to productexploitation (including operating cost contributions)equal 40% of sales per year for both USP and FS. USPand FS estimate that the total market return on theirroutine contributions to the CSA will amount to 6% ofthe operating expenses. USP is expected to bear 2/3sof the total cost contributions for the foreseeable fu-ture. Cost contributions are expected to total $375Xin Year 1 (of which $250X are borne by USP) and in-crease at a rate of 25% per annum through Year 6. InYears 7 through 10, cost contributions are expectedto increase 10% a year. Thereafter, cost contributionsare expected to decrease by 5% a year for the foresee-able future.

(iii) USP and FS determine the present value ofthe stream of the reasonably anticipated divisionalprofit or loss (revenues minus operating costs), minusthe market returns for routine contributions, minuscost contributions. USP and FS determine, based onthe considerations discussed in paragraph (g)(2)(v) ofthis section, that the appropriate discount rate is 12%per year. Therefore, the present value of the non-routine residual divisional profit in USP’s territoryis $41,115X and in CFC’s territory is $20,557X (forsimplicity of calculation in this example, all financialflows are assumed to occur at the beginning of eachperiod).

(iv) After analysis, USP and FS determine that,in the United States the relative value of the tech-nologies contributed by USP and FS to the CSA andof the operating intangibles used by USP in the ex-ploitation of the cost shared intangibles (reported asequaling 100 in total), equals: USP’s platform contri-bution (59.5); FS’s platform contribution (25.5); andUSP’s operating intangibles (15). Consequently, thepresent value of the arm’s length amount of the PCTpayments that USP should pay to FS for FS’s plat-form contribution is $10,484X (.255 X $41,115X).Similarly, USP and FS determine that, in the rest ofthe world, the relative value of the technologies con-tributed by USP and FS to the CSA and of the op-erating intangibles used by FS in the exploitation ofthe cost shared intangibles can be divided as follows:USP’s platform contribution (63); FS’s platform con-tribution (27); and FS’s operating intangibles (10).Consequently, the present value of the arm’s lengthamount of the PCT payments that FS should pay toUSP for USP’s platform contribution is $12,951X(.63 X $20,557X). Therefore, FS is required to make

a net payment to USP with a present value of $2,467X($12,951X - 10,484X).

(8) Unspecified methods. Methods notspecified in paragraphs (g)(3) through (7)of this section may be used to evaluatewhether the amount charged for a PCT isarm’s length. Any method used under thisparagraph (g)(8) must be applied in accor-dance with the provisions of §1.482–1 andof paragraph (g)(2) of this section. Consis-tent with the specified methods, an unspec-ified method should take into account thegeneral principle that uncontrolled taxpay-ers evaluate the terms of a transaction byconsidering the realistic alternatives to thattransaction, and only enter into a particu-lar transaction if none of the alternatives ispreferable to it. Therefore, in establishingwhether a PCT achieved an arm’s lengthresult, an unspecified method should pro-vide information on the prices or profitsthat the controlled participant could haverealized by choosing a realistic alternativeto the CSA. See paragraph (k)(2)(ii)(J) ofthis section. As with any method, an un-specified method will not be applied unlessit provides the most reliable measure ofan arm’s length result under the principlesof the best method rule. See §1.482–1(c)(Best method rule). In accordance with§1.482–1(d) (Comparability), to the extentthat an unspecified method relies on inter-nal data rather than uncontrolled compara-bles, its reliability will be reduced. Sim-ilarly, the reliability of a method will beaffected by the reliability of the data andassumptions used to apply the method, in-cluding any projections used.

(h) Form of payment rules—(1) CSTPayments. CST Payments may not be paidin shares of stock in the payor (or stock inany member of the controlled group thatincludes the controlled participants).

(2) PCT Payments—(i) In general. Theconsideration under a PCT for a platformcontribution may take one or a combina-tion of both of the following forms:

(A) Payments of a fixed amount (fixedpayments), either paid in a lump sum pay-ment or in installment payments spreadover a specified period, with interest cal-culated in accordance with §1.482–2(a)(Loans or advances).

(B) Payments contingent on the ex-ploitation of cost shared intangibles by thePCT Payor (contingent payments).

(ii) No PCT Payor Stock. PCT Pay-ments may not be paid in shares of stock in

February 17, 2009 497 2009–7 I.R.B.

the PCT Payor (or stock in any member ofthe controlled group that includes the con-trolled participants).

(iii) Specified form of payment—(A) Ingeneral. The form of payment selected(subject to the rules of this paragraph (h))for any PCT, including, in the case ofcontingent payments, the contingent baseand structure of the payments as set forthin paragraph (h)(2)(iii)(B) of this section,must be specified no later than the duedate of the applicable tax return (includ-ing extensions) for the later of the taxableyear of the PCT Payor or PCT Payee thatincludes the date of that PCT.

(B) Contingent payments. In accor-dance with paragraph (k)(1)(iv)(A) of thissection, a provision of a written contractdescribed in paragraph (k)(1) of this sec-tion, or of the additional documentationdescribed in paragraph (k)(2) of this sec-tion, that provides for payments for a PCT(or group of PCTs) to be contingent onthe exploitation of cost shared intangibleswill be respected as consistent with eco-nomic substance only if the allocation be-tween the controlled participants of therisks attendant on such form of paymentis determinable before the outcomes ofsuch allocation that would have materi-ally affected the PCT pricing are known orreasonably knowable. A contingent pay-ment provision must clearly and unam-biguously specify the basis on which thecontingent payment obligations are to bedetermined. In particular, the contingentpayment provision must clearly and un-ambiguously specify the events that giverise to an obligation to make PCT Pay-ments, the royalty base (such as sales orrevenues), and the computation used todetermine the PCT Payments. The roy-alty base specified must be one that per-mits verification of its proper use by refer-ence to books and records maintained bythe controlled participants in the normalcourse of business (for example, books andrecords maintained for financial account-ing or business management purposes).

(C) Examples. The following examplesillustrate the principles of this paragraph(h)(2)(iii).

Example 1. A CSA provides that PCT paymentswith respect to a particular platform contribution shallbe contingent payments equal to 15% of the revenuesfrom sales of products that incorporate cost shared in-tangibles. The terms further permit (but do not re-quire) the controlled participants to adjust such con-tingent payments in accordance with a formula set

forth in the arrangement so that the 15% rate is subjectto adjustment by the controlled participants at theirdiscretion on an after-the-fact, uncompensated basis.The Commissioner may impute payment terms thatare consistent with economic substance with respectto the platform contribution because the contingentpayment provision does not specify the computationused to determine the PCT Payments.

Example 2. Taxpayer, an automobile manu-facturer, is a controlled participant in a CSA thatinvolves research and development to perfect cer-tain manufacturing techniques necessary to theactual manufacture of a state-of-the-art, hybrid fuelinjection system known as DRL337. The arrange-ment involves the platform contribution of a designpatent covering DRL337. Pursuant to paragraph(h)(2)(iii)(B) of this section, the CSA provides forPCT payments with respect to the platform contribu-tion of the patent in the form of royalties contingenton sales of automobiles that contain the DRL337system. However, Taxpayer’s system of book- andrecord-keeping does not enable Taxpayer to trackwhich automobile sales involve automobiles thatcontain the DRL337 system. Because Taxpayer hasnot complied with paragraph (h)(2)(iii)(B) of thissection, the Commissioner may impute paymentterms that are consistent with economic substanceand susceptible to verification by the Commissioner.

(iv) Conversion from fixed to contingentform of payment. With regard to a con-version of a fixed present value to a con-tingent form of payment, see paragraphs(g)(2)(v) (Discount rate) and (g)(2)(vi) (Fi-nancial projections) of this section.

(3) Coordination of best method ruleand form of payment. A method describedin paragraph (g)(1) of this section eval-uates the arm’s length amount chargedin a PCT in terms of a form of payment(method payment form). For example, themethod payment form for the acquisitionprice method described in paragraph (g)(5)of this section, and for the market capi-talization method described in paragraph(g)(6) of this section, is fixed payment.Applications of the income method pro-vide different method payment forms. Seeparagraphs (g)(4)(i)(E) and (g)(4)(iv) ofthis section. The method payment formmay not necessarily correspond to theform of payment specified pursuant toparagraphs (h)(2)(iii) and (k)(2)(ii)(I) ofthis section (specified payment form). Thedetermination under §1.482–1(c) of themethod that provides the most reliablemeasure of an arm’s length result is tobe made without regard to whether therespective method payment forms underthe competing methods correspond to thespecified payment form. If the methodpayment form of the method determinedunder §1.482–1(c) to provide the most

reliable measure of an arm’s length resultdiffers from the specified payment form,then the conversion from such methodpayment form to such specified paymentform will be made to the satisfaction ofthe Commissioner.

(i) Allocations by the Commissioner inconnection with a CSA—(1) In general.The Commissioner may make allocationsto adjust the results of a controlled transac-tion in connection with a CSA so that theresults are consistent with an arm’s lengthresult, in accordance with the provisions ofthis paragraph (i).

(2) CST allocations—(i) In general.The Commissioner may make allocationsto adjust the results of a CST so that theresults are consistent with an arm’s lengthresult, including any allocations to makeeach controlled participant’s IDC share, asdetermined under paragraph (d)(4) of thissection, equal to that participant’s RABshare, as determined under paragraph(e)(1) of this section. Such allocationsmay result from, for purposes of CST de-terminations, adjustments to—

(A) Redetermine IDCs by adding anycosts (or cost categories) that are directlyidentified with, or are reasonably allocableto, the IDA, or by removing any costs (orcost categories) that are not IDCs;

(B) Reallocate costs between the IDAand other business activities;

(C) Improve the reliability of the se-lection or application of the basis usedfor measuring benefits for purposes ofestimating a controlled participant’s RABshare;

(D) Improve the reliability of the pro-jections used to estimate RAB shares,including adjustments described in para-graph (i)(2)(ii) of this section; and

(E) Allocate among the controlled par-ticipants any unallocated interests in costshared intangibles.

(ii) Adjustments to improve the relia-bility of projections used to estimate RABshares—(A) Unreliable projections. Asignificant divergence between projectedbenefit shares and benefit shares adjustedto take into account any available actualbenefits to date (adjusted benefit shares)may indicate that the projections were notreliable for purposes of estimating RABshares. In such a case, the Commissionermay use adjusted benefit shares as themost reliable measure of RAB shares andadjust IDC shares accordingly. The pro-

2009–7 I.R.B. 498 February 17, 2009

jected benefit shares will not be consideredunreliable, as applied in a given taxableyear, based on a divergence from adjustedbenefit shares for every controlled partic-ipant that is less than or equal to 20% ofthe participant’s projected benefits share.Further, the Commissioner will not makean allocation based on such divergence ifthe difference is due to an extraordinaryevent, beyond the control of the controlledparticipants, which could not reasonablyhave been anticipated at the time that costswere shared. The Commissioner generallymay adjust projections of benefits used tocalculate benefit shares in accordance withthe provisions of §1.482–1. In particular,if benefits are projected over a period ofyears, and the projections for initial yearsof the period prove to be unreliable, thismay indicate that the projections for theremaining years of the period are also un-reliable and thus should be adjusted. Forpurposes of this paragraph (i)(2)(ii)(A),all controlled participants that are not U.S.persons are treated as a single controlledparticipant. Therefore, an adjustmentbased on an unreliable projection of RABshares will be made to the IDC sharesof foreign controlled participants only ifthere is a matching adjustment to the IDCshares of controlled participants that areU.S. persons. Nothing in this paragraph(i)(2)(ii)(A) prevents the Commissionerfrom making an allocation if a taxpayerdid not use the most reliable basis for mea-suring anticipated benefits. For example,if the taxpayer measures its anticipatedbenefits based on units sold, and the Com-missioner determines that another basisis more reliable for measuring anticipatedbenefits, then the fact that actual unitssold were within 20% of the projected unitsales will not preclude an allocation underthis section.

(B) Foreign-to-foreign adjustments.Adjustments to IDC shares based on anunreliable projection also may be madeamong foreign controlled participants if

the variation between actual and projectedbenefits has the effect of substantially re-ducing U.S. tax.

(C) Correlative adjustments to PCTs.Correlative adjustments will be made toany PCT Payments of a fixed amount thatwere determined based on RAB shares thatare subsequently adjusted on a finding thatthey were based on unreliable projections.No correlative adjustments will be madeto contingent PCT Payments regardless ofwhether RAB shares were used as a param-eter in the valuation of those payments.

(D) Examples. The following examplesillustrate the principles of this paragraph(i)(2)(ii):

Example 1. U.S. Parent (USP) and Foreign Sub-sidiary (FS) enter into a CSA to develop new foodproducts, dividing costs on the basis of projectedsales two years in the future. In Year 1, USP andFS project that their sales in Year 3 will be equal,and they divide costs accordingly. In Year 3, theCommissioner examines the controlled participants’method for dividing costs. USP and FS actually ac-counted for 42% and 58% of total sales, respectively.The Commissioner agrees that sales two years in thefuture provide a reliable basis for estimating bene-fit shares. Because the differences between USP’sand FS’s adjusted and projected benefit shares areless than 20% of their projected benefit shares, theprojection of future benefits for Year 3 is reliable.

Example 2. The facts are the same as in Exam-ple 1, except that in Year 3 USP and FS actuallyaccounted for 35% and 65% of total sales, respec-tively. The divergence between USP’s projected andadjusted benefit shares is greater than 20% of USP’sprojected benefit share and is not due to an extra-ordinary event beyond the control of the controlledparticipants. The Commissioner concludes that theprojected benefit shares were unreliable, and uses ad-justed benefit shares as the basis for an adjustment tothe cost shares borne by USP and FS.

Example 3. U.S. Parent (USP), a U.S. corpo-ration, and its foreign subsidiary (FS) enter into aCSA in Year 1. They project that they will beginto receive benefits from cost shared intangibles inYears 4 through 6, and that USP will receive 60%of total benefits and FS 40% of total benefits. InYears 4 through 6, USP and FS actually receive50% each of the total benefits. In evaluating thereliability of the controlled participants’ projections,the Commissioner compares the adjusted benefitshares to the projected benefit shares. AlthoughUSP’s adjusted benefit share (50%) is within 20%

of its projected benefit share (60%), FS’s adjustedbenefit share (50%) is not within 20% of its projectedbenefit share (40%). Based on this discrepancy, theCommissioner may conclude that the controlled par-ticipants’ projections were unreliable and may useadjusted benefit shares as the basis for an adjustmentto the cost shares borne by USP and FS.

Example 4. Three controlled taxpayers, USP,FS1, and FS2 enter into a CSA. FS1 and FS2 are for-eign. USP is a domestic corporation that controls allthe stock of FS1 and FS2. The controlled participantsproject that they will share the total benefits of thecost shared intangibles in the following percentages:USP 50%; FS1 30%; and FS2 20%. Adjusted benefitshares are as follows: USP 45%; FS1 25%; and FS230%. In evaluating the reliability of the controlledparticipants’ projections, the Commissioner com-pares these adjusted benefit shares to the projectedbenefit shares. For this purpose, FS1 and FS2 aretreated as a single controlled participant. The ad-justed benefit share received by USP (45%) is within20% of its projected benefit share (50%). In addition,the non-US controlled participant’ adjusted benefitshare (55%) is also within 20% of their projectedbenefit share (50%). Therefore, the Commissionerconcludes that the controlled participant’s projec-tions of future benefits were reliable, despite the factthat FS2’s adjusted benefit share (30%) is not within20% of its projected benefit share (20%).

Example 5. The facts are the same as in Exam-ple 4. In addition, the Commissioner determines thatFS2 has significant operating losses and has no earn-ings and profits, and that FS1 is profitable and hasearnings and profits. Based on all the evidence, theCommissioner concludes that the controlled partici-pants arranged that FS1 would bear a larger cost sharethan appropriate in order to reduce FS1’s earningsand profits and thereby reduce inclusions USP oth-erwise would be deemed to have on account of FS1under subpart F. Pursuant to paragraph (i)(2)(ii)(B) ofthis section, the Commissioner may make an adjust-ment solely to the cost shares borne by FS1 and FS2because FS2’s projection of future benefits was un-reliable and the variation between adjusted and pro-jected benefits had the effect of substantially reducingUSP’s U.S. income tax liability (on account of FS1subpart F income).

Example 6. (i)(A) Foreign Parent (FP) and U.S.Subsidiary (USS) enter into a CSA in 1996 to de-velop a new treatment for baldness. USS’s interest inany treatment developed is the right to produce andsell the treatment in the U.S. market while FP retainsrights to produce and sell the treatment in the rest ofthe world. USS and FP measure their anticipated ben-efits from the CSA based on their respective projectedfuture sales of the baldness treatment. The followingsales projections are used:

Sales[In millions of dollars]

Year USS FP

1 5 102 20 203 30 304 40 405 40 40

February 17, 2009 499 2009–7 I.R.B.

Sales[In millions of dollars]

Year USS FP

6 40 407 40 408 20 209 10 10

10 5 5

(B) In Year 1, the first year of sales, USS is pro-jected to have lower sales than FP due to lags in U.S.regulatory approval for the baldness treatment. Ineach subsequent year, USS and FP are projected tohave equal sales. Sales are projected to build overthe first three years of the period, level off for severalyears, and then decline over the final years of the pe-

riod as new and improved baldness treatments reachthe market.

(ii) To account for USS’s lag in sales in the Year 1,the present discounted value of sales over the periodis used as the basis for measuring benefits. Based onthe risk associated with this venture, a discount rate of10 percent is selected. The present discounted valueof projected sales is determined to be approximately

$154.4 million for USS and $158.9 million for FP. Onthis basis USS and FP are projected to obtain approx-imately 49.3% and 50.7% of the benefit, respectively,and the costs of developing the baldness treatment areshared accordingly.

(iii) (A) In Year 6, the Commissioner examinesthe CSA. USS and FP have obtained the followingsales results through Year 5:

Sales[In millions of dollars]

Year USS FP

1 0 172 17 353 25 414 38 415 39 41

(B) USS’s sales initially grew more slowly thanprojected while FP’s sales grew more quickly. Ineach of the first three years of the period, the shareof total sales of at least one of the parties divergedby over 20% from its projected share of sales. How-ever, by Year 5 both parties’ sales had leveled off atapproximately their projected values. Taking into ac-count this leveling off of sales and all the facts andcircumstances, the Commissioner determines that itis appropriate to use the original projections for the

remaining years of sales. Combining the actual re-sults through Year 5 with the projections for subse-quent years, and using a discount rate of 10%, thepresent discounted value of sales is approximately$141.6 million for USS and $187.3 million for FP.This result implies that USS and FP obtain approxi-mately 43.1% and 56.9%, respectively, of the antici-pated benefits from the baldness treatment. Becausethese adjusted benefit shares are within 20% of thebenefit shares calculated based on the original sales

projections, the Commissioner determines that, basedon the difference between adjusted and projected ben-efit shares, the original projections were not unreli-able. No adjustment is made based on the differencebetween adjusted and projected benefit shares.

Example 7. (i) The facts are the same as in Exam-ple 6, except that the actual sales results through Year5 are as follows:

Sales[In millions of dollars]

Year USS FP

1 0 172 17 353 25 444 34 545 36 55

(ii) Based on the discrepancy between the projec-tions and the actual results and on consideration of all

the facts, the Commissioner determines that for the remaining years the following sales projections aremore reliable than the original projections:

Sales[In millions of dollars]

Year USS FP

6 36 557 36 558 18 289 9 14

10 4.5 7

2009–7 I.R.B. 500 February 17, 2009

(iii) Combining the actual results through Year 5with the projections for subsequent years, and usinga discount rate of 10%, the present discounted valueof sales is approximately $131.2 million for USS and$229.4 million for FP. This result implies that USSand FP obtain approximately 35.4% and 63.6%, re-spectively, of the anticipated benefits from the bald-ness treatment. These adjusted benefit shares divergeby greater than 20% from the benefit shares calcu-lated based on the original sales projections, and theCommissioner determines that, based on the differ-ence between adjusted and projected benefit shares,the original projections were unreliable. The Com-missioner adjusts cost shares for each of the taxableyears under examination to conform them to the re-calculated shares of anticipated benefits.

(iii) Timing of CST allocations. If theCommissioner makes an allocation to ad-just the results of a CST, the allocationmust be reflected for tax purposes in theyear in which the IDCs were incurred.When a CST payment is owed by one con-trolled participant to another controlledparticipant, the Commissioner may makeappropriate allocations to reflect an arm’slength rate of interest for the time value ofmoney, consistent with the provisions of§1.482–2(a) (Loans or advances).

(3) PCT allocations. The Commis-sioner may make allocations to adjust theresults of a PCT so that the results areconsistent with an arm’s length result inaccordance with the provisions of the ap-plicable sections of the regulations undersection 482, as determined pursuant toparagraph (a)(2) of this section.

(4) Allocations regarding changes inparticipation under a CSA. The Commis-sioner may make allocations to adjust theresults of any controlled transaction de-scribed in paragraph (f) of this section ifthe controlled participants do not reflectarm’s length results in relation to any suchtransaction.

(5) Allocations when CSTs are consis-tently and materially disproportionate toRAB shares. If a controlled participantbears IDC shares that are consistentlyand materially greater or lesser than itsRAB share, then the Commissioner mayconclude that the economic substance ofthe arrangement between the controlledparticipants is inconsistent with the termsof the CSA. In such a case, the Com-missioner may disregard such terms andimpute an agreement that is consistentwith the controlled participants’ courseof conduct, under which a controlled par-ticipant that bore a disproportionatelygreater IDC share received additional

interests in the cost shared intangibles.See §1.482–1(d)(3)(ii)(B) (Identifyingcontractual terms) and §1.482–4(f)(3)(ii)(Identification of owner). Such additionalinterests will consist of partial undividedinterests in the other controlled partici-pant’s interest in the cost shared intangible.Accordingly, that controlled participantmust receive arm’s length considerationfrom any controlled participant whoseIDC share is less than its RAB share overtime, under the provisions of §§1.482–1and 1.482–4 through 1.482–6 to providecompensation for the latter controlled par-ticipants’ use of such partial undividedinterest.

(6) Periodic adjustments—(i) In gen-eral. Subject to the exceptions in para-graph (i)(6)(vi) of this section, the Com-missioner may make periodic adjustmentsfor an open taxable year (the AdjustmentYear) and for all subsequent taxable yearsfor the duration of the CSA Activity withrespect to all PCT Payments, if the Com-missioner determines that, for a particularPCT (the Trigger PCT), a particular con-trolled participant that owes or owed aPCT Payment relating to that PCT (suchcontrolled participant being referred toas the PCT Payor for purposes of thisparagraph (i)(6)) has realized an ActuallyExperienced Return Ratio (AERR) that isoutside the Periodic Return Ratio Range(PRRR). The satisfaction of the condi-tion stated in the preceding sentence isreferred to as a Periodic Trigger. See para-graphs (i)(6)(ii) through (vi) of this sectionregarding the PRRR, the AERR, and peri-odic adjustments. In determining whetherto make such adjustments, the Commis-sioner may consider whether the outcomeas adjusted more reliably reflects an arm’slength result under all the relevant factsand circumstances, including any informa-tion known as of the Determination Date.The Determination Date is the date of therelevant determination by the Commis-sioner. The failure of the Commissionerto determine for an earlier taxable yearthat a PCT Payment was not arm’s lengthwill not preclude the Commissioner frommaking a periodic adjustment for a subse-quent year. A periodic adjustment underthis paragraph (i)(6) may be made withoutregard to whether the taxable year of theTrigger PCT or any other PCT remainsopen for statute of limitations purposes orwhether a periodic adjustment has previ-

ously been made with respect to any PCTpayment.

(ii) PRRR. Except as provided in thenext sentence, the PRRR will consist of re-turn ratios that are not less than .667 normore than 1.5. Alternatively, if the con-trolled participants have not substantiallycomplied with the documentation require-ments referenced in paragraph (k) of thissection, as modified, if applicable, by para-graphs (m)(2) and (3) of this section, thePRRR will consist of return ratios that arenot less than .8 nor more than 1.25.

(iii) AERR—(A) In general. TheAERR is the Present Value of Total Profits(PVTP) divided by the Present Value ofInvestment (PVI). In computing PVTPand PVI, present values are computed us-ing the Applicable Discount Rate (ADR),and all information available as of theDetermination Date is taken into account.

(B) PVTP. The PVTP is the presentvalue, as of the CSA Start Date, as de-fined in section (j)(1)(i) of this section,ofthe PCT Payor’s actually experienced divi-sional profits or losses from the CSA StartDate through the end of the AdjustmentYear.

(C) PVI. The PVI is the present value, asof the CSA Start Date, of the PCT Payor’sinvestment associated with the CSA Activ-ity, defined as the sum of its cost contribu-tions and its PCT Payments, from the CSAStart Date through the end of the Adjust-ment Year. For purposes of computing thePVI, PCT Payments means all PCT Pay-ments due from a PCT Payor before net-ting against PCT Payments due from othercontrolled participants pursuant to para-graph (j)(3)(ii) of this section.

(iv) ADR—(A) In general. Except asprovided in paragraph (i)(6)(iv)(B) of thissection, the ADR is the discount rate pur-suant to paragraph (g)(2)(v) of this section,subject to such adjustments as the Com-missioner determines appropriate.

(B) Publicly traded companies. If thePCT Payor meets the conditions of para-graph (i)(6)(iv)(C) of this section, the ADRis the PCT Payor WACC as of the date ofthe Trigger PCT. However, if the Commis-sioner determines, or the controlled partic-ipants establish to the satisfaction of theCommissioner, that a discount rate otherthan the PCT Payor WACC better reflectsthe degree of risk of the CSA Activity as ofsuch date, the ADR is such other discountrate.

February 17, 2009 501 2009–7 I.R.B.

(C) Publicly traded. A PCT Payormeets the conditions of this paragraph(i)(6)(iv)(C) if—

(1) Stock of the PCT Payor is publiclytraded; or

(2) Stock of the PCT Payor is not pub-licly traded, provided —

(i) The PCT Payor is included in a groupof companies for which consolidated fi-nancial statements are prepared; and

(ii) A publicly traded company in suchgroup owns, directly or indirectly, stockin PCT Payor. Stock of a company ispublicly traded within the meaning of thisparagraph (i)(6)(iv)(C) if such stock isregularly traded on an established UnitedStates securities market and the companyissues financial statements prepared inaccordance with United States generallyaccepted accounting principles for the tax-able year.

(D) PCT Payor WACC. The PCT PayorWACC is the WACC, as defined in para-graph (j)(1)(i) of this section, of the PCTPayor or the publicly traded company de-scribed in paragraph (i)(6)(iv)(C)(2)(ii) ofthis section, as the case may be.

(E) Generally accepted accountingprinciples. For purposes of paragraph(i)(6)(iv)(C) of this section, a financialstatement prepared in accordance witha comprehensive body of generally ac-cepted accounting principles other thanUnited States generally accepted account-ing principles is considered to be preparedin accordance with United States generallyaccepted accounting principles providedthat the amounts of debt, equity, andinterest expense are reflected in any rec-onciliation between such other accountingprinciples and United States generally ac-cepted accounting principles required tobe incorporated into the financial state-ment by the securities laws governingcompanies whose stock is regularly tradedon United States securities markets.

(v) Determination of periodic adjust-ments. In the event of a Periodic Trigger,subject to paragraph (i)(6)(vi) of thissection, the Commissioner may make pe-riodic adjustments with respect to all PCTPayments between all PCT Payors andPCT Payees for the Adjustment Year andall subsequent years for the duration ofthe CSA Activity pursuant to the residualprofit split method as provided in para-graph (g)(7) of this section, subject to thefurther modifications in this paragraph

(i)(6)(v). A periodic adjustment may bemade for a particular taxable year withoutregard to whether the taxable years of theTrigger PCT or other PCTs remain openfor statute of limitation purposes.

(A) In general. Periodic adjustmentsare determined by the following steps:

(1) First, determine the present value,as of the date of the Trigger PCT, ofthe PCT Payments under paragraph(g)(7)(iii)(C)(3) of this section pursuantto the Adjusted RPSM as defined in para-graph (i)(6)(v)(B) of this section (first stepresult).

(2) Second, convert the first step re-sult into a stream of contingent paymentson a base of reasonably anticipated divi-sional profits or losses over the entire dura-tion of the CSA Activity, using a level roy-alty rate (second step rate). See paragraph(h)(2)(iv) of this section (Conversion fromfixed to contingent form of payment). Thisconversion is made based on all informa-tion known as of the Determination Date.

(3) Third, apply the second step rate tothe actual divisional profit or loss for tax-able years preceding and including the Ad-justment Year to yield a stream of con-tingent payments for such years, and con-vert such stream to a present value as ofthe CSA Start Date under the principles ofparagraph (g)(2)(v) of this section (thirdstep result). For this purpose, the secondstep rate applied to a loss for a particularyear will yield a negative contingent pay-ment for that year.

(4) Fourth, convert any actual PCT Pay-ments up through the Adjustment Year toa present value as of the CSA Start Dateunder the principles of paragraph (g)(2)(v)of this section. Then subtract such amountfrom the third step result. Determine thenominal amount in the Adjustment Yearthat would have a present value as of theCSA Start Date equal to the present valuedetermined in the previous sentence to de-termine the periodic adjustment in the Ad-justment Year.

(5) Fifth, apply the second step rate tothe actual divisional profit or loss for eachtaxable year after the Adjustment Year upto and including the taxable year that in-cludes the Determination Date to yield astream of contingent payments for suchyears. For this purpose, the second steprate applied to a loss will yield a negativecontingent payment for that year. Thensubtract from each such payment any ac-

tual PCT Payment made for the same yearto determine the periodic adjustment forsuch taxable year.

(6) For each taxable year subsequentto the year that includes the Determina-tion Date, the periodic adjustment for suchtaxable year (which is in lieu of any PCTPayment that would otherwise be payablefor that year under the taxpayer’s position)equals the second step rate applied to theactual divisional profit or loss for that year.For this purpose, the second step rate ap-plied to a loss for a particular year willyield a negative contingent payment forthat year.

(7) If the periodic adjustment for anytaxable year is a positive amount, then itis an additional PCT Payment owed fromthe PCT Payor to the PCT Payee for suchyear. If the periodic adjustment for anytaxable year is a negative amount, then itis an additional PCT Payment owed by thePCT Payee to the PCT Payor for such year.

(B) Adjusted RPSM as of Determina-tion Date. The Adjusted RPSM is theresidual profit split method pursuant toparagraph (g)(7) of this section applied todetermine the present value, as of the dateof the Trigger PCT, of the PCT Paymentsunder paragraph (g)(7)(iii)(C)(3) of thissection, with the following modifications.

(1) Actual results up through the Deter-mination Date shall be substituted for whatotherwise were the projected results oversuch period, as reasonably anticipated asof the date of the Trigger PCT.

(2) Projected results for the balance ofthe CSA Activity after the DeterminationDate, as reasonably anticipated as of theDetermination Date, shall be substitutedfor what otherwise were the projected re-sults over such period, as reasonably an-ticipated as of the date of the Trigger PCT.

(3) The requirement in paragraph(g)(7)(i) of this section, that at least twocontrolled participants make significantnonroutine contributions, does not apply.

(vi) Exceptions to periodic adjust-ments—(A) Controlled participants estab-lish periodic adjustment not warranted.No periodic adjustment will be made un-der paragraphs (i)(6)(i) and (i)(6)(v) ofthis section if the controlled participantsestablish to the satisfaction of the Commis-sioner that all the conditions described inone of paragraphs (i)(6)(vi)(A)(1) through(4) of this section apply with respect to theTrigger PCT.

2009–7 I.R.B. 502 February 17, 2009

(1) Transactions involving the sameplatform contribution as in the TriggerPCT.

(i) The same platform contribution isfurnished to an uncontrolled taxpayer un-der substantially the same circumstancesas those of the relevant Trigger PCT andwith a similar form of payment as the Trig-ger PCT;

(ii) This transaction serves as the basisfor the application of the comparable un-controlled transaction method described inparagraph (g)(3) of this section, in the firstyear and all subsequent years in which sub-stantial PCT Payments relating to the Trig-ger PCT were required to be paid; and

(iii) The amount of those PCT Pay-ments in that first year was arm’s length.

(2) Results not reasonably anticipated.The differential between the AERR andthe nearest bound of the PRRR is due toextraordinary events beyond the control ofthe controlled participants that could notreasonably have been anticipated as of thedate of the Trigger PCT.

(3) Reduced AERR does not cause Peri-odic Trigger. The Periodic Trigger wouldnot have occurred had the PCT Payor’sdivisional profits or losses used to calcu-late its PVTP excluded those profits orlosses attributable to the PCT Payor’s rou-tine contributions to its exploitation of costshared intangibles, attributable to its op-erating cost contributions, and attributableto its nonroutine contributions to the CSAActivity.

(4) Increased AERR does not cause Pe-riodic Trigger—(i) The Periodic Triggerwould not have occurred had the divisional

profits or losses of the PCT Payor used tocalculate its PVTP included its reasonablyanticipated divisional profits or losses af-ter the Adjustment Year from the CSA Ac-tivity, including from its routine contribu-tions, its operating cost contributions, andits nonroutine contributions to that activ-ity, and had the cost contributions and PCTPayments of the PCT Payor used to cal-culate its PVI included its reasonably an-ticipated cost contributions and PCT Pay-ments after the Adjustment Year. The rea-sonably anticipated amounts in the previ-ous sentence are determined based on allinformation available as of the Determina-tion Date.

(ii) For purposes of this paragraph(i)(6)(vi)(A)(4), the controlled partic-ipants may, if they wish, assume thatthe average yearly divisional profits orlosses for all taxable years prior to andincluding the Adjustment Year, in whichthere has been substantial exploitation ofcost shared intangibles resulting from theCSA (exploitation years), will continueto be earned in each year over a periodof years equal to 15 minus the number ofexploitation years prior to and includingthe Determination Date.

(B) Circumstances in which PeriodicTrigger deemed not to occur. No PeriodicTrigger will be deemed to have occurredat the times and in the circumstances de-scribed in paragraph (i)(6)(vi)(B)(1) or (2)of this section.

(1) 10-year period. In any year subse-quent to the 10-year period beginning withthe first taxable year in which there is sub-stantial exploitation of cost shared intangi-

bles resulting from the CSA, if the AERRdetermined is within the PRRR for eachyear of such 10-year period.

(2) 5-year period. In any year of the5-year period beginning with the first tax-able year in which there is substantial ex-ploitation of cost shared intangibles result-ing from the CSA, if the AERR falls belowthe lower bound of the PRRR.

(vii) Examples. The following exam-ples illustrate the rules of this paragraph(i)(6):

Example 1. (i) At the beginning of Year 1, USP,a publicly traded U.S. company, and FS, its wholly-owned foreign subsidiary, enter into a CSA to developnew technology for cell phones. USP has a platformcontribution, the rights for an in-process technologythat when developed will improve the clarity of calls,for which compensation is due from FS. FS has noplatform contributions to the CSA, no operating con-tributions, and no operating cost contributions. USPand FS agree to fixed PCT payments of $40 million inYear 1 and $10 million per year for Years 2 through10. At the beginning of Year 1, the weighted aver-age cost of capital of the controlled group that in-cludes USP and FS is 15%. In Year 9, the Commis-sioner audits Years 5 through 7 of the CSA and con-siders whether any periodic adjustments should bemade. USP and FS have substantially complied withthe documentation requirements of paragraph (k) ofthis section.

(ii) FS experiences the results reported in the fol-lowing table from its participation in the CSA throughYear 7. In the table, all present values (PV) are re-ported as of the CSA Start Date, which is the same asthe date of the PCT (and reflect a 15% discount rate asdiscussed in paragraph (iii) of this Example 1). Thus,in any year the present value of the cumulative invest-ment is PVI and of the cumulative divisional profit orloss is PVTP. All amounts in this table and the tablesthat follow are reported in millions of dollars and costcontributions are referred to as “CCs” (for simplicityof calculation in this Example 1, all financial flowsare assumed to occur at the beginning of the year).

a b c d e f g h

Year SalesNon-CC

Costs CCsPCT

PaymentsInvestment

(d+e)

Divisional Profitor Loss

(b-c)

AERR(PVTP/PVI)

(g/f)

1 0 0 15 40 55 0

2 0 0 17 10 27 0

3 0 0 18 10 28 0

4 680 662 20 10 30 18

5 836 718 22 10 32 118

6 1,023 680 24 10 34 343

7 1,079 747 27 10 37 332

PV through Year 5 925 846 69 69 138 79 .58

PV through Year 6 1434 1,184 81 74 155 250 1.62

PV through Year 7 1900 1,507 93 78 171 393 2.31

February 17, 2009 503 2009–7 I.R.B.

(iii) Because USP is publicly traded in the UnitedStates and is a member of the controlled group towhich FS (the PCT Payor) belongs, for purposes ofcalculating the AERR for FS, the present values ofits PVTP and PVI are determined using an ADR of15%, the weighted average cost of capital of the con-trolled group. (It is assumed that no other rate was de-termined or established, under paragraph (i)(6)(iv)(B)of this section, to better reflect the relevant degree ofrisk.) At a 15% discount rate, the PVTP, calculated asof Year 1, and based on actual profits realized by FSthrough Year 7 from exploiting the new cell phonetechnology developed by the CSA, is $393 million.The PVI, based on FS’s cost contributions and its PCTPayments, is $171 million. The AERR for FS is equalto its PVTP divided by its PVI, $393 million/$171

million, or 2.31. There is a Periodic Trigger becauseFS’s AERR of 2.31 falls outside the PRRR of .67 to1.5, the applicable PRRR for controlled participantscomplying with the documentation requirements ofthis section.

(iv) At the time of the Determination Date, it isdetermined that the first Adjustment Year in whicha Periodic Trigger occurred was Year 6, when theAERR of FS was determined to be 1.62. It is alsodetermined that for Year 6 none of the exceptions toperiodic adjustments described in paragraph (i)(6)(vi)of this section applies. The Commissioner exercisesits discretion under paragraph (i)(6)(i) of this sec-tion to make periodic adjustments using Year 6 as theAdjustment Year. Therefore, the arm’s length PCTPayments from FS to USP shall be determined for

each taxable year using the adjusted residual profitsplit method described in paragraphs (g)(7)(v)(B) and(i)(6)(v)(B) of this section. Periodic adjustments willbe made for each year to the extent the PCT Pay-ments actually made by FS differ from the PCT Pay-ment calculation under the adjusted residual profitsplit method.

(v) It is determined, as of the Determination Date,that the cost shared intangibles will be exploitedthrough Year 10. FS’s return for routine functions(determined by the Commissioner, based on the re-turn for comparable routine functions undertaken bycomparable uncontrolled companies, to be 10% ofnon-CC costs), and its actual and projected results,are described in the following table.

a b c d e f g

Year Sales Non-CC Costs

Divisionalprofits or loss

(b-c) CCsRoutineReturn

ResidualProfit(d-e-f)

1 0 0 0 15 0 -15

2 0 0 0 17 0 -17

3 0 0 0 18 0 -18

4 680 662 18 20 66 -68

5 836 718 118 22 72 24

6 1,023 680 343 24 68 251

7 1,079 747 332 27 75 230

8 1,138 822 316 29 82 205

9 1,200 894 306 32 89 185

10 1.265 974 291 35 97 159

Cumulative PVthrough Year 10

as of CSA Start Date

3,080 2,385 695 124 238 332

(vi) The periodic adjustments are calculated ina series of steps set out in paragraph (i)(6)(v)(A) ofthis section. First, a lump sum for the PCT Paymentis determined using the adjusted residual profit splitmethod. Under the method, based on the consider-ations discussed in paragraph (g)(2)(v) of this sec-tion, the appropriate discount rate is 15% per year.The non-routine residual divisional profit or loss de-scribed in paragraph (g)(7)(iii)(B) of this section is$332 million. Further under paragraph (g)(7)(iii)(C)of this section, the entire nonroutine residual divi-sional profit constitutes the PCT Payment becauseonly USP has nonroutine contributions.

(vii) In step two, the first step result ($332 mil-lion) is converted into a level royalty rate based onthe reasonably anticipated divisional profits or lossesof the CSA Activity, the PV of which is reported inthe table above (net PV of divisional profit or lossfor Years 1 through 10 is $695 million). Conse-quently, the step two result is a level royalty rate of47.8% ($332/$694) of the divisional profit in Years1 through 10.

(viii) In step three, the Commissioner calculatesthe PCT Payments due through Year 6 by applying thestep two royalty rate to the actual divisional profits foreach year and then determines the aggregate PV of

these PCT Payments as of the CSA Start Date ($120million as reported in the following table). In stepfour, the PCT Payments actually made through Year 6are similarly converted to PV as of the CSA Start Date($74 million) and subtracted from the amount deter-mined in step three ($120 million - $74 million = $46million). That difference of $46 million, representinga net PV as of the CSA Start Date, is then convertedto a nominal amount, as of the Adjustment Year, ofequivalent present value (again using a discount rateof 15%). That nominal amount is $93 million (notshown in the table), and is the periodic adjustment inYear 6.

a b c d e

Year Divisional Profit Royalty Rate

Nominal Royalty Due underadjusted RPSM

(b*c)

Nominal Paymentsmade

Year 1 0 47.8% $0 $40

Year 2 0 47.8% $0 $10

Year 3 0 47.8% $0 $10

Year 4 18 47.8% $9 $10

2009–7 I.R.B. 504 February 17, 2009

a b c d e

Year Divisional Profit Royalty Rate

Nominal Royalty Due underadjusted RPSM

(b*c)

Nominal Paymentsmade

Year 5 118 47.8% $56 $10

Year 6 343 47.8% $164 $10

Cumulative PV as of Year 1 $120 $74

(ix) Under step five, the royalties due from FS toUSP for Year 7 (the year after the Adjustment Year)through Year 9 (the year including the Determina-tion Date) are determined. (These determinations aremade for Years 8 and 9 after the divisional profit forthose years becomes available.) For each year, the pe-riodic adjustment is a PCT Payment due in addition

to the $10 million PCT Payment that must otherwisebe paid under the CSA as described in paragraph (i)of this Example 1. That periodic adjustment is calcu-lated as the product of the step two royalty rate and thedivisional profit, minus the $10 million that was oth-erwise paid for that year. The calculations are shownin the following table:

a b c d E f

Year Divisional profit Royalty rate Royalty due (b*c)PCT Paymentsotherwise paid Periodic adjustment (d-e)

7 332 47.8% $159 $10 $149

8 316 47.8% $151 $10 $141

9 306 47.8% $146 $10 $136

(x) Under step six, the periodic adjustment forYear 10 (the only exploitation year after the year con-taining the Determination Date) will be determinedby applying the step two royalty rate to the divisional

profit. This periodic adjustment is a PCT Paymentpayable from FS to USP, and is in lieu of the $10payment otherwise due. The calculations are shownin the following table, based on a divisional profit of

$291 million. USP and FS experienced the followingresults in Year 10.

Year Divisional profit Royalty rate Royalty due

PCT Payment calledfor under

original agreementbut notmade Periodic adjustment

10 291 47.8% $139 $10 (not paid) $139

Example 2. The facts are the same as Example1 (i) through (iii). At the time of the DeterminationDate, it is determined that the first Adjustment Year inwhich a Periodic Trigger occurred was Year 6, whenthe AERR of FS was determined to be 1.62. Uponfurther investigation as to what may have caused the

high return in FS’s market, the Commissioner learnsthat, in Years 4 through 6, USP’s leading competitorsexperienced severe, unforeseen disruptions in theirsupply chains resulting in a significant increase inUSP’s and FS’s market share for cell phones. Fur-ther analysis determines that without this unforeseen

occurrence the Periodic Trigger would not have oc-curred. Based on paragraph (i)(6)(vi)(A)(2) of thissection, the Commissioner determines to his satisfac-tion that no adjustments are warranted.

(j) Definitions and special rules—(1) Defini-tions—(i) In general. For purposes of this section—

Term Definition Main Cross References

Acquisition price §1.482–7T(g)(5)(i)

Adjusted acquisition price §1.482–7T(g)(5)(iii)

Adjusted average market capitalization §1.482–7T(g)(6)(iv)

Adjusted benefit shares §1.482–7T(i)(2)(ii)(A)

Adjusted RPSM §1.482–7T(i)(6)(v)(B)

Adjustment Year §1.482–7T(i)(6)(i)

ADR §1.482–7T(i)(6)(iv)

AERR §1.482–7T(i)(6)(iii)

Applicable Method §1.482–7T(g)(2)(ix)(A)

Average market capitalization §1.482–7T(g)(6)(iii)

February 17, 2009 505 2009–7 I.R.B.

Term Definition Main Cross References

Benefits Benefits mean the sum of additional revenuegenerated, plus cost savings, minus any costincreases from exploiting cost shared intangibles.

§1.482–7T(e)(1)(i)

Capability variation §1.482–7T(f)(3)

Change in participation under a CSA §1.482–7T(f)

Consolidated group §1.482–7T(j)(2)(i)

Contingent payments §1.482–7T(h)(2)(i)(B)

Controlled participant Controlled participant means a controlled taxpayer,as defined under §1.482–1(i)(5), that is a party tothe contractual agreement that underlies the CSA,and that reasonably anticipates that it will derivebenefits, as defined in paragraph (e)(1)(i) of thissection, from exploiting one or more cost sharedintangibles.

§1.482–7T(a)(1)

Controlled transfer of interests §1.482–7T(f)(2)

Cost contribution §1.482–7T(d)(4)

Cost shared intangible Cost shared intangible means any intangible, withinthe meaning of §1.482–4(b), that is developed bythe IDA, including any portion of such intangiblethat reflects a platform contribution. Therefore, anintangible developed by the IDA is a cost sharedintangible even though the intangible was notalways or was never a reasonably anticipated costshared intangible.

§1.482–7T(b)

Cost sharing alternative §1.482–7T(g)(4)(i)(B)

Cost sharing arrangement or CSA §1.482–7T(a), (b)

Cost sharing transactions or CSTs §1.482–7T(a)(1), (b)(1)(i)

Cross operating contributions A cross operating contribution is any resourceor capability or right, other than a platformcontribution, that a controlled participant hasdeveloped, maintained, or acquired prior to theCSA Start Date that is reasonably anticipated tocontribute to the CSA Activity within anothercontrolled participant’s division.

§1.482–7T(a)(3)(iii), (g)(2)(iv)

CSA Activity CSA Activity is the activity of developing andexploiting cost shared intangibles.

§1.482–7T(c)(2)(i)

CSA Start Date The earliest date that any IDC described inparagraph (d)(1) of this section occurred.

§1.482–7T(i)(6)(iii)(B)

CST Payments §1.482–7T(b)(1)

Date of PCT §1.482–7T(b)(3)

Determination Date §1.482–7T(i)(6)(i)

Division Division means the territory or other division thatserves as the basis of the division of interests underthe CSA in the cost shared intangibles pursuant to§1.482–7T(b)(4).

See definitions of divisional profit or loss, operatingcontribution, and operating cost contribution

Divisional interest §1.482–7T(b)(1)(iii), (b)(4)

Divisional profit or loss Divisional profit or loss means the operating profitor loss as separately earned by each controlledparticipant in its division from the CSA Activity,determined before any expense (includingamortization) on account of cost contributions,operating cost contributions, routine platform andoperating contributions, nonroutine contributions(including platform and operating contributions),and tax.

§1.482–7T(g)(4)(iii)

Fixed payments §1.482–7T(h)(2)(i)(A)

2009–7 I.R.B. 506 February 17, 2009

Term Definition Main Cross References

IDC share §1.482–7T(d)(4)

Input parameters §1.482–7T(g)(2)(ix)(B)

Intangible development activity or IDA §1.482–7T(d)(1)

Intangible development costs or IDCs §1.482–7T(a)(1), (d)(1)

Licensing alternative §1.482–7T(g)(4)(i)(C)

Licensing payments Licensing payments means payments pursuant to thelicensing obligations under the licensing alternative.

§1.482–7T(g)(4)(iii)

Make-or-sell rights §1.482–7T(c)(4), (g)(2)(iv)

Market-based input parameter §1.482–7T(g)(2)(ix)(B)

Market returns for routine contributions Market returns for routine contributions meansreturns determined by reference to the returnsachieved by uncontrolled taxpayers engaged inactivities similar to the relevant business activityin the controlled participant’s division, consistentwith the methods described in §§1.482–3, 1.482–4,1.482–5, or §1.482–9T(c).

§1.482–7T(g)(4), (g)(7)

Method payment form §1.482–7T(h)(3)

Nonroutine contributions Nonroutine contributions means a controlledparticipant’s contributions to the relevant businessactivities that are not routine contributions.Nonroutine contributions ordinarily include bothnonroutine platform contributions and nonroutineoperating contributions used by controlledparticipants in the commercial exploitation oftheir interests in the cost shared intangibles (forexample, marketing intangibles used by a controlledparticipant in its division to sell products that arebased on the cost shared intangible).

§1.482–7T(g)

Nonroutine residual divisional profit or loss §1.482–7T(g)(7)(iii)

Operating contributions An operating contribution is any resourceor capability or right, other than a platformcontribution, that a controlled participant hasdeveloped, maintained, or acquired prior to theCSA Start Date that is reasonably anticipated tocontribute to the CSA Activity within the controlledparticipant’s division.

§1.482–7T(g)(2)(ii), (g)(4)(v)(E), (g)(7)(iii)(A)&(C)

Operating cost contributions Operating cost contributions means all costs inthe ordinary course of business on or after theCSA Start Date that, based on analysis of thefacts and circumstances, are directly identifiedwith, or are reasonably allocable to, developingresources, capabilities, or rights (other thanreasonably anticipated cost shared intangibles) thatare reasonably anticipated to contribute to the CSAActivity within the controlled participant’s division.

§1.482–7T(g)(2)(ii), (g)(4)(iii), (g)(7)(iii)(B)

PCT Payee §1.482–7T(b)(1)(ii)

PCT Payment §1.482–7T(b)(1)(ii)

PCT Payor §1.482–7T(b)(1)(ii), (i)(6)(i)

PCT Payor WACC §1.482–7T(i)(6)(iv)(D)

Periodic adjustments §1.482–7T(i)(6)(i)

Periodic Trigger §1.482–7T(i)(6)(i)

Platform contribution transaction or PCT §1.482–7T(a)(2), (b)(1)(ii)

Platform contributions §1.482–7T(c)(1)

Post-tax income §1.482–7T(g)(2)(v)(B)(3), (g)(4)(i)(G)

February 17, 2009 507 2009–7 I.R.B.

Term Definition Main Cross References

Pre-tax income §1.482–7T(g)(2)(v)(B)(3), (g)(4)(i)(G)

Projected benefit shares §1.482–7T(i)(2)(ii)(A)

PRRR §1.482–7T(i)(6)(ii)

PVI §1.482–7T(i)(6)(iii)(C)

PVTP §1.482–7T(i)(6)(iii)(B)

Reasonably anticipated benefits A controlled participant’s reasonably anticipatedbenefits mean the benefits that reasonably may beanticipated to be derived from exploiting cost sharedintangibles. For purposes of this definition, benefitsmean the sum of additional revenue generated,plus cost savings, minus any cost increases fromexploiting cost shared intangibles.

§1.482–7T(e)(1)

Reasonably anticipated benefits or RAB shares §1.482–7T(a)(1), (e)(1)

Reasonably anticipated cost shared intangible §1.482–7T(d)(1)(ii)

Relevant business activity §1.482–7T(g)(7)(i)

Routine contributions Routine contributions means a controlledparticipant’s contributions to the relevant businessactivities that are of the same or similar kind tothose made by uncontrolled taxpayers involved insimilar business activities for which it is possibleto identify market returns. Routine contributionsordinarily include contributions of tangible property,services and intangibles that are generally owned byuncontrolled taxpayers engaged in similar activities.A functional analysis is required to identify thesecontributions according to the functions performed,risks assumed, and resources employed by each ofthe controlled participants.

§1.482–7T(g)(4), (g)(7)

Routine platform and operating contributions, andnet routine platform and operating contributions

§1.482–7T(g)(4)(vi), 1.482–7(g)(7)(iii)(C)(4)

Specified payment form §1.482–7T(h)(3)

Stock-based compensation §1.482–7T(d)(3)

Stock options §1.482–7T(d)(3)(i)

Subsequent PCT §1.482–7T(g)(2)(viii)

Target §1.482–7T(g)(5)(i)

Trigger PCT §1.482–7T(i)(6)(i)

Variable input parameter §1.482–7T(g)(2)(ix)(C)

WACC WACC means weighted average cost of capital. §1.482–7T(i)(6)(iv)(D)

(ii) Examples. The following examples illustratecertain definitions in paragraph (j)(1)(i) of this sec-tion:

Example 1. Controlled participant. Foreign Par-ent (FP) is a foreign corporation engaged in the ex-traction of a natural resource. FP has a U.S. sub-sidiary (USS) to which FP sells supplies of this re-source for sale in the United States. FP enters intoa CSA with USS to develop a new machine to ex-tract the natural resource. The machine uses a newextraction process that will be patented in the UnitedStates and in other countries. The CSA provides thatUSS will receive the rights to exploit the machine inthe extraction of the natural resource in the UnitedStates, and FP will receive the rights in the rest of theworld. This resource does not, however, exist in theUnited States. Despite the fact that USS has receivedthe right to exploit this process in the United States,

USS is not a controlled participant because it will notderive a benefit from exploiting the intangible devel-oped under the CSA.

Example 2. Controlled participants. (i) U.S. Par-ent (USP), one foreign subsidiary (FS), and a secondforeign subsidiary constituting the group’s researcharm (R+D) enter into a CSA to develop manufactur-ing intangibles for a new product line A. USP and FSare assigned the exclusive rights to exploit the intan-gibles respectively in the United States and the restof the world, where each presently manufactures andsells various existing product lines. R+D is not as-signed any rights to exploit the intangibles. R+D’sactivity consists solely in carrying out research for thegroup. It is reliably projected that the RAB shares ofUSP and FS will be 662/3% and 331/3%, respectively,and the parties’ agreement provides that USP and FSwill reimburse 662/3% and 331/3%, respectively, of the

IDCs incurred by R+D with respect to the new intan-gible.

(ii) R+D does not qualify as a controlled partici-pant within the meaning of paragraph (j)(1)(i) of thissection, because it will not derive any benefits fromexploiting cost shared intangibles. Therefore, R+D istreated as a service provider for purposes of this sec-tion and must receive arm’s length consideration forthe assistance it is deemed to provide to USP and FS,under the rules of paragraph (a)(3) of this section and§§1.482–4(f)(3)(iii), 1.482–4T(f)(4), and 1.482–9T,as appropriate. Such consideration must be treatedas IDCs incurred by USP and FS in proportion totheir RAB shares (that is, 662/3% and 331/3%, respec-tively). R+D will not be considered to bear any shareof the IDCs under the arrangement.

Example 3. Cost shared intangible, reasonablyanticipated cost shared intangible. U.S. Parent

2009–7 I.R.B. 508 February 17, 2009

(USP) has developed and currently exploits an an-tihistamine, XY, which is manufactured in tabletform. USP enters into a CSA with its wholly-ownedforeign subsidiary (FS) to develop XYZ, a new im-proved version of XY that will be manufactured asa nasal spray. Work under the CSA is fully devotedto developing XYZ, and XYZ is developed. Duringthe development period, XYZ is a reasonably antic-ipated cost shared intangible under the CSA. Oncedeveloped, XYZ is a cost shared intangible under theCSA.

Example 4. Cost shared intangible. The facts arethe same as in Example 3, except that in the course ofdeveloping XYZ, the controlled participants by acci-dent discover ABC, a cure for disease D. ABC is acost shared intangible under the CSA.

Example 5. Reasonably anticipated benefits.Controlled parties A and B enter into a cost sharingarrangement to develop product and process intan-gibles for an already existing Product P. Withoutsuch intangibles, A and B would each reasonablyanticipate revenue, in present value terms, of $100Mfrom sales of Product P until it became obsolete.With the intangibles, A and B each reasonably antic-ipate selling the same number of units each year, butreasonably anticipate that the price will be higher.Because the particular product intangible is morehighly regarded in A’s market, A reasonably antici-pates an increase of $20M in present value revenuefrom the product intangible, while B reasonablyanticipates only an increase of $10M. Further, Aand B each reasonably anticipate spending an extra$5M present value in production costs to include thefeature embodying the product intangible. Finally, Aand B each reasonably anticipate saving $2M presentvalue in production costs by using the process in-tangible. A and B reasonably anticipate no othereconomic effects from exploiting the cost sharedintangibles. A’s reasonably anticipated benefits fromexploiting the cost shared intangibles equal its rea-sonably anticipated increase in revenue ($20M) plusits reasonably anticipated cost savings ($2M) minusits reasonably anticipated increased costs ($5M),which equals $17M. Similarly, B’s reasonably an-ticipated benefits from exploiting the cost sharedintangibles equal its reasonably anticipated increasein revenue ($10M) plus its reasonably anticipatedcost savings ($2M) minus its reasonably anticipatedincreased costs ($5M), which equals $7M. Thus A’sreasonably anticipated benefits are $17M and B’sreasonably anticipated benefits are $7M.

(2) Special rules—(i) Consolidatedgroup. For purposes of this section, allmembers of the same consolidated groupshall be treated as one taxpayer. For thesepurposes, the term consolidated groupmeans all members of a group of con-trolled entities created or organized withina single country and subjected to an in-come tax by such country on the basis oftheir combined income.

(ii) Trade or business. A participantthat is a foreign corporation or nonresi-dent alien individual will not be treatedas engaged in a trade or business withinthe United States solely by reason of itsparticipation in a CSA. See generally§1.864–2(a).

(iii) Partnership. A CSA, or an arrange-ment to which the Commissioner appliesthe rules of this section, will not be treatedas a partnership to which the rules of sub-chapter K of the Internal Revenue Codeapply. See §301.7701–1(c) of this chapter.

(3) Character—(i) CST Payments. CSTPayments generally will be considered thepayor’s costs of developing intangiblesat the location where such developmentis conducted. For these purposes, IDCsborne directly by a controlled participantthat are deductible are deemed to be re-duced to the extent of any CST Paymentsowed to it by other controlled participantspursuant to the CSA. Each cost shar-ing payment received by a payee will betreated as coming pro rata from paymentsmade by all payors and will be applied prorata against the deductions for the taxableyear that the payee is allowed in connec-tion with the IDCs. Payments received inexcess of such deductions will be treatedas in consideration for use of the land andtangible property furnished for purposesof the CSA by the payee. For purposes ofthe research credit determined under sec-tion 41, CST Payments among controlledparticipants will be treated as providedfor intra-group transactions in §1.41–6(i).Any payment made or received by a tax-payer pursuant to an arrangement thatthe Commissioner determines not to be aCSA will be subject to the provisions of§§1.482–1, 1.482–4 through 1.482–6 and1.482–9T. Any payment that in substanceconstitutes a cost sharing payment will betreated as such for purposes of this section,regardless of its characterization underforeign law.

(ii) PCT Payments. A PCT Payor’s pay-ment required under paragraph (b)(1)(ii)of this section is deemed to be reduced tothe extent of any payments owed to it un-der such paragraph from other controlled

participants. Each PCT Payment receivedby a PCT Payee will be treated as com-ing pro rata out of payments made by allPCT Payors. PCT Payments will be char-acterized consistently with the designationof the type of transaction pursuant to para-graphs (c)(3) and (k)(2)(ii)(H) of this sec-tion. Depending on such designation, suchpayments will be treated as either consid-eration for a transfer of an interest in intan-gible property or for services.

(iii) Examples. The following examplesillustrate this paragraph (j)(3):

Example 1. U.S. Parent (USP) and its whollyowned Foreign Subsidiary (FS) form a CSA to de-velop a miniature widget, the Small R. Based on RABshares, USP agrees to bear 40% and FS to bear 60%of the costs incurred during the term of the agreement.The principal IDCs are operating costs incurred by FSin Country Z of 100X annually, and costs incurredby USP in the United States also of 100X annually.Of the total costs of 200X, USP’s share is 80X andFS’s share is 120X so that FS must make a paymentto USP of 20X. The payment will be treated as a reim-bursement of 20X of USP’s costs in the United States.Accordingly, USP’s Form 1120 will reflect an 80Xdeduction on account of activities performed in theUnited States for purposes of allocation and appor-tionment of the deduction to source. The Form 5471“Information Return of U.S. Persons With Respect toCertain Foreign Corporations” for FS will reflect a100X deduction on account of activities performedin Country Z and a 20X deduction on account of ac-tivities performed in the United States.

Example 2. The facts are the same as in Example1, except that the 100X of costs borne by USP consistof 5X of costs incurred by USP in the United Statesand 95X of arm’s length rental charge, as describedin paragraph (d)(1)(iii) of this section, for the use of afacility in the United States. The depreciation deduc-tion attributable to the U.S. facility is 7X. The 20Xnet payment by FS to USP will first be applied in re-duction pro rata of the 5X deduction for costs and the7X depreciation deduction attributable to the U.S. fa-cility. The 8X remainder will be treated as rent forthe U.S. facility.

Example 3. (i) Four members A, B, C, and D ofa controlled group form a CSA to develop the nextgeneration technology for their business. Based onRAB shares, the participants agree to bear shares ofthe costs incurred during the term of the agreement inthe following percentages: A 40%; B 15%; C 25%;and D 20%. The arm’s length values of the platformcontributions they respectively own are in the follow-ing amounts for the taxable year: A 80X; B 40X; C30X; and D 30X. The provisional (before offsets) andfinal PCT Payments among A, B, C, and D are shownin the table as follows:

February 17, 2009 509 2009–7 I.R.B.

(All amounts stated in X’s)A B C D

Payments . . . . . . . . . . . . . . . <40> <21> <37.5> <30>Receipts . . . . . . . . . . . . . . . . 48 34 22.5 24Final . . . . . . . . . . . . . . . . . . . 8 13 <15> <6>

(ii) The first row/first column showsA’s provisional PCT Payment equal to theproduct of 100X (sum of 40X, 30X, and30X) and A’s RAB share of 40%. Thesecond row/first column shows A’s pro-visional PCT receipts equal to the sumof the products of 80X and B’s, C’s, andD’s RAB shares (15%, 25%, and 20%, re-spectively). The other entries in the firsttwo rows of the table are similarly com-puted. The last row shows the final PCTreceipts/payments after offsets. Thus, forthe taxable year, A and B are treated as re-ceiving the 8X and 13X, respectively, prorata out of payments by C and D of 15Xand 6X, respectively.

(k) CSA administrative requirements.A controlled participant meets the require-ments of this paragraph if it substantiallycomplies, respectively, with the CSAcontractual, documentation, accounting,and reporting requirements of paragraphs(k)(1), (k)(2), (k)(3), and (k)(4) of thissection.

(1) CSA contractual requirements—(i)In general. A CSA must be recorded inwriting in a contract that is contemporane-ous with the formation (and any revision)of the CSA and that includes the contrac-tual provisions described in this paragraph(k)(1).

(ii) Contractual provisions. The writtencontract described in this paragraph (k)(1)must include provisions that—

(A) List the controlled participants andany other members of the controlled groupthat are reasonably anticipated to benefitfrom the use of the cost shared intangibles,including the address of each domestic en-tity and the country of organization of eachforeign entity;

(B) Describe the scope of the IDA tobe undertaken and each reasonably antic-ipated cost shared intangible or class ofreasonably anticipated cost shared intangi-bles;

(C) Specify the functions and risks thateach controlled participant will undertakein connection with the CSA;

(D) Divide among the controlled partic-ipants all divisional interests in cost shared

intangibles and specify each controlledparticipant’s divisional interest in the costshared intangibles, as described in para-graphs (b)(1)(iii) and (b)(4) of this section,that it will own and exploit without anyfurther obligation to compensate any othercontrolled participant for such interest;

(E) Provide a method to calculate thecontrolled participants’ RAB shares, basedon factors that can reasonably be expectedto reflect the participants’ shares of antici-pated benefits, and require that such RABshares must be updated, as described inparagraph (e)(1) of this section (see alsoparagraph (k)(2)(ii)(F) of this section);

(F) Enumerate all categories of IDCs tobe shared under the CSA;

(G) Specify that the controlled par-ticipant must use a consistent method ofaccounting to determine IDCs and RABshares, as described in paragraphs (d) and(e) of this section, respectively, and musttranslate foreign currencies on a consistentbasis;

(H) Require the controlled participantto enter into CSTs covering all IDCs, asdescribed in paragraph (b)(1)(i) of this sec-tion, in connection with the CSA;

(I) Require the controlled participantsto enter into PCTs covering all platformcontributions, as described in paragraph(b)(1)(ii) of this section, in connection withthe CSA;

(J) Specify the form of payment due un-der each PCT (or group of PCTs) in exis-tence at the formation (and any revision)of the CSA, including information and ex-planation that reasonably supports an anal-ysis of applicable provisions of paragraph(h) of this section; and

(K) Specify the date on which the CSAis entered into and the duration of the CSA,the conditions under which the CSA maybe modified or terminated, and the conse-quences of a modification or termination(including consequences described underthe rules of paragraph (f) of this section).

(iii) Meaning of contemporane-ous—(A) In general. For purposes of thisparagraph (k)(1), a written contractualagreement is contemporaneous with the

formation (or revision) of a CSA if, andonly if, the controlled participants recordthe CSA, in its entirety, in a documentthat they sign and date no later than 60days after the first occurrence of any IDCdescribed in paragraph (d) of this sectionto which such agreement (or revision) isto apply.

(B) Example. The following exampleillustrates the principles of this paragraph(k)(1)(iii):

Example. Companies A and B, both of which aremembers of the same controlled group, commence anIDA on March 1, Year 1. Company A pays the firstIDCs in relation to the IDA, as cash salaries to A’s re-search staff, for the staff’s work during the first weekof March, Year 1. A and B, however, do not signand date any written contractual agreement until Au-gust 1, Year 1, whereupon they execute a “Cost Shar-ing Agreement” that purports to be “effective as of”March 1 of Year 1. The arrangement fails the require-ment that the participants record their arrangement ina written contractual agreement that is contempora-neous with the formation of a CSA. The arrangementhas failed to meet the requirements set forth in para-graph (b)(2) of this section and, pursuant to paragraph(b) of this section, cannot be a CSA.

(iv) Interpretation of contractual pro-visions—(A) In general The provisionsof a written contract described in thisparagraph (k)(1) and of the additionaldocumentation described in paragraph(k)(2) of this section must be clear andunambiguous. The provisions will be in-terpreted by reference to the economicsubstance of the transaction and the actualconduct of the controlled participants. See§1.482–1(d)(3)(ii)(B) (discussing inter-pretation of contractual terms in assessingthe comparability of controlled and un-controlled transactions). Accordingly,the Commissioner may impute contrac-tual terms in a CSA consistent with theeconomic substance of the CSA and maydisregard contractual terms that lack eco-nomic substance. An allocation of riskbetween controlled participants after theoutcome of such risk is known or reason-ably knowable lacks economic substance.See §1.482–1(d)(3)(iii)(B). A contractualterm that is disregarded due to a lack ofeconomic substance does not satisfy acontractual requirement set forth in thisparagraph (k)(1) or documentation re-

2009–7 I.R.B. 510 February 17, 2009

quirement set forth in paragraph (k)(2) ofthis section. See paragraph (b)(5) of thissection for the treatment of an arrange-ment among controlled taxpayers that failsto comply with the requirements of thissection.

(B) Examples. The following examplesillustrate the principles of this paragraph(k)(1)(iv). In each example, it is assumedthat the Commissioner will exercise thediscretion granted pursuant to paragraph(b)(5)(ii) of this section to apply the pro-visions of this section to the arrangementthat purports to be a CSA.

Example 1. The contractual provisions recordedupon formation of an arrangement that purports to bea CSA provide that PCT payments with respect to aparticular platform contribution will consist of pay-ments contingent on sales. Contrary to the contrac-tual provisions, the PCT payments actually made arecontingent on profits. Because the controlled partic-ipants’ actual conduct is different from the contrac-tual terms, the Commissioner may determine, basedon the facts and circumstances, that—

(i) The actual payments have economic substanceand, therefore, impute payment terms in the CSA con-sistent with the actual payments; or

(ii) The contract terms reflect the economic sub-stance of the arrangement and, therefore, the actualpayments must be adjusted to conform to the terms.

Example 2. An arrangement that purports to bea CSA provides that PCT payments with respect toa particular platform contribution shall be contingentpayments equal to 10% of sales of products that in-corporate cost shared intangibles. The contract termsfurther provide that the controlled participants mustadjust such contingent payments in accordance witha formula set forth in the terms. During the first threeyears of the arrangement, the controlled participantsfail to make the adjustments required by the termswith respect to the PCT payments. The Commis-sioner may determine, based on the facts and circum-stances, that—

(i) The contingent payment terms with respect tothe platform contribution do not have economic sub-stance because the controlled participants did not actin accordance with their upfront risk allocation; or

(ii) The contract terms reflect the economic sub-stance of the arrangement and, therefore, the actualpayments must be adjusted to conform to the terms.

(2) CSA documentation require-ments—(i) In general. The controlledparticipants must timely update and main-tain sufficient documentation to establishthat the participants have met the CSAcontractual requirements of paragraph(k)(1) of this section and the additionalCSA documentation requirements of thisparagraph (k)(2).

(ii) Additional CSA documentation re-quirements. The controlled participants toa CSA must timely update and maintaindocumentation sufficient to—

(A) Describe the current scope of theIDA and identify—

(1) Any additions or subtractions fromthe list of reasonably anticipated costshared intangibles reported pursuant toparagraph (k)(1)(ii)(B) of this section;

(2) Any cost shared intangible, togetherwith each controlled participant’s interesttherein; and

(3) Any further development of intan-gibles already developed under the CSAor of specified applications of such intan-gibles which has been removed from theIDA (see paragraphs (d)(1)(ii) and (j)(1)(i)of this section (definitions of reasonablyanticipated cost shared intangible, costshared intangible)) and the steps (includ-ing any accounting classifications andallocations) taken to implement such re-moval.

(B) Establish that each controlled par-ticipant reasonably anticipates that it willderive benefits from exploiting cost sharedintangibles;

(C) Describe the functions and risks thateach controlled participant has undertakenduring the term of the CSA;

(D) Provide an overview of each con-trolled participant’s business segments, in-cluding an analysis of the economic and le-gal factors that affect CST and PCT pric-ing;

(E) Establish the amount of each con-trolled participant’s IDCs for each taxableyear under the CSA, including all IDCsattributable to stock-based compensation,as described in paragraph (d)(3) of thissection (including the method of measure-ment and timing used in determining suchIDCs, and the data, as of the date of grant,used to identify stock-based compensationwith the IDA);

(F) Describe the method used to es-timate each controlled participant’s RABshare for each year during the course of theCSA, including—

(1) All projections used to estimate ben-efits;

(2) All updates of the RAB shares inaccordance with paragraph (e)(1) of thissection; and

(3) An explanation of why that methodwas selected and why the method providesthe most reliable measure for estimatingRAB shares;

(G) Describe all platform contributions;(H) Designate the type of transaction

involved for each PCT or group of PCTs;

(I) Specify, within the time period pro-vided in paragraph (h)(2)(iii) of this sec-tion, the form of payment due under eachPCT or group of PCTs, including informa-tion and explanation that reasonably sup-ports an analysis of applicable provisionsof paragraph (h) of this section;

(J) Describe and explain the method se-lected to determine the arm’s length pay-ment due under each PCT, including—

(1) An explanation of why the methodselected constitutes the best method, as de-scribed in §1.482–1(c)(2), for measuringan arm’s length result;

(2) The economic analyses, data, andprojections relied upon in developing andselecting the best method, including thesource of the data and projections used;

(3) Each alternative method that wasconsidered, and the reason or reasons thatthe alternative method was not selected;

(4) Any data that the controlled partic-ipant obtains, after the CSA takes effect,that would help determine if the controlledparticipant’s method selected has been ap-plied in a reasonable manner;

(5) The discount rate or rates, whereapplicable, used for purposes of evaluat-ing PCT Payments, including informationand explanation that reasonably supportsan analysis of applicable provisions ofparagraph (g)(2)(v) of this section;

(6) The estimated arm’s length values ofany platform contributions as of the datesof the relevant PCTs, in accordance withparagraph (g)(2)(ii) of this section;

(7) A discussion, where applicable, ofwhy transactions were or were not aggre-gated under the principles of paragraph(g)(2)(iv) of this section;

(8) The method payment form and anyconversion made from the method pay-ment form to the specified payment form,as described in paragraph (h)(3) of this sec-tion; and

(9) If applicable under paragraph(i)(6)(iv) of this section, the WACC ofthe parent of the controlled group thatincludes the controlled participants.

(iii) Coordination rules and pro-duction of documents—(A) Coordi-nation with penalty regulations. See§1.6662–6(d)(2)(iii)(D) regarding coordi-nation of the rules of this paragraph (k)with the documentation requirements forpurposes of the accuracy-related penaltyunder section 6662(e) and (h).

February 17, 2009 511 2009–7 I.R.B.

(B) Production of documentation. Eachcontrolled participant must provide to theCommissioner, within 30 days of a request,the items described in this paragraph (k)(2)and paragraph (k)(3) of this section. Thetime for compliance described in this para-graph (k)(2)(iii)(B) may be extended at thediscretion of the Commissioner.

(3) CSA accounting requirements—(i)In general. The controlled participantsmust maintain books and records (and re-lated or underlying data and information)that are sufficient to—

(A) Establish that the controlled partic-ipants have used (and are using) a consis-tent method of accounting to measure costsand benefits;

(B) Permit verification that the amountof any contingent PCT Payments due havebeen (and are being) properly determined;

(C) Translate foreign currencies on aconsistent basis; and

(D) To the extent that the method of ac-counting used materially differs from U.S.generally accepted accounting principles,explain any such material differences.

(ii) Reliance on financial accounting.For purposes of this section, the controlledparticipants may not rely solely upon fi-nancial accounting to establish satisfac-tion of the accounting requirements of thisparagraph (k)(3) of this section. Rather,the method of accounting must clearly re-flect income. Thor Power Tools Co. v.Commissioner, 439 U.S. 522 (1979).

(4) CSA reporting requirements—(i)CSA Statement. Each controlled partici-pant must file with the Internal RevenueService, in the manner described in thisparagraph (k)(4), a “Statement of Con-trolled Participant to §1.482–7T CostSharing Arrangement” (CSA Statement)that complies with the requirements of thisparagraph (k)(4).

(ii) Content of CSA Statement. TheCSA Statement of each controlled partic-ipant must—

(A) State that the participant is a con-trolled participant in a CSA;

(B) Provide the controlled participant’staxpayer identification number;

(C) List the other controlled partici-pants in the CSA, the country of organ-ization of each such participant, and thetaxpayer identification number of eachsuch participant;

(D) Specify the earliest date that anyIDC described in paragraph (d)(1) of thissection occurred; and

(E) Indicate the date on which the con-trolled participants formed (or revised) theCSA and, if different from such date, thedate on which the controlled participantsrecorded the CSA (or any revision) con-temporaneously in accordance with para-graphs (k)(1)(i) and (iii) of this section.

(iii) Time for filing CSA Statement—(A)90-day rule Each controlled participantmust file its original CSA Statementwith the Internal Revenue Service OgdenCampus, no later than 90 days after thefirst occurrence of an IDC to which thenewly-formed CSA applies, as describedin paragraph (k)(1)(iii)(A) of this section,or, in the case of a taxpayer that becamea controlled participant after the forma-tion of the CSA, no later than 90 daysafter such taxpayer became a controlledparticipant. A CSA Statement filed in ac-cordance with this paragraph (k)(4)(iii)(A)must be dated and signed, under penaltiesof perjury, by an officer of the controlledparticipant who is duly authorized (underlocal law) to sign the statement on behalfof the controlled participant.

(B) Annual return requirement—(1) Ingeneral. Each controlled participant mustattach to its U.S. income tax return, foreach taxable year for the duration of theCSA, a copy of the original CSA Statementthat the controlled participant filed in ac-cordance with the 90-day rule of paragraph(k)(4)(iii)(A) of this section. In addition,the controlled participant must update theinformation reflected on the original CSAStatement annually by attaching a sched-ule that documents changes in such infor-mation over time.

(2) Special filing rule for annual returnrequirement. If a controlled participant isnot required to file a U.S. income tax re-turn, the participant must ensure that thecopy or copies of the CSA Statement andany updates are attached to Schedule M ofany Form 5471, any Form 5472, “Infor-mation Return of a 25% Foreign OwnedU.S. Corporation, or a Foreign Corpora-tion Engaged in a U.S. Trade or Business”any Form 8865, “Return of U.S. PersonsWith Respect to Certain Foreign Partner-ships”, filed with respect to that partici-pant.

(iv) Examples. The following examplesillustrate this paragraph (k)(4). In each

example, Companies A and B are membersof the same controlled group.

Example 1. A and B, both of which file U.S.tax returns, agree to share the costs of developing anew chemical formula in accordance with the provi-sions of this section. On March 30, Year 1, A andB record their agreement in a written contract styled,“Cost Sharing Agreement.” The contract applies byits terms to IDCs occurring after March 1, Year 1.The first IDCs to which the CSA applies occurredon March 15, Year 1. To comply with paragraph(k)(4)(iii)(A) of this section, A and B individuallymust file separate CSA Statements no later than 90days after March 15, Year 1 (June 13, Year 1). Fur-ther, to comply with paragraph (k)(4)(iii)(B) of thissection, A and B must attach copies of their respec-tive CSA Statements to their respective Year 1 U.S.income tax returns.

Example 2. The facts are the same as in Exam-ple 1, except that a year has passed and C, whichfiles a U.S. tax return, joined the CSA on May 9,Year 2. To comply with the annual filing requirementdescribed in paragraph (k)(4)(iii)(B) of this section,A and B must each attach copies of their respectiveCSA Statements (as filed for Year 1) to their respec-tive Year 2 income tax returns, along with a scheduleupdated appropriately to reflect the changes in infor-mation described in paragraph (k)(4)(ii) of this sec-tion resulting from the addition of C to the CSA. Tocomply with both the 90-day rule described in para-graph (k)(4)(iii)(A) of this section and the annual fil-ing requirement described in paragraph (k)(4)(iii)(B)of this section, C must file a CSA Statement no laterthan 90 days after May 9, Year 2 (August 7, Year 2),and must attach a copy of such CSA Statement to itsYear 2 income tax return.

(l) Effective/applicability date. Thissection applies on January 5, 2009.

(m) Transition rule—(1) In general. Anarrangement in existence on January 5,2009, will be considered a CSA, as de-scribed under paragraph (b) of this section,if, prior to such date, it was a qualifiedcost sharing arrangement under the provi-sions of §1.482–7 (as contained in the 26CFR part 1 edition revised as of January1, 1996, hereafter referred to as “former§1.482–7”), but only if the written con-tract, as described in paragraph (k)(1) ofthis section, is amended, if necessary, toconform with, and only if the activitiesof the controlled participants substantiallycomply with, the provisions of this sec-tion, as modified by paragraphs (m)(2) and(m)(3) of this section, by July 6, 2009.

(2) Transitional modification of appli-cable provisions. For purposes of thisparagraph (m), conformity and substantialcompliance with the provisions of this sec-tion shall be determined with the followingmodifications:

(i) CSTs and PCTs occurring prior toJanuary 5, 2009, shall be subject to the

2009–7 I.R.B. 512 February 17, 2009

provisions of former §1.482–7 rather thanthis section.

(ii) Except to the extent provided inparagraph (m)(3) of this section, PCTsthat occur under a CSA that was a qual-ified cost sharing arrangement under theprovisions of former §1.482–7 and re-mained in effect on January 5, 2009, shallbe subject to the periodic adjustment rulesof §1.482–4(f)(2) rather than the rules ofparagraph (i)(6) of this section.

(iii) Paragraphs (b)(1)(iii) and (b)(4) ofthis section shall not apply.

(iv) Paragraph (k)(1)(ii)(D) of this sec-tion shall not apply.

(v) Paragraphs (k)(1)(ii)(H) and(k)(1)(ii)(I) of this section shall be con-strued as applying only to transactionsentered into on or after January 5, 2009.

(vi) The deadline for recordation of therevised written contractual agreement pur-suant to paragraph (k)(1)(iii) of this sectionshall be no later than July 6, 2009.

(vii) Paragraphs (k)(2)(ii)(G) through(J) of this section shall be construed as ap-plying only with reference to PCTs enteredinto on or after January 5, 2009.

(viii) Paragraph (k)(4)(iii)(A) of thissection shall be construed as requiring aCSA Statement with respect to the revisedwritten contractual agreement describedin paragraph (m)(2)(vi) of this section nolater than September 2, 2009.

(ix) Paragraph (k)(4)(iii)(B) of this sec-tion shall be construed as only applyingfor taxable years ending after the filing ofthe CSA Statement described in paragraph(m)(2)(viii) of this section.

(3) Special rule for certain periodic ad-justments. The periodic adjustment rulesin paragraph (i)(6) of this section (ratherthan the rules of §1.482–4(f)(2)) shall ap-ply to PCTs that occur on or after the dateof a material change in the scope of theCSA from its scope as of January 5, 2009.A material change in scope would includea material expansion of the activities un-dertaken beyond the scope of the intangi-ble development area, as described in for-mer §1.482–7(b)(4)(iv). For this purpose,a contraction of the scope of a CSA, ab-sent a material expansion into one or morelines of research and development beyondthe scope of the intangible developmentarea, does not constitute a material changein scope of the CSA. Whether a mate-rial change in scope has occurred is deter-mined on a cumulative basis. Therefore,

a series of expansions, any one of which isnot a material expansion by itself, may col-lectively constitute a material expansion.

(n) Expiration date. The applicabilityof this section expires on or before Decem-ber 30, 2011.

Par. 13. Section 1.482–8 is amendedby revising paragraph (b) Examples 10, 11,and 12 and adding Examples 13, 14, 15,16, 17 and 18 at the end of paragraph (b)to read as follows:

§1.482–8 Examples of the best methodrule.

* * * * *(b) * * *Examples 10 through 18. [Reserved].

For further guidance, see §1.482–8T(b)Examples 10 through 18.

Par. 14. Section 1.482–8T is amendedby:

1. Adding Examples13, 14, 15, 16, 17and 18 at the end of paragraph (b).

2. Revising paragraph (c).The additions and revision reads as fol-

lows:

§1.482–8T Examples of the best methodrule (temporary).

* * * * *(b) * * *Example 13. Preference for acquisition price

method. (i) USP develops, manufacturers, anddistributes pharmaceutical products. USP and FS,USP’s wholly-owned subsidiary, enter into a CSAto develop a new oncological drug, Oncol. Immedi-ately prior to entering into the CSA, USP acquiresCompany X, an unrelated U.S. pharmaceutical com-pany. Company X is solely engaged in oncologicalpharmaceutical research, and its only significantresources and capabilities are its workforce and itssole patent, which is associated with Compound X,a promising molecular compound derived from arare plant, which USP reasonably anticipates willcontribute to developing Oncol. All of Company Xresearchers will be engaged solely in research thatis reasonably anticipated to contribute to developingOncol as well. The rights in the Compound X andthe commitment of Company X’s researchers to thedevelopment of Oncol are platform contributions forwhich compensation is due from FS as part of a PCT.

(ii) In this case, the acquisition price method,based on the lump sum price paid by USP forCompany X, is likely to provide a more reliablemeasure of an arm’s length PCT Payment due toUSP than the application of any other method. See§§1.482–4(c)(2) and 1.482–7T(g)(5)(iv)(A).

Example 14. Preference for market capitaliza-tion method. (i) Company X is a publicly traded U.S.company solely engaged in oncological pharmaceuti-cal research and its only significant resources and ca-pabilities are its workforce and its sole patent, which

is associated with Compound Y, a promising molecu-lar compound derived from a rare plant. Company Xhas no marketable products. Company X enters intoa CSA with FS, a newly-formed foreign subsidiary,to develop a new oncological drug, Oncol, derivedfrom Compound Y. Compound Y is reasonably antic-ipated to contribute to developing Oncol. All of Com-pany X researchers will be engaged solely in researchthat is reasonably anticipated to contribute to devel-oping Oncol under the CSA. The rights in CompoundY and the commitment of Company X’s researchersare platform contributions for which compensation isdue from FS as part of a PCT.

(ii) In this case, given that Company X’s platformcontributions covered by PCTs relate to its entire eco-nomic value, the application of the market capital-ization method, based on the market capitalization ofCompany X, provides a reliable measure of an arm’slength result for Company X’s PCTs to the CSA. See§§1.482–4(c)(2) and 1.482–7T(g)(6)(v)(A).

Example 15. Preference for market capitaliza-tion method. (i) MicroDent, Inc. (MDI) is a publiclytraded company that developed a new dental surgi-cal microscope ScopeX–1, which drastically shortensmany surgical procedures. On January 1 of Year 1,MDI entered into a CSA with a wholly-owned foreignsubsidiary (FS) to develop ScopeX–2, the next gener-ation of ScopeX–1. In the CSA, divisional interestsare divided on a territorial basis. The rights associ-ated with ScopeX–1, as well as MDI’s research capa-bilities are reasonably anticipated to contribute to thedevelopment of ScopeX–2 and are therefore platformcontributions for which compensation is due from FSas part of a PCT. At the time of the PCT, MDI’s onlyproduct was the ScopeX-I microscope, although MDIwas in the process of developing ScopeX–2. Concur-rent with the CSA, MDI separately transfers exclu-sive and perpetual exploitation rights associated withScopeX–1 to FS in the same territory as assigned toFS in the CSA.

(ii) Although the transactions between MDI andFS under the CSA are distinct from the transactionsbetween MDI and FS relating to the exploitationrights for ScopeX–1, it is likely to be more reliableto evaluate the combined effect of the transactionsthan to evaluate them in isolation. This is becausethe combined transactions between MDI and FSrelate to all of the economic value of MDI (that is,the exploitation rights and research rights associatedwith ScopeX–1, as well as the research capabilitiesof MDI). In this case, application of the market cap-italization method, based on the enterprise value ofMDI on January 1 of Year 1, is likely to provides areliable measure of an arm’s length payment for theaggregated transactions. See §§1.482–4(c)(2) and1.482–7T(g)(6)(v)(A).

(iii) Notwithstanding that the market capitaliza-tion method provides the most reliable measure ofthe aggregated transactions between MDI and FS,see §1.482–7T(g)(2)(iv) for further considerations ofwhen further analysis may be required to distinguishbetween the remuneration to MDI associated withPCTs under the CSA (for research rights and capa-bilities associated with ScopeX–1) and the remunera-tion to MDI for the exploitation rights associated withScopeX–1.

Example 16. Income method (applied usingCPM) preferred to acquisition price method. Thefacts are the same as Example 13, except that the ac-

February 17, 2009 513 2009–7 I.R.B.

quisition occurred significantly in advance of forma-tion of the CSA, and reliable adjustments cannot bemade for this time difference. In addition, CompanyX has other valuable molecular patents and associ-ated research capabilities, apart from Compound X,that are not reasonably anticipated to contribute tothe development of Oncol and that cannot be reliablyvalued. The CSA divides divisional interests on aterritorial basis. Under the terms of the CSA, USPwill undertake all R&D (consisting of laboratoryresearch and clinical testing) and manufacturingassociated with Oncol, as well as the distributionactivities for its territory (the United States). FS willdistribute Oncol in its territory (the rest of the world).FS’s distribution activities are routine in nature, andthe profitability from its activities may be reliablydetermined from third-party comparables. FS doesnot furnish any platform contributions. At the timeof the PCT, reliable (ex ante) financial projectionsassociated with the development of Oncol and itsseparate exploitation in each of USP’s and FSub’sassigned geographical territories are undertaken. Inthis case, application of the income method usingCPM is likely to provide a more reliable measureof an arm’s length result than application of theacquisition price method based on the price paid byUSP for Company X. See §1.482–7T(g)(4)(v) and(g)(5)(iv)(C).

Example 17. Evaluation of alternative methods.(i) The facts are the same as Example 13, exceptthat the acquisition occurred sometime prior to theCSA, and Company X has some areas of promisingresearch that are not reasonably anticipated to con-tribute to developing Oncol. For purposes of this ex-ample, the CSA is assumed to divide divisional in-terests on a territorial basis. In general, the Com-missioner determines that the acquisition price datais useful in informing the arm’s length price, but notnecessarily determinative. Under the terms of theCSA, USP will undertake all R&D (consisting of lab-oratory research and clinical testing) and manufactur-ing associated with Oncol, as well as the distributionactivities for its territory (the United States). FS willdistribute Oncol in its territory (the rest of the world).FS’s distribution activities are routine in nature, andthe profitability from its activities may be reliably de-termined from third-party comparables. At the timeof the PCT, financial projections associated with thedevelopment of Oncol and its separate exploitation ineach of USP’s and FSub’s assigned geographical ter-ritories are undertaken.

(ii) Under the facts, it is possible that the acquisi-tion price method or the income method using CPMmight reasonably be applied. Whether the acquisi-tion price method or the income method provides themost reliable evidence of the arm’s length price ofUSP’s contributions depends on a number of factors,including the reliability of the financial projections,the reliability of the discount rate chosen, and the ex-tent to which the acquisition price of Company X canbe reliably adjusted to account for changes in valueover the time period between the acquisition and theformation of the CSA and to account for the value ofthe in-process research done by Company X that doesnot constitute platform contributions to the CSA. See§1.482–7T(g)(4)(v) and (g)(5)(iv)(A) and (C).

Example 18. Evaluation of alternative methods.(i) The facts are the same as Example 17, except thatFS has a patent on Compound Y, which the parties

reasonably anticipate will be useful in mitigating po-tential side effects associated with Compound X andthereby contribute to the development of Oncol. Therights in Compound Y constitute a platform contri-bution for which compensation is due from USP aspart of a PCT. The value of FS’s platform contributioncannot be reliably measured by market benchmarks.

(ii) Under the facts, it is possible that either theacquisition price method and the income method to-gether or the residual profit split method might rea-sonably be applied to determine the arm’s length PCTPayments due between USP and FS. Under the firstoption the PCT Payment for the platform contribu-tions related to Company X’s workforce and Com-pound X would be determined using the acquisitionprice method referring to the lump sum price paid byUSP for Company X. Because the value of these plat-form contributions can be determined by referenceto a market benchmark, they are considered routineplatform contributions. Accordingly, under this op-tion, the platform contribution related to CompoundY would be the only nonroutine platform contributionand the relevant PCT Payment is determined usingthe income method. Under the second option, ratherthan looking to the acquisition price for Company X,all the platform contributions are considered nonrou-tine and the RPSM is applied to determine the PCTPayments for each platform contribution. Under ei-ther option, the PCT Payments will be netted againsteach other.

(iii) Whether the acquisition price method to-gether with the income method or the residual profitsplit method provides the most reliable evidence ofthe arm’s length price of the platform contributions ofUSP and FS depends on a number of factors, includ-ing the reliability of the determination of the relativevalues of the platform contributions for purposes ofthe RPSM, and the extent to which the acquisitionprice of Company X can be reliably adjusted toaccount for changes in value over the time periodbetween the acquisition and the formation of theCSA and to account for the value of the rights in thein-process research done by Company X that doesnot constitute platform contributions to the CSA. Inthese circumstances, it is also relevant to considerwhether the results of each method are consistentwith each other, or whether one or both methods areconsistent with other potential methods that couldbe applied. See §1.482–7T(g)(4)(v), (g)(5)(iv), and(g)(7)(iv).

(c) Effective/applicability date—(1) Ingeneral. Paragraphs (a) and (b) Examples10 through 12 of this section are generallyapplicable for taxable years beginning af-ter December 31, 2006. Paragraph (b) Ex-amples 13 through 18 of this section aregenerally applicable on January 5, 2009.

(2) Election to apply regulation to ear-lier taxable years. A person may elect toapply the provisions of paragraph (b) Ex-amples 10 through 12 of this section to ear-lier taxable years in accordance with rulesset forth in §1.482–9T(n)(2).

(3) Expiration date. The applicabil-ity of paragraphs (a) and (b) Examples 10through 12 of this section expires on or be-

fore July 31, 2009. The applicability ofparagraph (b) Examples 13 through 18 ofthis section expires on or before Decem-ber 30, 2011.

Par. 15. Section 1.482–9T is amendedby revising paragraph (m)(3), the headingfor paragraph (n) and paragraph (n)(3) toread as follows:

§1.482–9T Methods to determine taxableincome in connection with a controlledservices transaction (temporary).

* * * * *(m) * * *(3) Coordination with rules govern-

ing cost sharing arrangements. Section1.482–7T provides the specific methods tobe used to determine arm’s length resultsof controlled transactions in connectionwith a cost sharing arrangement. This sec-tion provides the specific methods to beused to determine arm’s length results ofa controlled service transaction, includingin an arrangement for sharing the costsand risks of developing intangibles otherthan a cost sharing arrangement coveredby §1.482–7T. In the case of such an ar-rangement, consideration of the principles,methods, comparability, and reliabilityconsiderations set forth in §1.482–7T isrelevant in determining the best method,including an unspecified method, underthis section, as appropriately adjusted inlight of the differences in the facts andcircumstances between such arrangementand a cost sharing arrangement.

* * * * *(n) Effective/applicability dates. * * *(3) Expiration dates. The applicability

of this section expires on July 31, 2009,except paragraph (m)(3) of this section,which expires on December 30, 2011.

Par. 16. Section 1.861–17 is amendedby revising paragraph (c)(3)(iv) to read asfollows:

§1.861–17 Allocation and apportionmentof research and experimental expenditures.

* * * * *(c) * * *(3) * * *(iv) Effect of cost sharing arrange-

ments. If the corporation controlled by thetaxpayer has entered into a cost sharingarrangement, in accordance with the pro-visions of §1.482–7T, with the taxpayer

2009–7 I.R.B. 514 February 17, 2009

for the purpose of developing intangibleproperty, then that corporation shall notreasonably be expected to benefit from thetaxpayer’s share of the research expense.

* * * * *Par. 17. Section 1.6662–6 is amended

by:1. Removing the third and fourth sen-

tences from paragraph (d)(2)(i)2. Adding a new paragraph

(d)(2)(iii)(D).The addition reads as follows:

§1.6662–6 Transaction between personsdescribed in section 482 and net section482 transfer price adjustments.

* * * * *(d) * * *(2) * * *(iii) * * *(D) Satisfaction of the docu-

mentation requirements described in§1.482–7T(k)(2) for the purpose of com-plying with the rules for CSAs under§1.482–7T also satisfies all of the doc-umentation requirements listed in para-

graph (d)(2)(iii)(B) of this section, exceptthe requirements listed in paragraphs(d)(2)(iii)(B)(2) and (10) of this section,with respect to CSTs and PCTs describedin §1.482–7T(b)(1)(i) and (ii), providedthat the documentation also satisfies therequirements of paragraph (d)(2)(iii)(A)of this section.

* * * * *

PART 301—PROCEDURE ANDADMINISTRATION

Par. 18. The authority citation for part301 continues to read in part as follows:

Authority: 26 U.S.C. 7805* * *Par. 19. Section 301.7701–1 is

amended by revising paragraphs (c) and(f) to read as follows:

§301.7701–1 Classification oforganizations for Federal tax purposes.

* * * * *(c) Cost sharing arrangements. A cost

sharing arrangement that is described in§1.482–7T of this chapter, including anyarrangement that the Commissioner treats

as a CSA under §1.482–7T(b)(5) of thischapter, is not recognized as a separate en-tity for purposes of the Internal RevenueCode. See §1.482–7T of this chapter forthe rules regarding CSAs.

* * * * *(f) Effective/applicability dates. Except

as provided in the following sentence, therules of this section are applicable as ofJanuary 1, 1997. The rules of paragraph (c)of this section are applicable on January 5,2009.

PART 602—OMB CONTROLNUMBER UNDER THE PAPERWORKREDUCTION ACT

Par. 20. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7805Par. 21. In §602.101, paragraph (b) is

amended by adding the following entry innumerical order to the table:

§602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part or section whereidentified and described

Current OMBControl No.

* * * * *

1.482–7T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1364

* * * * *

Linda E. Stiff,Deputy Commissioner forServices and Enforcement.

Approved December 18, 2008.

Eric Solomon,Assistant Secretary of

the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on December 31,2008, 11:15 a.m., and published in the issue of the FederalRegister for January 5, 2009, 74 F.R. 236)

February 17, 2009 515 2009–7 I.R.B.

Part III. Administrative, Procedural, and MiscellaneousTreatment of CorporationsWhose Instruments areAcquired by the TreasuryDepartment Under CertainPrograms Pursuant tothe Emergency EconomicStabilization Act of 2008

Notice 2009–14

This notice provides additional guid-ance regarding the application of section382 and other provisions of law to cor-porations whose instruments are acquiredby the Treasury Department (Treasury)pursuant to the Emergency EconomicStabilization Act of 2008, P. L. 110–343(EESA). This notice amplifies and super-sedes Notice 2008–100, 2008–44 I.R.B.1081, to address other EESA programs.

I. Purpose.

The Internal Revenue Service (Service)and Treasury Department (Treasury) in-tend to issue regulations implementing cer-tain of the rules as described below. Pend-ing the issuance of further guidance, tax-payers may rely on the rules set forth inthis notice to the extent provided herein.

Section 101(a)(1) of EESA authorizesthe Secretary to establish the TroubledAsset Relief Program (TARP). This noticeprovides guidance to corporate issuerswith respect to five programs establishedunder EESA: (i) the Capital Purchase Pro-gram for publicly-traded issuers (PublicCPP); (ii) the Capital Purchase Programfor private issuers (Private CPP); (iii) theCapital Purchase Program for S corpo-rations (S Corp CPP); (iv) the TargetedInvestment Program (TARP TIP); and(v) the Automotive Industry FinancingProgram (TARP Auto). Unless otherwisespecified below, a reference to “the Pro-grams” shall include any of the variousEESA programs described in the preced-ing sentence.

II. Background.

Section 382(a) of the Internal RevenueCode (Code) provides that the taxableincome of a loss corporation for a year fol-lowing an ownership change that may be

offset by pre-change losses cannot exceedthe section 382 limitation for such year.An ownership change occurs with respectto a corporation if it is a loss corporationon a testing date and, immediately after theclose of the testing date, the percentage ofstock of the corporation owned by one ormore 5-percent shareholders has increasedby more than 50 percentage points overthe lowest percentage of stock of suchcorporation owned by such sharehold-ers at any time during the testing period.See § 1.382–2T(a)(1) of the Income TaxRegulations. Section 382(m) of the Codeprovides that the Secretary shall prescribesuch regulations as may be necessary orappropriate to carry out the purposes ofsections 382 and 383.

Section 101(c)(5) of EESA providesthat the Secretary is authorized to issuesuch regulations and other guidance asmay be necessary or appropriate to carryout the purposes of EESA.

Except as otherwise provided, any def-initions and terms used herein have thesame meaning as they do in section 382of the Code and the regulations thereunderor in EESA. Unless otherwise specified, areference herein to “section” is to the par-ticular section of the Code or regulationsthereunder.

III. Guidance Regarding CorporationsWhose Instruments are Acquired by theTreasury Pursuant to EESA

Taxpayers may rely on the rules de-scribed in this Section III to the extent pro-vided below.

RULES:

A. Treatment of indebtedness and pre-ferred stock acquired by Treasury. Forall Federal income tax purposes, any in-strument issued to Treasury pursuant tothe Programs, whether owned by Treasuryor subsequent holders, shall be treated asan instrument of indebtedness if denom-inated as such, and as stock described insection 1504(a)(4) if denominated as pre-ferred stock. Any amount received by anissuer under the Programs shall be treatedas received, in its entirety, as considerationin exchange for the instruments issued. Nosuch instrument shall be treated as stock

for purposes of section 382 while held byTreasury or by other holders, except thatpreferred stock will be treated as stock forpurposes of section 382(e)(1).

B. Treatment of warrants acquiredby Treasury. For all Federal income taxpurposes, any warrant to purchase stockacquired by Treasury pursuant to the Pub-lic CPP, TARP TIP, and TARP Auto,whether owned by Treasury or subsequentholders, shall be treated as an option (andnot as stock). While held by Treasury,such warrant will not be deemed exercisedunder § 1.382–4(d)(2). For all Federalincome tax purposes, any warrant to pur-chase stock acquired by Treasury pursuantto the Private CPP shall be treated asan ownership interest in the underlyingstock, which shall be treated as preferredstock described in section 1504(a)(4).For all Federal income tax purposes, anywarrant acquired by Treasury pursuantto the S Corp CPP shall be treated asan ownership interest in the underlyingindebtedness.

C. Section 382 treatment of stock ac-quired by Treasury. For purposes of sec-tion 382, with respect to any stock (otherthan preferred stock) acquired by Treasurypursuant to the Programs (either directly orupon the exercise of a warrant), the owner-ship represented by such stock on any dateon which it is held by Treasury shall not beconsidered to have caused Treasury’s own-ership in the issuing corporation to have in-creased over its lowest percentage ownedon any earlier date. Except as describedbelow, such stock is considered outstand-ing for purposes of determining the per-centage of stock owned by other 5-percentshareholders on a testing date.

D. Section 382 treatment of redemp-tions of stock from Treasury. For purposesof measuring shifts in ownership by any5-percent shareholder on any testing dateoccurring on or after the date on which theissuing corporation redeems stock held byTreasury that was acquired pursuant to thePrograms (either directly or upon the exer-cise of a warrant), the stock so redeemedshall be treated as if it had never been out-standing.

E. Section 382(l)(1) not applicable withrespect to capital contributions made byTreasury pursuant to the Programs. For

2009–7 I.R.B. 516 February 17, 2009

purposes of section 382(l)(1), any capitalcontribution made by Treasury pursuant tothe Programs shall not be considered tohave been made as part of a plan a principalpurpose of which was to avoid or increaseany section 382 limitation.

IV. Reliance on Notice.

Taxpayers may rely on the rules de-scribed in Section III. These rules will con-tinue to apply unless and until there isadditional guidance. Any future contraryguidance will not apply to instruments (i)

held by Treasury that were acquired pur-suant to the Programs prior to the publi-cation of that guidance, or (ii) issued toTreasury pursuant to the Programs underbinding contracts entered into prior to thepublication of that guidance. In exercis-ing its authority under EESA in this no-tice, the Treasury and the Service do notintend to suggest that similar Federal in-come tax results would obtain with respectto instruments similar to those describedherein that are not issued under the Pro-grams. Accordingly, the Federal incometax consequences of instruments not issued

under the Programs should continue to bedetermined based upon specific facts andcircumstances.

The principal author of this notice isKeith Stanley of the Office of AssociateChief Counsel (Corporate). For furtherinformation regarding this notice, contactKeith Stanley at (202) 622–7750 (not atoll-free call).

Note. This revenue procedure will be reproduced as the next revision of IRS Publication 1167, General Rules and Specifications forSubstitute Forms and Schedules.

Rev. Proc. 2009–17

TABLE OF CONTENTS

PART 1 – INTRODUCTION TO SUBSTITUTE FORMS

SECTION 1.1 – OVERVIEW OF REVENUE PROCEDURE 2009–17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519

SECTION 1.2 – IRS CONTACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520

SECTION 1.3 – WHAT’S NEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520

SECTION 1.4 – DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 521

SECTION 1.5 – AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523

PART 2 – GENERAL GUIDELINES FOR SUBMISSIONS AND APPROVALS

SECTION 2.1 – GENERAL SPECIFICATIONS FOR APPROVAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524

SECTION 2.2 – HIGHLIGHTS OF PERMITTED CHANGES AND REQUIREMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525

SECTION 2.3 – VOUCHERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526

SECTION 2.4 – RESTRICTIONS ON CHANGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 528

SECTION 2.5 – GUIDELINES FOR OBTAINING IRS APPROVAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 528

SECTION 2.6 – OFFICE OF MANAGEMENT AND BUDGET (OMB) REQUIREMENTS FOR ALLSUBSTITUTE FORMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 531

PART 3 – PHYSICAL ASPECTS AND REQUIREMENTS

SECTION 3.1 – GENERAL GUIDELINES FOR SUBSTITUTE FORMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 532

SECTION 3.2 – PAPER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534

SECTION 3.3 – PRINTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535

SECTION 3.4 – MARGINS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537

SECTION 3.5 – EXAMPLES OF APPROVED FORMATS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537

SECTION 3.6 – MISCELLANEOUS INFORMATION FOR SUBSTITUTE FORMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 538

February 17, 2009 517 2009–7 I.R.B.

PART 4 – ADDITIONAL RESOURCES

SECTION 4.1 – GUIDANCE FROM OTHER REVENUE PROCEDURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539

SECTION 4.2 – ELECTRONIC TAX PRODUCTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539

SECTION 4.3 – IRS TAX PRODUCTS ON DVD (PUBLICATION 1796) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

PART 5 – REQUIREMENTS FOR SPECIFIC TAX RETURNS

SECTION 5.1 – TAX RETURNS (FORMS 1040, 1040A, 1120, ETC.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

SECTION 5.2 – CHANGES PERMITTED TO GRAPHICS (FORMS 1040A AND 1040) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 541

SECTION 5.3 – CHANGES PERMITTED TO FORM 1040A GRAPHICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542

SECTION 5.4 – CHANGES PERMITTED TO FORM 1040 GRAPHICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543

PART 6 – FORMAT AND CONTENT OF SUBSTITUTE RETURNS

SECTION 6.1 – ACCEPTABLE FORMATS FOR SUBSTITUTE FORMS AND SCHEDULES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544

SECTION 6.2 – ADDITIONAL INSTRUCTIONS FOR ALL FORMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545

PART 7 – MISCELLANEOUS FORMS AND PROGRAMS

SECTION 7.1 – SPECIFICATIONS FOR SUBSTITUTE SCHEDULES K-1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546

SECTION 7.2 – PROCEDURES FOR PRINTING IRS ENVELOPES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551

SECTION 7.3 – GUIDELINES FOR SUBSTITUTE FORMS 8655 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 553

PART 8 – ALTERNATIVE METHODS OF FILING

SECTION 8.1 – FORMS FOR ELECTRONICALLY FILED RETURNS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 554

SECTION 8.2 – EFFECT ON OTHER DOCUMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 554

EXHIBITS

Exhibit A-1 – Schedule A (Preferred Format) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555

Exhibit A-2 – Schedule A (Acceptable Format) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556

Exhibit B-1 – Form 2106-EZ (Preferred Format) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557

Exhibit B-2 – Form 2106-EZ (Acceptable Format) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558

Exhibit C – Software Developers Voucher . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 559

Exhibit D – Sample Check Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560

2009–7 I.R.B. 518 February 17, 2009

Part 1Introduction to Substitute Forms

Section 1.1 – Overview of Revenue Procedure 2009–17

1.1.1Purpose

The purpose of this revenue procedure is to provide guidelines and general requirementsfor the development, printing, and approval of substitute tax forms. Approval will be based onthese guidelines. After review and approval, submitted forms will be accepted as substitutesfor official IRS forms.

1.1.2Unique Forms

Certain unique specialized forms require the use of other additional publications to supple-ment this publication. See Part 4.

1.1.3Scope

The IRS accepts quality substitute tax forms that are consistent with the official forms andhave no adverse impact on our processing. The IRS Substitute Forms Unit administers the for-mal acceptance and processing of these forms nationwide. While this program deals primarilywith paper documents, it also reviews for approval other processing and filing forms such asthose used in electronic filing.

Only those substitute forms that comply fully with these requirements are acceptable. Thisrevenue procedure is updated as required to reflect pertinent tax year form changes and to meetprocessing and/or legislative requirements.

1.1.4Forms Covered by This RevenueProcedure

The following types of forms are covered by this revenue procedure:

• IRS tax forms and their related schedules,• Worksheets as they appear in instruction packages,• Applications for permission to file returns electronically and forms used as required docu-

mentation for electronically filed returns,• Powers of Attorney,• Over-the-counter estimated tax payment vouchers, and• Forms and schedules relating to partnerships, exempt organizations, and employee plans.

1.1.5Forms Not Covered byThis Revenue Procedure

The following types of forms are not covered by this revenue procedure:

• W-2 and W-3 (see Publication 1141 for information on these forms),• W-2c and W-3c (see Publication 1223 for information on these forms),• 941 and Schedule B (Form 941) (see Publication 4436 for information on these forms),• 1096, 1098 series, 1099 series, 5498 series, W-2G, and 1042-S (see Publication 1179 for

information on these forms),• Federal Tax Deposit (FTD) coupons, which may not be reproduced,• Forms 1040-ES (OCR) and 1041-ES (OCR), which may not be reproduced,• Forms 5500, 5500-EZ, and associated schedules (see the Department of Labor website at

www.dol.gov for information on these forms),• Forms 5307, 8717, and 8905, bar-coded forms requiring separate approval,• FinCEN forms, TD F 90-22 forms, and Form 8300,• Requests for information or documentation initiated by the IRS,• Forms used internally by the IRS,• State tax forms,

February 17, 2009 519 2009–7 I.R.B.

• Forms developed outside the IRS, and• General Instructions and Specific Instructions (not reviewed by the Substitute Forms Pro-

gram Unit).

Section 1.2 – IRS Contacts

1.2.1Where To SendSubstitute Forms

Send your substitute forms for approval to the following offices (do not send forms withtaxpayer data):

Form Office and Address

All FinCEN family of forms, TD F 90-22family of forms, and Form 8300

Enterprise Computing Center - Detroit(ECC-D)BSA Compliance BranchP.O. Box 32063Detroit, MI 48232-0063

5500, 5500-EZ, and Schedules A, C, D, E,G, H, I, MB, R, SB, and SSA for Form 5500

Check EFAST information at theDepartment of Labor’s website atwww.efast.dol.gov

5307, 8717, and 8905 Joanna.H.Weber@irs.gov

Software developer vouchers (See Sections2.3.7 - 2.3.9)

Internal Revenue ServiceAttn: Doris Bethea, C5-1635000 Ellin Rd.Lanham, MD 20706Doris.E.Bethea@irs.gov orBrenda.C.Martinez@irs.gov

All others (except W-2, W-2c, W-3, W-3c,941, Schedule B (Form 941), 1096, 1098,1099, 5498, W-2G, and 1042-S) covered bythis publication

Internal Revenue ServiceAttn: Substitute Forms ProgramSE:W:CAR:MP:T:T:SP1111 Constitution Avenue, NWRoom 6526Washington, DC 20224

In addition, the Substitute Forms Program Unit can be contacted via email atSubstituteforms@irs.gov. Please include “PDF Submissions” on the subject line.

For questions about Forms W-2 and W-3, refer to IRS Publication 1141, General Rules andSpecifications for Substitute Forms W-2 and W-3. For Forms W-2c and W-3c, refer to IRSPublication 1223, General Rules and Specifications for Substitute Forms W-2c and W-3c. ForForms 941 and Schedule B (Form 941), refer to IRS Publication 4436, General Rules and Spec-ifications for Substitute Form 941 and Schedule B (Form 941). For Forms 1096, 1098, 1099,5498, W-2G, and 1042-S, refer to IRS Publication 1179, General Rules and Specifications forSubstitute Forms 1096, 1098, 1099, 5498, W-2G, and 1042-S.

Section 1.3 – What’s New

1.3.1What’s New

The following changes have been made to the Revenue Procedure for tax year 2008.

• The table for “Where To Send Substitute Forms” (Section 1.2.1) has been updated.

2009–7 I.R.B. 520 February 17, 2009

• The Vouchers section (Section 2.3) has been updated to add some items and to add infor-mation for an additional contact person.

• Section 4.1.1 listed updated titles to reflect that magnetic media are no longer accepted.• Section 4.3 has been updated to highlight changes to Publication 1796 (IRS Tax Products

DVD).• Sections 5.4.6 and 5.4.7 were updated to reflect changes to the 2008 Form 1040.• Section 7.1 concerning Schedules K-1 was updated.• Section 8.1.3 concerning electronic filing was updated.• IRS website addresses were updated as needed.• The Exhibits section has been changed and updated.• We made editorial changes as needed.

Section 1.4 – Definitions

1.4.1Substitute Form

A tax form (or related schedule) that differs in any way from the official version and isintended to replace the form that is printed and distributed by the IRS. This term also coversthose approved substitute forms exhibited in this revenue procedure.

1.4.2Printed/PreprintedForm

A form produced using conventional printing processes, or a printed form which has beenreproduced by photocopying or a similar process.

1.4.3Preprinted Pin-FedForm

A printed form that has marginal perforations for use with automated and high-speed print-ing equipment.

1.4.4Computer PreparedSubstitute Form

A preprinted form in which the taxpayer’s tax entry information has been inserted by acomputer, computer printer, or other computer-type equipment.

1.4.5Computer Generated SubstituteTax Return or Form

A tax return or form that is entirely designed and printed using a computer printer such as alaser printer, etc., on plain white paper. This return or form must conform to the physical layoutof the corresponding IRS form, although the typeface may differ. The text should match thetext on the officially printed form as closely as possible. Condensed text and abbreviations willbe considered on a case-by-case basis.

Exception. All jurats (perjury statements) must be reproduced verbatim.

1.4.6Manually PreparedForm

A preprinted reproduced form in which the taxpayer’s tax entry information is entered byan individual using a pen, pencil, typewriter, or other non-automated equipment.

February 17, 2009 521 2009–7 I.R.B.

1.4.7Graphics

Parts of a printed tax form that are not tax amount entries or required text. Examples ofgraphics are line numbers, captions, shadings, special indicators, borders, rules, and strokescreated by typesetting, photographics, photocomposition, etc.

1.4.8Acceptable ReproducedForm

A legible photocopy of an original form.

1.4.9Supporting Statement(Supplemental Schedule)

A document providing detailed information to support a line entry on an official or approvedsubstitute form and filed with (attached to) a tax return.

Note. A supporting statement is not a tax form and does not take the place of an officialform.

1.4.10Specific Form Terms

The following specific terms are used throughout this revenue procedure in reference to allsubstitute forms: format, sequence, line reference, item caption, and data entry field.

1.4.11Format

The overall physical arrangement and general layout of a substitute form.

1.4.12Sequence

Sequence is an integral part of the total format requirement. The substitute form shouldshow the same numeric and logical placement order of data, as shown on the official form.

1.4.13Line Reference

The line numbers, letters, or alphanumerics used to identify each captioned line on an offi-cial form. These line references are printed to the immediate left of each caption and/or dataentry field.

1.4.14Item Caption

The text on each line of a form, which identifies the data required.

1.4.15Data Entry Field

Designated areas for the entry of data such as dollar amounts, quantities, responses andcheckboxes.

1.4.16Advance Draft

A draft version of a new or revised form may be posted to the IRS website for informationpurposes. Substitute forms may be submitted based on these advance drafts, but any submit-ter that receives forms approval based on these early drafts is responsible for monitoring andrevising forms to mirror any revisions in the final forms provided by the IRS.

2009–7 I.R.B. 522 February 17, 2009

1.4.17Approval

Generally, approval could be in writing or assumed after 20 business days from our receiptfor forms that have not been substantially changed by the IRS. Also, this does not apply tonewly created or substantially revised IRS forms.

Section 1.5 – Agreement

1.5.1Important Stipulationof This Revenue Procedure

Any person or company who uses substitute forms and makes all or part of the changesspecified in this revenue procedure agrees to the following stipulations.

• The IRS presumes that any required changes are made in accordance with these proceduresand will not be disruptive to the processing of the tax return.

• Should any of the changes be disruptive to the IRS’s processing of the tax return, the personor company agrees to accept the determination of the IRS as to whether the form maycontinue to be filed.

• The person or company agrees to work with the IRS in correcting noted deficiencies. No-tification of deficiencies may be made by any combination of fax, letter, email, or phonecontact and may include the request for the re-submission of unacceptable forms.

1.5.2Response Policyand Stipulations

The Substitute Forms Unit (the Unit) will email confirmation of receipt of your forms sub-mission. Your submission can be considered approved if you do not receive a response fromthe Unit within 20 business days of the receipt date. If the Unit anticipates problems in com-pleting the review of your submission within the 20 business day period, the Unit will send aninterim email notifying you of the extended period for review.

Once the substitute forms have been approved by the Substitute Forms Unit, you can releasethem after the final versions of the forms have been issued by the IRS. Before releasing theforms, you are responsible for updating forms approved as draft and for making form changeswe requested.

The policy has the following stipulations.

• This 20-day policy applies to electronic submissions only. It does not apply to substituteforms submitted for approval by paper or fax.

• The policy applies to submissions of 15 or fewer items. Submissions of more than 15 itemsmay require additional review time.

• If you send a large number of submissions within a short period of time, processing maybe delayed.

• Delays in processing could occur if the Unit finds significant errors in your submission.The Unit will send you an interim email in this case.

• Any anticipated problems in processing your submission within the 20-day period willgenerate an interim email on or about the 15th business day.

• If any significant inaccuracies are discovered after the 20-day period, the Unit reserves theright to inform you and will require that changes be made to correct the inaccuracies.

• The policy does not apply to substantially revised forms or to new forms created by theIRS for which you have already made an initial submission.

February 17, 2009 523 2009–7 I.R.B.

Part 2General Guidelines for Submissions and Approvals

Section 2.1 – General Specifications for Approval

2.1.1Overview

If you produce any tax forms following the guidelines on only those changes specificallyoutlined by the Substitute Forms Unit, you can generate your own substitute forms withoutfurther approval. If your changes are more extensive, you must get IRS approval before usingsubstitute forms. More extensive changes can include the use of typefaces and sizes other thanthose found on the official form and the condensing of line item descriptions to save space.

Note. The 20-day turnaround policy may not apply to extensive changes.

2.1.2Email Submissions

The Substitute Forms Program accepts substitute forms submissions via email. The emailaddress is Substituteforms@irs.gov . Please include the term “PDF Submissions” on the subjectline.

Follow these guidelines.

• Your submission should include all the forms you wish to submit in one attached pdf file.Do not email each form individually.

• Small (fewer than 15 forms), rather than large, submissions should expedite processing. Asubmission should contain a maximum of 15 forms.

• An approval check sheet listing the forms you are submitting should always be included inthe pdf file along with the forms. See a sample check sheet in Exhibit D.

• Optimize pdf files before submitting.

• The maximum allowable email attachment is 2.5 megabytes.

• The Substitute Forms Unit accepts zip files.

• To alleviate delays during the peak time of September through December, submit advancedraft forms as early as possible.

If the guidelines are not followed, you may need to resubmit.

Emailing pdf submissions will not expedite review and approval. The pdf submissions willbe assigned a control number and put in queue along with mailed-in paper submissions. Inaddition to submitting forms via email, you may send your submissions to:

Internal Revenue ServiceSE:W:CAR:MP:T:T:SPAttn: Substitute Forms Program1111 Constitution Avenue, NWRoom 6526Washington, DC 20224

2.1.3Expediting the Process

Follow these basic guidelines for expediting the process.

• Always include a check sheet for the Substitute Forms Unit’s response.

2009–7 I.R.B. 524 February 17, 2009

• Follow Publication 1167 for general substitute form guidelines. Follow the specializedpublications produced by the Substitute Forms Unit for other specific forms.

• To spread out the workload, send in draft versions of substitute forms when they are posted.

Note. Be sure to make any changes to approved drafts before releasing final versions.

2.1.4Schedules

Schedules are considered to be an integral part of a complete tax return. A schedule may beincluded as part of a form or printed separately.

2.1.5Examples of SchedulesThat Must Be Submittedwith the Return

Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, is an ex-ample of this situation. Its Schedules A through U have pages numbered as part of the basicreturn. For Form 706 to be considered for approval, the entire form including Schedules Athrough U must be submitted.

2.1.6Examples of SchedulesThat Can Be SubmittedSeparately

However, Schedules 1, 2, and 3 of Form 1040A are examples of schedules that can be sub-mitted separately. Although printed by the IRS as a supplement to Form 1040A, none of theseschedules are required to be filed with Form 1040A. These schedules may be separated fromForm 1040A and submitted as substitute forms.

2.1.7Use and Distribution ofUnapproved Forms

The IRS is continuing a program to identify and contact tax return preparers, forms devel-opers, and software publishers who use or distribute unapproved forms that do not conform tothis revenue procedure. The use of unapproved forms hinders the processing of the returns.

Section 2.2 – Highlights of Permitted Changes and Requirements

2.2.1Methods ofReproducing InternalRevenue Service Forms

Official IRS tax forms are supplied by the IRS. These forms may be provided in the tax-payer’s tax package or over-the-counter. Forms can also be picked up at many IRS offices,post offices, or libraries, and are available on DVD and online at www.irs.gov.

There are methods of reproducing IRS printed tax forms suitable for use as substitutes with-out prior approval.

• You can photocopy most tax forms and use them instead of the official ones. The entiresubstitute form, including entries, must be legible.

• You can reproduce any current tax form as cut sheets, snap sets, and marginally punched,pin-fed forms as long as you use an official IRS version as the master copy.

• You can reproduce a form that requires a signature as a valid substitute form. Many taxforms (including returns) have a taxpayer signature requirement as part of the form layout.The jurat/perjury statement/signature line areas must be retained and worded exactly as onthe official form. The requirement for a signature, by itself, does not prohibit a tax formfrom being properly computer-generated.

February 17, 2009 525 2009–7 I.R.B.

Section 2.3 – Vouchers

2.3.1Overview

All payment vouchers (Forms 940-V, 940-EZ(V), 941-V, 943-V, 945-V, 1040-V, and2290-V) must be reproduced in conjunction with their forms. Substitute vouchers must be thesame size as the officially printed vouchers. Vouchers that are prepared for printing on a laserprinter may include a scan line.

2.3.2Scan LineSpecifications

NNNNNNNNN AA XXXX NN N NNNNNN NNN

Item: A B C D E F G

A. Social Security Number/Employer Identification Number (SSN/EIN) has 9 numeric(N) spaces.

B. Check Digits have 2 alpha (A) spaces.

C. Name Control has 4 alphanumeric (X) spaces.

D. Master File Tax (MFT) Code has 2 numeric (N) spaces (see below).

E. Taxpayer Identification Number (TIN) Type has 1 numeric (N) space (see below).

F. Tax Period has 6 numeric (N) spaces in year/month format (YYYYMM).

G. Transaction Code has 3 numeric (N) spaces.

2.3.3MFT Code

Code Number for Forms:

• 1040 (family) – 30,• 940/940-EZ – 10,• 941 – 01,• 943 – 11,• 944 – 14,• 945 – 16,• 2290 – 60, and• 4868 – 30.

2.3.4TIN Type

Type Number for:

• Form 1040 (family), 4868 – 0, and• Forms 940, 940-EZ, 941, 943, 944, 945, and 2290 – 2.

2.3.5Voucher Size

The voucher size must be exactly 8.0′ ′ x 3.25′ ′ (Forms 1040-ES and 1041-ES must be7.625′ ′ x 3.0′ ′ ). The document scan line must be vertically positioned 0.25 inches from thebottom of the scan line to the bottom of the voucher. The last character on the right of the scanline must be placed 3.5 inches from the right leading edge of the document. The minimumrequired horizontal clear space between characters is .014 inches. The line to be scanned musthave a clear band 0.25 inches in height from top to bottom of the scan line, and from border toborder of the document. “Clear band” means no printing except for dropout ink.

2009–7 I.R.B. 526 February 17, 2009

2.3.6Print and Paper Weight

Vouchers must be imaged in black ink using OCR A, OCR B, or Courier 10. These fontsmay not be mixed in the scan line. The horizontal character pitch is 10 CPI. The preferredpaper weight is 20 to 24 pound OCR bond.

2.3.7Specifications for SoftwareDevelopers

Certain vouchers may be reproduced for use in the IRS lockbox system. These includethe 1040-V, 1040-ES, the 940 family, and 2290 vouchers. Software developers must followthese specific guidelines to produce scannable vouchers strictly for lockbox purposes. Alsosee Exhibit C.

• The total depth must be 3.25 inches.

• The scan line must be .5 inches from the bottom edge and 1.75 inches from the left edgeof the voucher and left-justified.

• Software developers vouchers must be 8.5 inches wide (instead of 8 inches with a cut line).Therefore, no vertical cut line is required.

• Scan line positioning must be exact.

• Do not use the over-the-counter format voucher and add the scan line to it.

• All scanned data must be in 12-point OCR A font.

• The 4-digit NACTP ID code should be placed under the payment indicator arrow.

• Windowed envelopes must not display the scan line in order to avoid disclosure and privacyissues.

Note. All software developers must ensure that their software uses OCR A font so taxpayerswill be able to print the vouchers in the correct font.

2.3.8Specific Line Positions

Follow these line specifications for entering taxpayer data in the lockbox vouchers.

Start RowStart

Column WidthEnd

Column

Line Specifications forTaxpayer Data:

Taxpayer Name 56 6 36 41

Taxpayer Address, Apt. 57 6 36 41

Taxpayer City, State, ZIP 58 6 36 41

Line Specifications forMail To Data:

Mail Address 57 43 38 80

Mail City, State, ZIP 58 43 38 80

Line Specifications for:

Scan Line 63 26 n/a n/a

February 17, 2009 527 2009–7 I.R.B.

2.3.9How to Get Approval

To receive approval, please send 25 voucher samples yearly, by December 10, for testing tothe following address.

Internal Revenue ServiceAttn: Doris Bethea, C5-1635000 Ellin Rd.Lanham, MD 20706

For further information, contact either Doris Bethea, Doris.E.Bethea@irs.gov, at202-283-0218 or Brenda Martinez, Brenda.C.Martinez@irs.gov, at 202-283-5789.

Section 2.4 – Restrictions on Changes

2.4.1What You CannotDo to Forms Suitablefor SubstituteTax Forms

You cannot, without prior IRS approval, change any IRS tax form or use your own (non-approved) versions including graphics, unless specifically permitted by this revenue procedure.See Sections 2.5.7 to 2.5.11.

You cannot adjust any of the graphics on Forms 1040, 1040A, and 1040EZ (except in thoseareas specified in Part 5 of this revenue procedure) without prior approval from the IRS Sub-stitute Forms Unit.

You cannot use your own preprinted label on tax returns filed with the IRS unless you fullycomply with the criteria specified in Section 3.6.3 on the use of pre-addressed IRS labels.

Note. The 20-day turnaround policy may not apply to extensive changes.

Section 2.5 – Guidelines for Obtaining IRS Approval

2.5.1Basic Requirements

Preparers who submit substitute privately designed, privately printed, computer generated,or computer prepared tax forms must develop these substitutes using the guidelines establishedin this part. These forms, unless there is an exception outlined by the revenue procedure, mustbe approved by the IRS before being filed.

2.5.2Conditional Approval Based onAdvanced Drafts

The IRS cannot grant final approval of your substitute form until the official form has beenpublished. However, the IRS posts advance draft forms on its website at:

http://www.irs.gov/app/picklist/list/draftTaxForms.html

We encourage submission of proposed substitutes of these advance draft forms and willgrant conditional approval based solely on these early drafts. These advance drafts are subjectto significant change before forms are finalized. If these advance drafts are used as the basisfor your substitute forms, you will be responsible for subsequently updating your final formsto agree with the final official version. These revisions need not be resubmitted for furtherapproval.

2009–7 I.R.B. 528 February 17, 2009

Note. Approval of forms based on advance drafts will not be granted after the final versionof an official form is published.

2.5.3Submission Procedures

Follow these general guidelines when submitting substitute forms for approval.

• Any alteration of forms must be within the limits acceptable to the IRS. It is possible that,from one filing period to another, a change in law or a change in internal need (processing,audit, compliance, etc.) may change the allowable limits for the alteration of the officialform.

• When approval of any substitute form (other than those exceptions specified in Part 1,Section 1.2 – IRS Contacts) is requested, a sample of the proposed substitute form shouldbe forwarded for consideration via email or by letter to the Substitute Forms Unit at theaddress shown in Section 1.2.1.

• Schedules and forms (for example, Forms 3468, 4136, etc.) that can be used with morethan one type of return (for example, 1040, 1041, 1120, etc.) should be submitted onlyonce for approval, regardless of the number of different tax returns with which they maybe associated. Also, all pages of multi-page forms or returns should be submitted in thesame package.

2.5.4Approving Offices

Because only the Substitute Forms Unit is authorized to approve substitute forms, unneces-sary delays may occur if forms are sent to the wrong office. You may receive an interim letterabout the delay. The Substitute Forms Unit may then coordinate the response with the origina-tor responsible for revising that particular form. Such coordination may include allowing theoriginator to officially approve the form. No IRS office is authorized to allow deviations fromthis revenue procedure.

2.5.5IRS Review ofSoftware Programs, etc.

The IRS does not review or approve the logic of specific software programs, nor does theIRS confirm the calculations on the forms produced by these programs. The accuracy of theprogram remains the responsibility of the software package developer, distributor, or user.

The Substitute Forms Unit is primarily concerned with the pre-filing quality review of thefinal forms that are expected to be processed by IRS field offices. For this purpose, you shouldsubmit forms without including any taxpayer information such as names, addresses, monetaryamounts, etc.

2.5.6When To SendProposed Substitutes

Proposed substitutes, which are required to be submitted per this revenue procedure, shouldbe sent as much in advance of the filing period as possible. This is to allow adequate time foranalysis and response.

2.5.7AccompanyingStatement

When submitting sample substitutes, you should include an accompanying statement thatlists each form number and its changes from the official form (position, arrangement, appear-ance, line numbers, additions, deletions, etc.). With each of the items you should include adetailed reason for the change.

February 17, 2009 529 2009–7 I.R.B.

When requesting approval, please include a check sheet. Check sheets expedite the approvalprocess. The check sheet may look like the example in Exhibit D displayed in the back of thisprocedure or may be one of your own design. Please include your fax number on the checksheet.

2.5.8Approval/Non-Approval Notice

The Substitute Forms Unit will fax the check sheet or an approval letter to the originator ifa fax number has been provided, unless:

• The requester has asked for an email response or for a formal letter, or• Significant corrections to the submitted forms are required.

Notice of approval may impose qualifications before using the substitutes. Notices of un-approved forms may specify the changes required for approval and require re-submission ofthe form(s) in question. When appropriate, you will be contacted by telephone.

2.5.9Duration ofApproval

Most signature tax returns and many of their schedules and related forms have the tax (li-ability) year printed in the upper right corner. Approvals for these annual forms are usuallygood for one calendar year (January through December of the year of filing). Quarterly taxforms in the 940 series and Form 720 require approval for any quarter in which the form hasbeen revised.

Because changes are usually made to an annual form every year, each new filing seasongenerally requires a new submission of a substitute form. Very rarely is updating the preprintedyear the only change made to an annual form.

2.5.10LimitedContinued Use of an ApprovedChange

Limited changes approved for one tax year may be allowed for the same form in the follow-ing tax year. Examples are the use of abbreviated words, revised form spacing, compressedtext lines, and shortened captions, etc., which do not change the integrity of lines or text on theofficial forms.

If substantial changes are made to the form, new substitutes must be submitted for approval.If only minor editorial changes are made to the form, it is not subject to review. It is the re-sponsibility of each vendor who has been granted permission to use substitute forms to monitorand revise forms to mirror any revisions to official forms made by the Service. If there are anyquestions, please contact the Substitute Forms Unit.

2.5.11When ApprovalIs Not Required

If you received approval for a specific change on a form last year, you may make the samechange this year if the item is still present on the official form.

• The new substitute form does not have to be submitted to the IRS and approval based onthat change is not required.

• However, the new substitute form must conform to the official current year IRS form inother respects: date, Office of Management and Budget (OMB) approval number, attach-ment sequence number, Paperwork Reduction Act Notice statement, arrangement, itemcaption, line number, line reference, data sequence, etc.

• The new substitute form must also comply with changes to the guidelines in this revenueprocedure. The procedure may have eliminated, added to, or otherwise changed the guide-line(s) that affected the change approved in the prior year.

• An approved change is authorized only for the period from a prior tax year substitute formto a current tax year substitute form.

2009–7 I.R.B. 530 February 17, 2009

Exception. Forms with temporary, limited, or interim approvals (or with approvals thatstate a change is not allowed in any other tax year) are subject to review in subsequent years.

2.5.12Continuous-Use Forms

Forms without preprinted tax years are called “continuous-use” forms. Continuous-useforms are revised when a legislative change affects the form or a change will facilitate pro-cessing. These forms frequently have revision dates that are valid for longer than one year.

2.5.13IRS WebsitePosting Schedule

A schedule of print dates (for annual and quarterly forms) and most current revision dates(for continuous-use forms) are maintained on the IRS website. The Tax Products PostingSchedule can be found at www.irs.gov/formspubs/article/0,,id=103641,00.html. See Section4.2.2.

2.5.14Required Copies

Generally, you must send us one copy of each form being submitted for approval. However,if you are producing forms for different computer systems (for example, IBM compatible vs.Macintosh) or different types of printers (for example, laser vs. inkjet), and these forms differsignificantly in appearance, submit one copy for each type of system or printer.

2.5.15Requestor’sResponsibility

Following receipt of an initial approval for a substitute forms package or a software outputprogram to print substitute forms, it is the responsibility of the originator (designer or distrib-utor) to provide client firms or individuals with forms that meet the IRS’s requirements forcontinuing acceptability. Examples of this responsibility include:

• Using the prescribed print paper, font size, legibility, state tax data deletion, etc., and• Informing all users of substitute forms of the legal requirements of the Paperwork Reduc-

tion Act Notice, which is generally found in the instructions for the official IRS forms.

2.5.16Source Code

The Substitute Forms Unit will assign a unique source code to each firm that submits sub-stitute paper forms for approval. This source code will be a permanent identifier that must beused on every submission by a particular firm.

The source code consists of three alpha characters and should generally be printed at thebottom left margin area on the first page of every approved substitute form.

Section 2.6 – Office of Management and Budget (OMB) Requirements for All Substitute Forms

2.6.1OMB Requirementsfor All Substitute Forms

There are legal requirements of the Paperwork Reduction Act of 1995 (The Act). PublicLaw 104-13 requires the following.

• OMB approves all IRS tax forms that are subject to the Act.• Each IRS form contains (in the upper right corner) the OMB number, if assigned.• Each IRS form (or its instructions) states why the IRS needs the information, how it will

be used, and whether or not the information is required to be furnished to the IRS.

February 17, 2009 531 2009–7 I.R.B.

This information must be provided to every user of official or substitute IRS forms or in-structions.

2.6.2Application of the PaperworkReduction Act

On forms that have been assigned OMB numbers:

• All substitute forms must contain in the upper right corner the OMB number that is on theofficial form, and

• The required format is: OMB No. 1545-XXXX (Preferred) or OMB # 1545-XXXX (Ac-ceptable).

2.6.3RequiredExplanation to Users

You must inform the users of your substitute forms of the IRS use and collection require-ments stated in the instructions for official IRS forms.

• If you provide your users or customers with the official IRS instructions, each form mustretain either the Paperwork Reduction Act Notice (or Disclosure, Privacy Act, and Pa-perwork Reduction Act Notice), or a reference to it as the IRS does on the official forms(usually in the lower left corner of the forms).

• This notice reads, in part, “We ask for the information on this form to carry out the InternalRevenue laws of the United States....”

Note. If no IRS instructions are provided to users of your forms, the exact text of the Paper-work Reduction Act Notice (or Disclosure, Privacy Act, and Paperwork Reduction Act Notice)must be furnished separately or on the form.

2.6.4Finding the OMBNumber and PaperworkReduction Act Notice

The OMB number and the Paperwork Reduction Act Notice, or references to it, may befound printed on an official form (or its instructions). The number and the notice are includedon the official paper format and in other formats produced by the IRS (for example, DVD(Publication 1796) or Internet download).

Part 3Physical Aspects and Requirements

Section 3.1 – General Guidelines for Substitute Forms

3.1.1General Information

The official form is the standard. Because a substitute form is a variation from the officialform, you should know the requirements of the official form for the year of use before youmodify it to meet your needs. The IRS provides several means of obtaining the most frequentlyused tax forms. These include the Internet and DVD (see Part 4).

2009–7 I.R.B. 532 February 17, 2009

3.1.2Design

Each form must follow the design of the official form as to format arrangement, item cap-tion, line numbers, line references, and sequence.

3.1.3State TaxInformation Prohibited

Generally, state tax information must not appear on the federal tax return, associated form,or schedule that is filed with the IRS. Exceptions occur when amounts are claimed on, or re-quired by, the federal return (for example, state and local income taxes, on Schedule A of Form1040).

3.1.4Vertical Alignmentof Amount Fields

IF a form is to be... THEN...

1. The entry column must have a vertical line or sometype of indicator in the amount field to separate dollarsfrom cents.

Manually prepared

2. The cents column must be at least 3/10′ ′ wide.

1. Vertically align the amount entry fields where possible.

2. Use one of the following amount formats:

a) 0,000,000, or

Computer generated

b) 0,000,000.00.

1. You may remove the vertical line in the amount fieldthat separates dollars from cents.

2. Use one of the following amount formats:

a) 0,000,000, or

Computer prepared

b) 0,000,000.00.

3.1.5AttachmentSequence Number

Many individual income tax forms have a required “attachment sequence number” locatedjust below the year designation in the upper right corner of the form. The IRS uses this numberto indicate the order in which forms are to be attached to the tax return for processing. Someof the attachment sequence numbers may change from year to year.

The following applies to computer prepared forms.

• The sequence number may be printed in no less than 12-point boldface type and centeredbelow the form’s year designation.

• The sequence number may also be placed following the year designation for the tax formand separated with an asterisk.

• The actual number may be printed without labeling it the “Attachment Sequence Number.”

3.1.6Assembly of Forms

When developing software or forms for use by others, please inform your customers/clientsthat the order in which the forms are arranged may affect the processing of the package. Areturn must be arranged in the order indicated below.

February 17, 2009 533 2009–7 I.R.B.

IF the form is... THEN the sequence is...

1040 • Form 1040, and• Schedules and forms in attachment sequence number order.

Any other tax return(Form 1120, 1120S,1065, 1041, etc.)

• The tax returns,• Directly associated schedules (Schedule D, etc.),• Directly associated forms,• Additional schedules in alphabetical order, and• Additional forms in numerical order.

Supporting statements should then follow in the same sequence as the forms they support.Additional information required should be attached last.

In this way, the forms are received in the order in which they must be processed. If you donot send returns to the IRS in order, processing may be delayed.

3.1.7Paid Preparer’sInformation andSignature Area

On Forms 1040EZ, 1040A, 1040, and 1120, etc., the “Paid Preparer’s Use Only” area maynot be rearranged or relocated. You may, however, add three extra lines to the paid preparer’saddress area without prior approval. This applies to other tax forms as well.

3.1.8Some Common Reasonsfor Requiring Changes toSubstitute Forms

Some reasons that substitute form submissions may require changes include the following.

• Failing to preprint certain amounts in entry spaces.• Shading areas incorrectly.• Failing to include a reference to the location of the Paperwork Reduction Act Notice.• Not including parentheses for losses.• Not including “Attach Statement” when appropriate.• Including line references or entry spaces that don’t match the official form.• Printing text that is different from the official form.• Altering the jurat.

Section 3.2 – Paper

3.2.1Paper Content

The paper must be:

• Chemical wood writing paper that is equal to or better than the quality used for the officialform,

• At least 18 pound (17′ ′ x 22′ ′ , 500 sheets), or• At least 50 pound offset book (25′ ′ x 38′ ′ , 500 sheets).

3.2.2Paper withChemical TransferProperties

There are several kinds of paper prohibited for substitute forms. These are:

1. Carbon-bonded paper, and

2. Chemical transfer paper except when the following specifications are met:

2009–7 I.R.B. 534 February 17, 2009

a. Each ply within the chemical transfer set of forms must be labeled, and

b. Only the top ply (ply one and white in color), the one that contains chemicalon the back only (coated back), may be filed with the IRS.

3.2.3Example

A set containing three plies would be constructed as follows: ply one (coated back), “Fed-eral Return, File with IRS”; ply two (coated front and back), “Taxpayer’s copy”; and ply three(coated front), “Preparer’s copy.”

The file designation, “Federal Return, File with IRS” for ply one, must be printed in thebottom right margin (just below the last line of the form) in 12-point boldface type.

It is not mandatory, but recommended, that the file designation “Federal Return, File withIRS” be printed in a contrasting ink for visual emphasis.

3.2.4Carbon Paper

Do not attach any carbon paper to any return you file with the IRS.

3.2.5Paper and InkColor

It is preferred that the color and opacity of paper substantially duplicates that of the originalform. This means that your substitute must be printed in black ink and may be on white or onthe colored paper the IRS form is printed on. Forms 1040A and 1040 substitute reproductionsmay be in black ink without the colored shading. The only exception to this rule is Form1041-ES, which should always be printed with a very light gray shading in the color screenedarea. This is necessary to assist us in expeditiously separating this form from the very similarForm 1040-ES.

3.2.6Page Size

Substitute or reproduced forms and computer prepared/generated substitutes may be thesame size as the official form or they may be the standard commercial size (8 1/2′ ′ x 11′ ′ ). Thethickness of the stock cannot be less than .003 inches.

Section 3.3 – Printing

3.3.1Printing Medium

The private printing of all substitute tax forms must be by conventional printing processes,photocopying, computer graphics, or similar reproduction processes.

3.3.2Legibility

All forms must have a high standard of legibility as to printing, reproduction, and fill-inmatter. Entries of taxpayer data may be no smaller than eight points. The IRS reserves theright to reject those with poor legibility. The ink and printing method used must ensure that nopart of a form (including text, graphics, data entries, etc.) develops “smears” or similar qualitydeterioration. This standard must be followed for any subsequent copies or reproductions madefrom an approved master substitute form, either during preparation or during IRS processing.

February 17, 2009 535 2009–7 I.R.B.

3.3.3Type Font

Many federal tax forms are printed using “Helvetica” as the basic type font. It is preferredthat you use this type font when composing substitute forms.

3.3.4Print Spacing

Substitute forms should be printed using a 6 lines/inch vertical print option. They shouldalso be printed horizontally in 10 pitch pica (that is, 10 print characters per inch) or 12 pitchelite (that is, 12 print positions per inch).

3.3.5Image Size

The image size of a printed substitute form should be as close as possible to that of theofficial form. You may omit any text on both computer prepared and computer generated formsthat is solely instructional.

3.3.6Title Area Changes

To allow a large top margin for marginal printing and more lines per page, the title line(s)for all substitute forms (not including the form’s year designation and sequence number, whenpresent), may be photographically reduced by 40 percent or reset as one line of type. Whenreset as one line, the type size may be no smaller than 14-point. You may omit “Departmentof the Treasury, Internal Revenue Service” and all reference to instructions in the form’s titlearea.

3.3.7RemoveGovernment PrintingOffice Symbol and IRSCatalog Number

When privately printing substitute tax forms, the Government Printing Office (GPO) sym-bol and/or jacket number must be removed. In the same place using the same type size, printthe Employer Identification Number (EIN) of the printer or designer or the IRS assigned sourcecode. (We prefer this last number be printed in the lower left area of the first page of each form.)Also, remove the IRS Catalog Number (Cat. No.) and the recycle symbol if the substitute isnot produced on recycled paper.

3.3.8Printing on OneSide of Paper

While it is preferred that both sides of the paper be used for substitutes and reproducedforms, resulting in the same page arrangement as that of the official form or schedule, the IRSwill accept your forms if only one side of the paper is used.

3.3.9PhotocopyEquipment

The IRS does not undertake to approve or disapprove the specific equipment or processused in reproducing official forms. Photocopies of forms must be entirely legible and satisfythe conditions stated in this and other revenue procedures.

3.3.10Reproductions

Reproductions of official forms and substitute forms that do not meet the requirements ofthis revenue procedure may not be filed instead of the official forms. Illegible photocopies aresubject to being returned to the filer for re-submission of legible copies.

3.3.11Removal ofInstructions

Generally, you may remove references to instructions. No prior approval is needed. How-ever in some instances, you may be requested to include references to instructions.

2009–7 I.R.B. 536 February 17, 2009

Exception. The words “For Paperwork Reduction Act Notice, see instructions” must beretained or a similar statement indicating the location of the Notice must be provided on eachform.

Section 3.4 – Margins

3.4.1Margin Size

The format of a reproduced tax form when printed on the page must have margins on allsides at least as large as the margins on the official form. This allows room for IRS employeesto make necessary entries on the form during processing.

• A 1/2-inch to 1/4-inch margin must be maintained across the top, bottom, and both sides ofall substitute forms.

• The marginal, perforated strips containing pin-fed holes must be removed from all formsprior to filing with the IRS.

3.4.2Marginal Printing

Prior approval is not required for the marginal printing allowed when printed on an officialform or on a photocopy of an official form.

• With the exception of the actual tax forms (for example, Forms 1040, 1040A, 1040EZ,1120, 940, 941, etc.), you may print in the left vertical margin and in the left half of thebottom margin.

• Printing is never allowed in the top right margin of the tax form (for example, Forms 1040,1040A, 1040EZ, 1120, 940, 941, etc.). The Service uses this area to imprint a DocumentLocator Number for each return. There are no exceptions to this requirement.

Section 3.5 – Examples of Approved Formats

3.5.1Examples ofApproved Formats Fromthe Exhibits

Two sets of exhibits (Exhibits A-1 and 2; B-1 and 2) at the end of this revenue procedureare examples of how these guidelines may be used. Vertical spacing is six (6) lines to the inch.A combination of upper-case and lower-case print font is acceptable in producing substituteforms.

The same logic may be applied to any IRS form that is normally reproducible as a substituteform, with the exception of the tax return forms as discussed elsewhere.

Note. These exhibits may be from a prior year and are not to be used as current substituteforms.

February 17, 2009 537 2009–7 I.R.B.

Section 3.6 – Miscellaneous Information for Substitute Forms

3.6.1Filing SubstituteForms

To be acceptable for filing, a substitute form must print out in a format that will allow thefiler to follow the same instructions as for filing official forms. These instructions are in thetaxpayer’s tax package or in the related form instructions. The form must be legible, must beon the appropriately sized paper, and must include a jurat where one appears on the publishedform.

3.6.2Caution to SoftwarePublishers

The IRS has received returns produced by software packages with approved output whereeither the form heading was altered or the lines were spaced irregularly. This produces anillegible or unrecognizable return or a return with the wrong number of pages. We realizethat many of these problems are caused by individual printer differences but they may delayinput of return data and, in some cases, generate correspondence to the taxpayer. Therefore,in the instructions to the purchasers of your product, both individual and professional, pleasestress that their returns will be processed more efficiently if they are properly formatted. Thisincludes:

• Having the correct form numbers and titles at the top of the return, and• Submitting the same number of pages as if the form were an official IRS form with the line

items on the proper pages.

3.6.3Use Pre-AddressedIRS Label

If you are a practitioner filling out a return for a client or a software publisher who printsinstruction manuals, stress the use of the pre-addressed label provided in the tax package theIRS sent to the taxpayer, when available. The use of this label (or its precisely duplicated labelinformation) is extremely important for the efficient, accurate, and economical processing ofa taxpayer’s return. Labeled returns indicate that a taxpayer is an established filer and permitsthe IRS to automatically accelerate processing of those returns. This results in quicker refunds,less manual review by IRS functions, and greater accuracy in names, addresses, and postaldeliveries.

3.6.4Caution toProducers ofSoftware Packages

If you are producing a software package that generates name and address data onto the taxreturn, do not under any circumstances program either the IRS preprinted check digits or apractitioner derived name control to appear on any return prepared and filed with the IRS.

3.6.5Programmingto Print Forms

Whenever applicable:

• Use only the following label information format for single filers:JOHN Q. PUBLIC310 OAK DRIVEHOMETOWN, STATE 94000

• Use only the following information for joint filers:JOHN Q. PUBLICMARY I. PUBLIC310 OAK DRIVEHOMETOWN, STATE 94000

2009–7 I.R.B. 538 February 17, 2009

Part 4Additional Resources

Section 4.1 – Guidance From Other Revenue Procedures

4.1.1General

The IRS publications listed below provide guidance for substitute tax forms not coveredin this revenue procedure. These publications are available on the IRS website. Identify therequested document by the IRS publication number.

• Publication 1141, General Rules and Specifications for Substitute Forms W-2 and W-3.• Publication 1179, General Rules and Specifications for Substitute Forms 1096, 1098, 1099,

5498, W-2G, and 1042-S.• Publication 1187, Specifications for Filing Forms 1042-S, Foreign Person’s U.S. Source

Income Subject to Withholding, Electronically.• Publication 1220, Specifications for Filing Forms 1098, 1099, 5498, and W-2G Electroni-

cally.• Publication 1223, General Rules and Specifications for Substitute Forms W-2c and W-3c.• Publication 1239, Specifications for Filing Form 8027, Employer’s Annual Information

Return of Tip Income and Allocated Tips, Electronically.• Publication 1345, Handbook for Authorized IRS e-file Providers of Individual Income Tax

Returns.• Publication 1345-A, Filing Season Supplement for Authorized IRS e-file Providers.• Publication 4436, General Rules and Specifications for Substitute Form 941 and Schedule

B (Form 941).

Section 4.2 – Electronic Tax Products

4.2.1The IRS Website

Copies of tax forms with instructions, publications, draft forms, fillable forms, prior yearforms and publications, and other tax-related information may be found on the IRS website atwww.irs.gov.

4.2.2Tax ProductsPosting Schedule

The IRS website provides a Tax Products Posting Schedule for the official forms releasedfor use by taxpayers. The schedule has three parts.

• Anticipated print dates of annual returns.• Anticipated print dates of quarterly returns.• Last revision dates and target print dates for continuous-use forms.

The site address is www.irs.gov/formspubs/article/0,,id=103641,00.html. The site will beupdated weekly during peak printing periods and as necessary at other times. The planneddates are subject to change.

February 17, 2009 539 2009–7 I.R.B.

Section 4.3 – IRS Tax Products on DVD (Publication 1796)

4.3.1InformationAbout IRS TaxProducts DVD

The DVD contains approximately 2,700 tax forms and publications for small businesses,return preparers, and others who frequently need current or prior year tax products. Most cur-rent tax forms on the DVD may be filled in electronically, then printed out for submission andsaved for recordkeeping. Other products on the DVD include the Internal Revenue Bulletins,Tax Supplements, and Internet resources for the tax professional with links to the World WideWeb.

4.3.2SystemRequirements andHow To Order the IRS TaxProducts DVD

For system requirements, contact the National Technical Information Service (NTIS) athttp://www.ntis.gov. Prices are subject to change.

The cost of the DVD if purchased from NTIS via the Internet atwww.irs.gov/formspubs/article/0,,id=108660,00.html is $30 (with no handling fee).

If purchased using the following methods, the cost for each DVD is $30 (plus a $5 handlingfee). These methods are:

• By phone – 1-877-CDFORMS (1-877-233-6767),• By fax – 703-605-6900,• By mail to:

National Technical Information Service5285 Port Royal RoadSpringfield, VA 22161

Part 5Requirements for Specific Tax Returns

Section 5.1 – Tax Returns (Forms 1040, 1040A, 1120, etc.)

5.1.1Acceptable Forms

Tax forms (such as Forms 1040, 1040A, and 1120) require a signature and establish taxliability. Computer generated versions are acceptable under the following conditions.

• These substitute forms must be printed on plain white paper.• Substitute forms must conform to the physical layout of the corresponding IRS form al-

though the typeface may differ. The text should match the text on the officially publishedform as closely as possible. Condensed text and abbreviations will be considered on acase-by-case basis.Caution. All jurats (perjury statements) must be reproduced verbatim. No text can beadded, deleted, or changed in meaning.

• Various computer graphic print media such as laser printing, inkjet printing, etc., may beused to produce the substitute forms.

• The substitute form must be the same number of pages and contain the same line text asthe official form.

• All substitute forms must be submitted for approval prior to their original use. You do notneed approval for a substitute form if its only change is the preprinted year and you hadreceived a prior year approval letter.

2009–7 I.R.B. 540 February 17, 2009

Exception. If the approval letter specifies a one time exception for your form, the nextyear’s form must be approved.

5.1.2Prohibited Forms

The following are prohibited.

• Computer generated tax forms (for example, Form 1040, etc.) on lined or color barredpaper.

• Tax forms that differ from the official IRS forms in a manner that makes them non-standardor unable to process.

5.1.3ChangesPermitted to Forms1040 and 1040A

Certain changes (listed in Sections 5.2 through 5.4) are permitted to the graphics of the formwithout prior approval, but these changes apply to only acceptable preprinted forms. Changesnot requiring prior approval are good only for the annual filing period, which is the current taxyear. Such changes are valid in subsequent years only if the official form does not change.

5.1.4Other ChangesNot Listed

All changes not listed in Sections 5.2 through 5.4 require approval from the IRS before theform can be filed.

Section 5.2 – Changes Permitted to Graphics (Forms 1040A and 1040)

5.2.1Adjustments

You may make minor vertical and horizontal spacing adjustments to allow for computer orword processing printing. This includes widening the amount columns or tax entry areas if theadjustments comply with other provisions stated in revenue procedures. No prior approval isneeded for these changes.

5.2.2Name and Address Area

The horizontal rules and instructions within the name and address area may be removed andthe entire area left blank. No line or instruction can remain in the area. However, the statementregarding use of the IRS label should be retained. The heavy ruled border (when present) thatoutlines the name, address area, and social security number must not be removed, relocated,expanded, or contracted.

5.2.3Required Format

When the name and address area is left blank, the following format must be used whenprinting the taxpayer’s name and address. Otherwise, unless the taxpayer’s preprinted label isaffixed over the information entered in this area, the lines must be filled in as shown below.

• 1st name line (35 characters maximum).• 2nd name line (35 characters maximum).• In-care-of name line (35 characters maximum).• City, state (25 characters maximum), one blank character, and ZIP code.

February 17, 2009 541 2009–7 I.R.B.

5.2.4ConventionalName andAddress Data

When there is no in-care-of name line, the name and address will consist of only three lines(single filer) or four lines (joint filer). Name and address (joint filer) with no in-care-of nameline:

JOHN Z. JONESMARY I. JONES1234 ANYWHERE ST., APT. 111ANYTOWN, STATE 12321

5.2.5Example ofIn-Care-OfName Line

Name and address (single filer) with in-care-of name line:

JOHN Z. JONESC/O THOMAS A. JONES4311 SOMEWHERE AVE.SAMETOWN, STATE 54345

5.2.6SSN andEmployer IdentificationNumber (EIN) Area

The vertical lines separating the format arrangement of the SSN/EIN may be removed.When the vertical lines are removed, the SSN and EIN formats must be 000-00-0000 or00-0000000, respectively.

5.2.7Cents Column

• You may remove the vertical rule that separates the dollars from the cents.• All entries in the amount column should have a decimal point following the whole dollar

amounts whether or not the vertical line that separates the dollars from the cents is present.• You may omit printing the cents, but all amounts entered on the form must follow a con-

sistent format. You are strongly urged to round off the figures to whole dollar amounts,following the official form instructions.

• When several amounts are summed together, the total should be rounded off after addition(that is, individual amounts should not be rounded off for computation purposes).

• When printing money amounts, you must use one of the following formats:(a) 0,000,000.;(b) 0,000,000.00.

• When there is no entry for a line, leave the line blank.

5.2.8“Paid Preparer’sUse Only” Area

On all forms, the paid preparer’s information area may not be rearranged or relocated. Youmay add three lines and remove the horizontal rules in the preparer’s address area.

Section 5.3 – Changes Permitted to Form 1040A Graphics

5.3.1General

No prior approval is needed for the following changes (for use with computer preparedforms only).

2009–7 I.R.B. 542 February 17, 2009

5.3.2Line 4 ofForm 1040A

This line may be compressed horizontally (to allow for same line entry for the name of thequalifying child) by using the following caption: “Head of household; child’s name” (namefield).

5.3.3Other Lines

Any line with text that takes up two or more vertical lines may be compressed to one lineby using contractions, etc., and by removing instructional references.

5.3.4Page 2 ofForm 1040A

All lines must be present and numbered in the order shown on the official form. These linesmay also be compressed.

5.3.5Color Screening

It is not necessary to duplicate the color screening used on the official form. A substituteForm 1040A may be printed in black and white only with no color screening.

5.3.6Other ChangesProhibited

No other changes to the Form 1040A graphics are allowed without prior approval exceptfor the removal of instructions and references to instructions.

Section 5.4 – Changes Permitted to Form 1040 Graphics

5.4.1General

No prior approval is needed for the following changes (for use with computer preparedforms only). Specific line numbers in the following headings may have changed due to tax lawchanges.

5.4.2Line 4 ofForm 1040

This line may be compressed horizontally (to allow for a larger entry area for the name ofthe qualifying child) by using the following caption: “Head of household; child’s name” (namefield).

5.4.3Line 6c ofForm 1040

The vertical lines separating columns (1) through (4) may be removed. The captions maybe shortened to allow a one line caption for each column.

5.4.4Other Lines

Any other line with text that takes up two or more vertical lines may be compressed to oneline by using contractions, etc., and by removing instructional references.

February 17, 2009 543 2009–7 I.R.B.

5.4.5Line 21 – Other Income

The fill-in portion of this line may be expanded vertically to three lines. The amount entrybox must remain a single entry.

5.4.6Line 44 ofForm 1040 – Tax

You may change the line caption to read “Tax” and computer print the words “Total includestax from” and either “Form(s) 8814” or “Form 4972.” If both forms are used, print both formnumbers. This specific line number may have changed.

5.4.7Line 54 ofForm 1040 –Other Credits

You may change the caption to read: “Other credits from Form” and computer print onlythe form(s) that apply.

5.4.8Color Screening

It is not necessary to duplicate the color screening used on the official form. A substituteForm 1040 may be printed in black and white only with no color screening.

5.4.9Other ChangesProhibited

No other changes to the Form 1040 graphics are permitted without prior approval exceptfor the removal of instructions and references to instructions.

Part 6Format and Content of Substitute Returns

Section 6.1 – Acceptable Formats for Substitute Forms and Schedules

6.1.1Exhibits and Use of AcceptableFormats

Exhibits of acceptable formats for Schedule A, usually attached to the Form 1040, and Form2106-EZ are shown in the exhibits section of this revenue procedure.

• If your computer generated forms appear exactly like the exhibits, no prior authorizationis needed.

• You may computer generate forms not shown here, but you must design them by followingthe manner and style of those in the exhibits section.

• Take care to observe other requirements and conditions in this revenue procedure. The IRSencourages the submission of all proposed forms covered by this revenue procedure.

6.1.2Instructions

The format of each substitute form or schedule must follow the format of the official formor schedule as to item captions, line references, line numbers, sequence, form arrangementand format, etc. Basically, try to make the form look like the official one, with readability andconsistency being primary factors. You may use periods and/or other similar special charactersto separate the various parts and sections of the form. Do not use alpha or numeric charactersfor these purposes. All line numbers and items must be printed even though an amount is notentered on the line.

2009–7 I.R.B. 544 February 17, 2009

6.1.3Line Numbers

When a line on an official form is designated by a number or a letter, that designation (ref-erence code) must be used on a substitute form. The reference code must be printed to the leftof the text of each line and immediately preceding the data entry field, even if no referencecode precedes the data entry field on the official form. If an entry field contains multiple linesand shows the line references once on the left and right side of the form, use the same numberof line references on the substitute form.

In addition, the reference code that is immediately before the data field must either be fol-lowed by a period or enclosed in parentheses. There also must be at least two blank spacesbetween the period or the right parenthesis and the first digit of the data field. (See examplebelow.)

6.1.4Decimal Points

A decimal point (that is, a period) should be used for each money amount regardless ofwhether the amount is reported in dollars and cents or in whole dollars, or whether or not thevertical line that separates the dollars from the cents is present. The decimal points must bevertically aligned when possible.

Example:

5 STATE & LOCAL INC. TAXES............... 5. 495.006 REAL ESTATE TAXES............................ 6.7 PERSONAL PROPERTY TAXES............ 7. 198.00

or5 STATE & LOCAL INC. TAXES............... (5) 495.006 REAL ESTATE TAXES............................. (6)7 PERSONAL PROPERTY TAXES............. (7) 198.00

6.1.5Multi-Page Forms

When submitting a multi-page form, send all its pages in the same package.

Exception. If you will not be producing certain pages, please note that in your cover letter.

Section 6.2 – Additional Instructions for All Forms

6.2.1Use of YourOwn Internal ControlNumbers andIdentifying Symbols

You may show the computer prepared internal control numbers and identifying symbols onthe substitute if using such numbers or symbols is acceptable to the taxpayer and the taxpayer’srepresentative. Such information must not be printed in the top 1/2 inch clear area of any formor schedule requiring a signature. Except for the actual tax return form (Forms 1040, 1120,940, 941, etc.), you may print in the left vertical and bottom left margins. The bottom leftmargin you may use extends 31/2 inches from the left edge of the form.

6.2.2Descriptions forCaptions, Lines, etc.

Descriptions for captions, lines, etc., appearing on the substitute forms may be limited to oneprint line by using abbreviations and contractions, and by omitting articles, prepositions, etc.However, sufficient key words must be retained to permit ready identification of the caption,line, or item.

February 17, 2009 545 2009–7 I.R.B.

6.2.3DeterminingFinal Totals

Explanatory detail and/or intermediate calculations for determining final line totals maybe included on the substitute. We prefer that such calculations be submitted in the form of asupporting statement. If intermediate calculations are included on the substitute, the line onwhich they appear may not be numbered or lettered. Intermediate calculations may not beprinted in the right column. This column is reserved only for official numbered and letteredlines that correspond to the ones on the official form. Generally, you may choose the formatfor intermediate calculations or subtotals on supporting statements to be submitted.

6.2.4InstructionalText on the Official Form

Text on the official form, which is solely instructional (for example, “See instructions,”etc.), may generally be omitted from the substitute form.

6.2.5Mixing Formson the Same Page Prohibited

You may not show more than one form or schedule on the same printout page. Both sidesof the paper may be printed for multi-page official forms, but it is unacceptable to intermixsingle page schedules of forms except for Schedules A and B (Form 1040), which are printedback to back by the IRS.

For instance, Schedule E can be printed on both sides of the paper because the official formis multi-page, with page 2 continued on the back. However, do not print Schedule E on thefront page and Schedule SE on the back, or Schedule A on the front and Form 8615 on theback, etc. Both pages of a substitute form must match the official form. The back page maybe left blank if the back page of the official form contains only the instructions.

6.2.6IdentifyingSubstitutes

Identify all computer prepared substitutes clearly. Print the form designation 1/2 inch fromthe top margin and 11/2 inches from the left margin. Print the title centered on the first line ofprint. Print the taxable year and, where applicable, the sequence number on the same line 1/2

inch to 1 inch from the right margin. Include the taxpayer’s name and SSN on all forms andattachments. Also, print the OMB number as reflected on the official form.

6.2.7Negative Amounts

Negative (or loss) amount entries should be enclosed in brackets or parentheses or includea minus sign. This assists in accurate computation and input of form data. The IRS pre-printsparentheses in negative data fields on many official forms. These parentheses should be re-tained or inserted on printouts of affected substitute forms.

Part 7Miscellaneous Forms and Programs

Section 7.1 – Specifications for Substitute Schedules K-1

2009–7 I.R.B. 546 February 17, 2009

7.1.1Requirementsfor Schedules K-1 ThatAccompanyForms 1041, 1065, 1065-B,and 1120S

Because of significant changes to improve processing, prior approval is now required forsubstitute Schedules K-1 that accompany Form 1041 (for estates and trusts), Form 1065 (forpartnerships), Form 1065-B (for electing large partnerships), or Form 1120S (for S corpora-tions). Substitute Schedules K-1 should be as close as possible to exact replicas of copies ofthe official IRS schedules and follow the same process for submitting other substitute formsand schedules. Before releasing their substitute forms, software vendors are responsible formaking any subsequent changes that have been made to the final official IRS forms after thedraft forms have been posted.

You must include all information on the form. Submit Schedules K-1 to the IRSat Substituteforms@irs.gov with “Attn: PDF Submissions” on the subject line or at:

Internal Revenue ServiceAttn: Substitute Forms ProgramSE:W:CAR:MP:T:T:SP1111 Constitution Avenue, NWRoom 6526Washington, D.C. 20224

Include the 6-digit form ID code in the upper right of Schedules K-1 of Forms 1041, 1065,and 1120S.

• 661108 for Form 1041,

• 651108 for Form 1065, and

• 671108 for Form 1120S.Please allow white space around the 6-digit code.

Schedules K-1 that accompany Forms 1041, 1065, 1065-B, or 1120S must meet all specifi-cations. The specifications include, but are not limited to, the following requirements.

• You will no longer be able to produce Schedules K-1 that contain only those lines or boxesthat taxpayers are required to use. All lines must be included.

• The words “*See attached statement for additional information.” must be preprinted in thelower right hand side on Schedules K-1 of Forms 1041, 1065, and 1120S.

• All K-1s that are filed with the IRS should be printed on standard 8.5” x 11” paper (theinternational standard (A4) of 8.27” x 11.69” may be substituted).

• Each recipient’s information must be on a separate sheet of paper. Therefore, you mustseparate all continuously printed substitutes, by recipient, before filing with the IRS.

• No carbon copies or pressure-sensitive copies will be accepted.• The Schedule K-1 must contain the name, address, and SSN or EIN of both the entity (es-

tate, trust, partnership, or S corporation) and the recipient (beneficiary, partner, or share-holder).

• The Schedule K-1 must contain the tax year, the OMB number, the schedule number (K-1),the related form number (1041, 1065, 1065-B, or 1120S), and the official schedule namein substantially the same position and format as shown on the official IRS schedule.

• The Schedule K-1 must contain all the line items as shown on the official form, except forthe instructions, if any are printed on the back of the official Schedule K-1.

• The line items or boxes must be in the same order and arrangement as those on the officialform.

• The amount of each recipient’s share of each item must be shown. Furnishing a total amountof each item and a percentage (or decimal equivalent) to be applied to such total amountby the recipient does not satisfy the law and the specifications of this revenue procedure.

• State or local tax-related information may not be included on the Schedules K-1 filed withthe IRS.

• The entity may have to pay a penalty if substitute Schedules K-1 are filed that do not con-form to specifications.

February 17, 2009 547 2009–7 I.R.B.

• Additionally, the IRS may consider the Schedules K-1 that do not conform to specificationsas not being able to be processed and may return Forms 1041, 1065, 1065-B, or 1120S tothe filer to be filed correctly.

Schedules K-1 that are 2-D bar-coded will continue to require prior approval from the IRS(see Sections 7.1.3 through 7.1.5).

7.1.2Special Requirements forRecipient Copies ofSchedules K-1

Standardization for reporting information is required for recipient copies of substituteSchedules K-1 of Forms 1041, 1065, 1065-B, and 1120S. Uniform visual standards areprovided to increase compliance by allowing recipients and practitioners to more easilyrecognize a substitute Schedule K-1. The entity must furnish to each recipient a copy ofSchedule K-1 that meets the following requirements.

• Include the 6-digit form ID code in the upper right of Schedules K-1 of Forms 1041, 1065,and 1120S.• 661108 for Form 1041,• 651108 for Form 1065, and• 671108 for Form 1120S.Please allow white space around the 6-digit code.

• You will no longer be able to produce Schedules K-1 that contain only those lines or boxesthat taxpayers are required to use. All lines must be included.

• Both pages 1 and 2 of Schedules K-1 of Forms 1065 and 1120S must be provided to eachrecipient.

• The words “*See attached statement for additional information.” must be preprinted in thelower right hand side on Schedules K-1 of Forms 1041, 1065, and 1120S.

• The Schedule K-1 must contain the name, address, and SSN or EIN of both the entity andrecipient.

• The Schedule K-1 must contain the tax year, the OMB number, the schedule number (K-1),the related form number (1041, 1065, 1065-B, or 1120S), and the official schedule namein substantially the same position and format as shown on the official IRS schedule.

• All applicable amounts and information required to be reported must be titled and numberedin the same manner as shown on the official IRS schedule. The line items or boxes mustbe in the same order and arrangement and must be numbered like those on the official IRSschedule.

• The Schedule K-1 must contain all items required for use by the recipient. The instructionsto the schedule must identify the line or box number and code, if any, for each item asshown in the official IRS schedule.

• The amount of each recipient’s share of each item must be shown. Furnishing a total amountof each line item and a percentage (or decimal equivalent) to be applied to such total amountby the recipient does not satisfy the law and the specifications of this revenue procedure.

• Instructions to the recipient that are substantially similar to those on or accompanying theofficial IRS schedule must be provided to aid in the proper reporting of the items on therecipient’s income tax return. Where items are not reported to a recipient because they donot apply, the related instructions may be omitted.

• The quality of the ink or other material used to generate recipients’ schedules must produceclearly legible documents. In general, black chemical transfer inks are preferred.

• In order to assure uniformity of substitute Schedules K-1, the paper size should be standard8.5” x 11” (the international standard (A4) of 8.27” x 11.69” may be substituted.)

• The paper weight, paper color, font type, font size, font color, and page layout must be suchthat the average recipient can easily decipher the information on each page.

• State or local tax-related information may be included on recipient copies of substituteSchedules K-1. All non-tax-related information should be separated from the tax informa-tion on the substitute schedule to avoid confusion for the recipient.

• The legend “Important Tax Return Document Enclosed” must appear in a bold and con-spicuous manner on the outside of the envelope that contains the substitute recipient copyof Schedule K-1.

2009–7 I.R.B. 548 February 17, 2009

• The entity may have to pay a penalty if a substitute Schedule K-1 furnished to any recipientdoes not conform to the specifications of this revenue procedure and results in impedingprocessing.

7.1.3Requirementsfor Schedules K-1with Two-Dimensional(2-D) Bar Codes

In an effort to reduce the burden of manually transcribing tax documents, improve qual-ity, and increase government efficiency, the IRS is pleased to provide specifications for 2-Dbar-coded substitute Schedules K-1 for Forms 1041, 1065, and 1120S. The IRS encouragesvoluntary participation in adding 2-D barcoding.

Note. If software vendors do not want to produce bar-coded Schedules K-1, they mayproduce the official IRS Schedules K-1 but cannot use the expedited process for approvingbar-coded K-1s and their parent returns as outlined in Section 7.1.6.

In addition to the requirements in Sections 7.1.1 and 7.1.2, the bar-coded Schedules K-1must meet the following specifications.

• The bar code should print in the space labeled “For IRS Use Only” on each Schedule K-1.The entire bar code must print within the “For IRS Use Only” box surrounded by a whitespace of at least 1/4 inch.

• Bar codes must print in PDF 417 format.• The bar codes must always be in the specified format with every field represented by at

least a field delimiter (carriage return). Leaving out a field in a bar code will cause everysubsequent field to be misread.

• Be sure to include the 6-digit form ID code in the upper right of Schedules K-1 of Forms1041, 1065, and 1120S.

• 661108 for Form 1041,

• 651108 for Form 1065, and

• 671108 for Form 1120S.Please allow white space around the 6-digit code.

7.1.42-D Bar CodeSpecifications for Schedules K-1

Follow these general specifications for preparing all 2-D bar-coded Schedules K-1.

• Numeric fields –

• Do not include leading zeros (except Taxpayer Identification Numbers, Zip Codes, andpercentages).

• Do not use non-numeric characters except that the literal “STMT” can be put in moneyfields.

• All money fields should be rounded to the nearest whole dollar amount – If a moneyamount ends in 00 to 49 cents, drop the cents; if it ends in 50 to 99 cents, truncate thecents and increment the dollar amount by one. Use the same rounding technique forthe bar-coded and the printed K-1s.

• All numeric-only fields are right justified (except Taxpayer Identification Numbers andZip Codes).

• All field lengths are expressed as maximum lengths. If the value in the field has fewerpositions or the software program does not support that many positions, put in the bar codeonly those positions actually used.

• Alpha fields –

• Do not include leading blanks (left justified).

• Do not include trailing blanks.

February 17, 2009 549 2009–7 I.R.B.

• Use uppercase alpha characters only.• Variable fields –

• Do not include leading blanks (left justified).

• Do not include trailing blanks.

• Use uppercase alpha characters, numerics, and special characters as defined in eachfield.

• Delimit each field with a carriage return.• Express percentages as 6-digit numbers without the percent sign. Left justify with leading

zeroes (for percentages less than 100%) and no decimal point (decimal point is assumed be-tween 3rd and 4th positions). Examples: 25.32% expressed as “025320”; 105% expressedas “105000”; 8.275% expressed as “008275”; 10.24674% express as “010247”.

• It is vital that the print routine reinitialize the bar code prior to printing each succeedingK-1. Failure to do this will result in each K-1 for a parent return having the same bar codeas the document before it.

7.1.5ApprovalProcess forBar-Coded Schedules K-1

Prior to releasing commercially available tax software that creates bar-coded Schedules K-1,the printed schedule and the bar code must both be tested. Bar code testing must be doneusing the final official IRS Schedule K-1. Bar code approval requests must be resubmitted forany subsequent changes to the official IRS form that would affect the bar code. Below areinstructions and a sequence of events that will comprise the testing process.

• The IRS has released the final Schedule K-1 bar-code specifications by publishing themon the IRS.gov website (see http://www.irs.gov/efile/article/0,,id=129860,00.html).

• The IRS will publish a set of test documents that will be used to test the ability of taxpreparation software to create bar codes in the correct format.

• Software developers will submit two identical copies of the test documents – one to theIRS and one to a contracted testing vendor.

• The IRS will use one set to ensure the printed schedules comply with standard substituteforms specifications.

• If the printed forms fail to meet the substitute form criteria, the IRS will inform the softwaredeveloper of the reason for noncompliance.

• The software developer must resubmit the Schedule(s) K-1 until they pass the substituteforms criteria.

• The testing vendor will review the bar codes to ensure they meet the published bar-codespecifications.

• If the bar code(s) does not meet published specifications, the testing vendor will contactthe software developer directly informing them of the reason for noncompliance.

• Software developers must submit new bar-coded schedules until they pass the bar-codetest.

• When the bar code passes, the testing vendor will inform the IRS that the developer haspassed the bar-code test and the IRS will issue an overall approval for both the substituteform and the bar code.

• After receiving this consolidated response, the software vendor is free to release softwarefor tax preparation as long as any subsequent revisions to the schedules do not change thefields.

• Find the mailing address for the testing vendor below. Separate and simultaneous mailingsto the IRS and the vendor will reduce testing time.

7.1.6Proceduresfor Reducing Testing Time

In order to help provide incentives to the software development community to participatein the Schedule K-1 2-D project, the IRS has committed to expediting the testing of bar-codedSchedules K-1 and their associated parent returns. To receive this expedited service, followthe instructions below.

2009–7 I.R.B. 550 February 17, 2009

• Mail the parent returns (Forms 1065, 1120S, 1041) and associated bar-coded Schedule(s)K-1 to the appropriate address below in a separate package from all other approval requests.

Internal Revenue ServiceAttn: Bar-Coded K-1SE:W:CAR:MP:T:T:SP1111 Constitution Avenue, NWRoom 6526Washington, D.C. 20224

• Mail one copy of the parent form(s) and Schedule(s) K-1 to the IRS and another copy tothe testing vendor at the address below.

Northrop Grumman Information TechAttn: Cecilia Siamundo, Quality Assurance Lead1800 Alexander Bell DriveSuite 300Reston, VA 20191Phone: 703-453-1200

• Include multiple email and phone contact points in the packages.• While the IRS can expedite bar-coded Schedules K-1 and their associated parent returns,

it cannot expedite the approval of non-associated tax returns.

Section 7.2 – Procedures for Printing IRS Envelopes

7.2.1Procedures for Printing IRSEnvelopes

Organizations are permitted to produce substitute tax return envelopes. Use of substitutereturn envelopes that comply with the requirements set forth in this section will assist in de-livery of mail by the U.S. Postal Service and facilitate internal sorting at the Internal RevenueService Centers.

Use the following 5-digit ZIP codes when mailing returns to the IRS Service Centers:

Service Center ZIP Code

Atlanta, GA 39901

Kansas City, MO 64999

Austin, TX 73301

Philadelphia, PA 19255

Memphis, TN 37501

Andover, MA 05501

Cincinnati, OH 45999

Ogden, UT 84201

Fresno, CA 93888

February 17, 2009 551 2009–7 I.R.B.

7.2.2Sorting Returnsby Form Type

Sorting returns by form type is accomplished by the preprinted bar codes on return envelopesincluded in each specific type of form or package mailed to the taxpayers. The 32-bit bar codeon the left of the address on each envelope identifies the type of form the taxpayer is filing, andit assists in consolidating like returns for processing. Failure to use the envelopes furnished bythe IRS results in additional processing time and effort, and possibly delays the timely depositof funds, processing of returns, and issuance of refund checks.

7.2.3ZIP+4 or 9-DigitZIP Codes

The IRS will not furnish or sell bulk quantities of preprinted tax return envelopes to tax-payers or tax practitioners. A suitable alternative has been developed that will accommodatethe sorting needs of both the IRS and the United States Postal Service (USPS). The alternativeis based on the use of ZIP+4, or 9-digit ZIP codes, for mailing various types of tax returns tothe IRS Service Centers. The IRS uses the last four digits to identify and sort the various formtypes into separate groups for processing. The list of 4-digit extensions with the related formdesignations is provided below.

ZIP+4 Package

XXXXX-0002 1040

XXXXX-0005 941

XXXXX-0006 940

XXXXX-0008 943

XXXXX-0011 1065

XXXXX-0012 1120

XXXXX-0013 1120S

XXXXX-0014 1040EZ

XXXXX-0015 1040A

XXXXX-0027 990

XXXXX-0031 2290

7.2.4Guidelines forHaving Envelopes Preprinted

You may use the preparers’ company names, addresses, and logos as long as you do notinterfere with the clear areas. The government recommends that the envelope stocks have anaverage opacity of not less than 89 percent and contain a minimum of 50 percent waste paper.Use of carbon based ink is essential for effective address and bar-code reading. Envelopeconstruction can be of side seam or diagonal seam design. The government recommends thatthe size of the envelope should be 53/4 inches by 9 inches. Continuous pin-fed constructionis not desirable, but is permissible, if the glued edge is at the top. This requirement is firmbecause mail opening equipment is designed to open the bottom edge of each envelope.

2009–7 I.R.B. 552 February 17, 2009

7.2.5Envelopes/ZIPCodes

The above procedures or guidelines are written for the user having envelopes preprinted.Many practitioners may not wish to have large quantities of envelopes with differing ZIPcodes/form designations preprinted due to low volume, warehousing, waste, etc. In this case,the practitioner can type or machine print the addresses with the appropriate ZIP codes to ac-commodate sorting. If the requirements/guidelines outlined in this section cannot be met, thenuse only the appropriate 5-digit service center ZIP code.

Section 7.3 – Guidelines for Substitute Forms 8655

7.3.1Increased Standardization forForms 8655

Increased standardization for reporting information on substitute Forms 8655 is now re-quired to aid in processing and for compliance purposes. Please follow the guidelines in Sec-tion 7.3.2.

7.3.2Requirements for SubstituteForms 8655

Please follow these specific requirements when producing substitute Forms 8655.

• The first line of the title must be “Reporting Agent Authorization.”

• If you want to include a reference to “State Limited Power of Attorney,” it can be in paren-theses under the title. “State” must be the first word within the parentheses.

• You must include “Form 8655” on the form.

• While the line numbers do not have to match the official form, the sequence of the infor-mation must be in the same order.

• The size of any variable data must be printed in a font no smaller than 10-point.

• For adequate disclosure checks, the following must be included for each taxpayer:(a) Name,(b) EIN, and(c) Address.

• At this time, Form 944 will not be required if Form 941 is checked. Only those forms thatthe reporting agent company supports need to be listed.

• The jurat (perjury statement) must be identical with the exception of references to linenumbers.

• A contact name and number for the reporting agent is not required.

• You must include line 17, or the equivalent line, and it must include two checkboxes.

• Any state information included should be contained in a separate section of the substituteform. Preferably this information will be in the same area as line 19 of the official form.

• All substitute Forms 8655 must be approved by the Substitute Forms Unit as outlined inthe Form 8655 specifications in Publication 1167.

• If you have not already been assigned a 3-letter source code, you will be given one whenyour substitute form is submitted for approval. This source code should be included in thelower left corner of the form.

• The 20-day assumed approval policy does not apply to Form 8655 approvals.

February 17, 2009 553 2009–7 I.R.B.

Part 8Alternative Methods of Filing

Section 8.1 – Forms for Electronically Filed Returns

8.1.1Electronic FilingProgram

Electronic filing is a method by which authorized providers transmit tax return informationto an IRS Service Center in the format of the official IRS forms. The IRS accepts both refundand balance due Form 1040, 1040A, 1040EZ, or 1040SS (PR) tax returns that are filed elec-tronically.

8.1.2Applying toParticipate in IRS e-file

Anyone wishing to participate in IRS e-file of tax returns must submit an e-file applica-tion. The application can be completed and submitted electronically on the IRS website atwww.irs.gov after first registering for e-services on the website.

8.1.3Obtaining theTaxpayer Signature / Submissionof Required Paper Documents

Beginning in January 2009, Form 8453-OL, U.S. Individual Income Tax Declaration foran IRS e-file Online Return, is obsolete and can no longer be used as an IRS e-file signaturedocument. Taxpayers choosing to electronically prepare and file their return will be requiredto use the Self-Select PIN method as their signature.

Electronic Return Originators (EROs) can e-file individual income tax returns only if thereturns are signed electronically using either the Self-Select or Practitioner PIN method.

Taxpayers must use Form 8453, U.S. Individual Income Tax Transmittal for an IRS e-fileReturn, to send supporting documents that are required to be submitted to the IRS.

For specific information about electronic filing, refer to Publication 1345, Handbook forAuthorized IRS e-file Providers of Individual Income Tax Returns.

8.1.4Guidelines forPreparing Substitute Forms in theElectronic Filing Program

A participant in the electronic filing program, who wants to develop a substitute form shouldfollow the guidelines throughout this publication and send a sample form for approval to theSubstitute Forms Unit at the address in Part 1. If you do not prepare Substitute Form 8453using a font in which all IRS wording fits on a single page, the form will not be accepted.

Note. Use of unapproved forms could result in suspension of the participant from the elec-tronic filing program.

Section 8.2 – Effect on Other Documents

8.2.1Effect on OtherDocuments

This revenue procedure supersedes Revenue Procedure 2007-68, 2007-49 I.R.B. 1093.

2009–7 I.R.B. 554 February 17, 2009

February 17, 2009 555 2009–7 I.R.B.

2009–7 I.R.B. 556 February 17, 2009

February 17, 2009 557 2009–7 I.R.B.

2009–7 I.R.B. 558 February 17, 2009

February 17, 2009 559 2009–7 I.R.B.

2009–7 I.R.B. 560 February 17, 2009

Part IV. Items of General InterestNotice of ProposedRulemaking byCross-Reference toTemporary Regulations,Notice of ProposedRulemaking, and Noticeof Public Hearing

Section 482: Methods toDetermine Taxable Incomein Connection With a CostSharing Arrangement

REG–144615–02

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemakingby cross-reference to temporary regula-tions, notice of proposed rulemaking, andnotice of public hearing.

SUMMARY: In this issue of the Bulletin,the IRS is issuing temporary regulationsthat provide further guidance and clarifica-tion regarding methods under section 482to determine taxable income in connectionwith a cost sharing arrangement in order toaddress issues that have arisen in adminis-tering the current regulations. These tem-porary regulations potentially affect con-trolled taxpayers within the meaning ofsection 482 that enter into cost sharing ar-rangements as defined therein. The textof those temporary regulations (T.D. 9441)also serves as the text of these proposedregulations. This document also providesnotice of a public hearing on those pro-posed regulations.

DATES: Written or electronic commentsmust be received by April 6, 2009. Out-line of topics to be discussed at the publichearing scheduled for April 21, 2009 mustbe received by April 6, 2009.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–144615–02),Room 5203, Internal Revenue Service,PO Box 7604, Ben Franklin Station,Washington, DC 20044. Submissions maybe hand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.

to CC:PA:LPD:PR (REG–144615–02),Courier’s Desk, Internal RevenueService, 1111 Constitution Avenue, N.W.,Washington DC, or sent electronically,via the Federal eRulemakingPortal at www.regulations.gov (IRSREG–144615–02).

FOR FURTHER INFORMATIONCONTACT: Concerning the proposedregulations, Kenneth P. Christman, (202)435–5265; concerning submissions ofcomments, the hearing, and/or to be placedon the building access list to attend thehearings, Oluwafunmilayo Taylor, (202)622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in this notice of proposed rulemak-ing have been submitted to the Office ofManagement and Budget.

An agency may not conduct or sponsor,and a person is not required to respondto, a collection of information unless thecollection of information displays a validcontrol number assigned by the Office ofManagement and Budget.

The collection of information require-ments are in proposed §1.482–7(b)(2) and(k). Responses to the collections of infor-mation are required by the IRS to monitorcompliance of controlled taxpayers withthe provisions applicable to cost sharingarrangements.

Estimated total annual reporting and/orrecordkeeping burden: 9350 hours.

Estimated average annual burden hoursper respondent and/or recordkeeper: 18.7hours.

Estimated number of respondentsand/or recordkeepers: 500.

Estimated frequency of responses: OnOccasion and Annually.

Comments on the collection of infor-mation should be sent to the Office ofManagement and Budget, Attn: DeskOfficer for the Department of the Trea-sury, Office of Information and RegulatoryAffairs, Washington, DC 20503, withcopies to the Internal Revenue Service,Attn: IRS Reports Clearance Officer,SE:W:CAR:MP:T:T:SP, Washington, DC

20224. Comments on the collection ofinformation should be received by March6, 2009.

Comments are specifically requestedconcerning:

Whether the proposed collection of in-formation is necessary for the proper per-formance of the functions of the IRS, in-cluding whether the information will havepractical utility;

The accuracy of the estimated burdenassociated with the proposed collection ofinformation (see above);

How the burden of complying with theproposed collection of information may beminimized, including through the appli-cation of automated collection techniquesor other forms of information-technology;and

Estimates of capital or start-up costsand costs of operation, maintenance, andpurchase of services to provide informa-tion.

Books or records relating to a collectionof information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as requiredby 26 U.S.C. 6103.

Background and Explanation ofProvisions

Temporary regulations in this issue ofthe Bulletin amend the Income Tax Regu-lations (26 CFR part 1) relating to section482. The temporary regulations provideguidance regarding methods under section482 to determine taxable income in con-nection with a cost sharing arrangement.These temporary regulations potentiallyaffect controlled taxpayers within themeaning of section 482 that enter into costsharing arrangements as defined therein.The text of those temporary regulationsalso serves as the text of these proposedregulations. The preamble to the tempo-rary regulations explains the amendments.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-

February 17, 2009 561 2009–7 I.R.B.

sessment is not required. It has been deter-mined also that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulations.It is hereby certified that the collections ofinformation in these regulations will nothave a significant economic impact on asubstantial number of small entities. Thiscertification is based on the fact that thisrule applies to U.S. businesses and for-eign affiliates that enter into cost sharingarrangements. Few small entities are ex-pected to enter into cost sharing arrange-ments, as defined by these regulations. Ac-cordingly, a Regulatory Flexibility Anal-ysis under the Regulatory Flexibility Act(5 U.S.C. chapter 6) is not required. Pur-suant to section 7805(f), this notice of pro-posed rulemaking will be submitted to theChief Counsel for Advocacy of the SmallBusiness Administration for comment onits impact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(a signed original and eight (8) copies)or electronic comments that are submittedtimely to the IRS. The IRS and the Trea-sury Department specifically request com-ments on the clarity of the proposed ruleand how it may be made easier to under-stand. All comments will be available forpublic inspection and copying.

A public hearing has been scheduled forApril 21, 2009, beginning at 10 AM in theIRS Auditorium, Internal Revenue Build-ing, 1111 Constitution Avenue, NW, Wash-ington, DC. Due to building security pro-cedures, visitors must enter at the Consti-tution Avenue entrance. In addition, allvisitors must present photo identificationto enter the building. Because of accessrestrictions, visitors will not be admittedbeyond the immediate entrance area morethan 30 minutes before the hearing starts.For information about having your nameplaced on the building access list to attendthe hearing, see the “FOR FURTHER IN-FORMATION CONTACT” section of thispreamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit written comments by April 6, 2009and an outline of the topics to be discussed

and the time to be devoted to each topic(signed original and eight (8) copies) byApril 6, 2009. A period of 10 minutes willbe allotted to each person for making com-ments. An agenda showing the scheduleof the speakers will be prepared after thedeadline for receiving outlines has passed.Copies of the agenda will be available freeof charge at the hearing.

Drafting Information

The principal author of these proposedregulations is Kenneth P. Christman of theOffice of Chief Counsel (International).However, other personnel from the Trea-sury Department and the IRS participatedin their development.

* * * * *

Proposed Amendment to theRegulations

Accordingly, 26 CFR parts 1 and 301are proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.367(a)–1 is revised to

read as follows:

§1.367(a)–1 Transfers to foreigncorporations subject to section 367(a):In general.

(a) through (d)(2) [Reserved].(3) Transfer. For purposes of section

367 and regulations thereunder, the termtransfer means any transaction that con-stitutes a transfer for purposes of section332, 351,354,355, 356, or 361, as applica-ble. A person’s entering into a cost shar-ing arrangement under §1.482–7 or acquir-ing rights to intangible property under suchan arrangement shall not be considered atransfer of property described in section367(a)(1). See §1.6038B–1T(b)(4) for thedate on which the transfer is considered tobe made.

(d)(4) through (g) [Reserved].Par. 3. Section 1.482–0 is

amended by revising the entries for§§1.482–1(b)(2)(iii), 1.482–2(e) and (f),1.482–4(g) and (h), 1.482–7, and 1.482–9to read as follows:

§1.482–0 Outline of regulations undersection 482.

* * * * *

§1.482–1 Allocation of income anddeductions among taxpayers.

* * * * *(b) * * *(2)* * *(iii) Coordination of methods applica-

ble to certain intangible development ar-rangements.

§1.482–2 Determination of taxableincome in specific situations.

* * * * *(e) Cost sharing arrangement.(f) Effective/applicability date.(1) In general.(2) Election to apply paragraph (b) to

earlier taxable years.

§1.482–4 Methods to determine taxableincome in connection with a transfer ofintangible property

* * * * *(g) Coordination with rules governing

cost sharing arrangements.(h) Effective/applicability date.(1) In general.(2) Election to apply regulation to ear-

lier taxable years.

* * * * *

§1.482–7 Methods to determine taxableincome in connection with a cost sharingarrangement.

[The text of the proposed entries for§1.482–7 is the same as the entries for§1.482–7T in §1.482–0T published else-where in this issue of the Bulletin].

* * * * *

§1.482–9 Methods to determine taxableincome in connection with a controlledservices transaction.

* * * * *(a) through (m)(2) [Reserved].(3) [The text of the proposed entry for

§1.482–9(m)(3) is the same as the entry for§1.482–9T(m)(3) in §1.482–0T publishedelsewhere in this issue of the Bulletin].

(m)(4) through (n)(3) [Reserved].Par. 4. Section 1.482–1 is amended by:

2009–7 I.R.B. 562 February 17, 2009

1. Revising paragraph (b)(2)(i) and thelast sentence of paragraph (j)(6)(i).

2. Adding a new paragraph (b)(2)(iii).The addition and revisions read as fol-

lows:

§1.482–1 Allocation of income anddeductions among taxpayers.

* * * * *(b) * * *(2) * * *(i) [The text of the proposed amend-

ment to §1.482–1(b)(2)(i) is the same asthe text of §1.482–1T(b)(2)(i) publishedelsewhere in this issue of the Bulletin].

* * * * *(iii) [The text of the proposed

§1.482–1(b)(2)(iii) is the same as the textof §1.482–1T(b)(2)(iii) published else-where in this issue of the Bulletin].

* * * * *(j) * * *(6) * * *(i) * * * [The text of the proposed

amendment to §1.482–1(j)(6)(i) is thesame as the text of the amendment to§1.482–1T(j)(6)(i) published elsewhere inthis issue of the Bulletin].

Par. 5. Section 1.482–2 is amended asfollows:

1. Paragraph (e) is redesignated as para-graph (f) and newly-designated paragraphs(f)(1) and (f)(2) are revised.

2. New paragraph (e) is added.The addition and revision reads as fol-

lows:

§1.482–2 Determination of taxableincome in specific situations.

* * * * *(e) [The text of proposed §1.482–2(e)

is the same as the text of §1.482–2T(e)

published elsewhere in this issue of theBulletin].

(f) * * * (1) [The text of the proposedamendment to §1.482–2(f)(1) is the sameas the text of §1.482–2T(f)(1) publishedelsewhere in this issue of the Bulletin].

(2) [The text of the proposed amend-ment to §1.482–2(f)(2) is the same as thetext of §1.482–2T(f)(2) published else-where in this issue of the Bulletin].

* * * * *Par. 6. Section 1.482–4 is amended as

follows:1. Paragraph (f)(3)(i)(B) is revised.2. Paragraph (f)(7) is removed.3. New paragraphs (g) and (h) are

added.The additions and revision reads as fol-

lows:

§1.482–4 Methods to determine taxableincome in connection with a transfer ofintangible property.

* * * * *(f) * * *(3) * * *(i) * * *(B) [The text of the proposed amend-

ment to §1.482–4(f)(3)(i)(B) is the sameas the text of §1.482–4T(f)(3)(i)(B) pub-lished elsewhere in this issue of the Bul-letin].

* * * * *(g) [The text of proposed §1.482–4(g)

is the same as the text of §1.482–4T(g)published elsewhere in this issue of theBulletin].

(h) [The text of proposed §1.482–4(h)is the same as the text of §1.482–4T(h)published elsewhere in this issue of theBulletin].

Par. 7. Section 1.482–7 is revised toread as follows:

§1.482–7 Methods to determine taxableincome in connection with a cost sharingarrangement.

[The text of the proposed §1.482–7is the same as the text of §1.482–7T(a)through (m) published elsewhere in thisissue of the Bulletin].

Par. 8. Section 1.482–8 is amended byrevising paragraph (b) Examples 13, 14,15, 16, 17 and 18 to read as follows:

§1.482–8 Examples of the best methodrule.

* * * * *(b) * * *Examples 13 through 18. [The text

of the proposed §1.482–8(b) Examples13 through 18 is the same as the text of§1.482–8T(b) Examples 13 through 18published elsewhere in this issue of theBulletin].

* * * * *Par. 9. Section 1.482–9 is added to read

as follows:

§1.482–9 Methods to determine taxableincome in connection with a controlledservices transaction.

(a) through (m)(2) [Reserved].(3) [The text of the proposed amend-

ment to §1.482–9(m)(3) is the same as thetext of §1.482–9T(m)(3) published else-where in this issue of the Bulletin].

(m)(4) through (n)(3) [Reserved].

Linda E. Stiff,Deputy Commissioner forServices and Enforcement.

(Filed by the Office of the Federal Register on December 31,2008, 11:15 a.m., and published in the issue of the FederalRegister for January 5, 2009, 74 F.R. 236)

February 17, 2009 563 2009–7 I.R.B.

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe the ef-fect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more than re-state the substance and situation of a previ-ously published ruling (or rulings). Thus,the term is used to republish under the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome of casesin litigation, or the outcome of a Servicestudy.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.E.O.—Executive Order.

ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.

PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D. —Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z —Corporation.

2009–7 I.R.B. i February 17, 2009

Numerical Finding List1

Bulletins 2009–1 through 2009–7

Announcements:

2009-1, 2009-1 I.R.B. 242

2009-2, 2009-5 I.R.B. 424

2009-3, 2009-6 I.R.B. 459

Notices:

2009-1, 2009-2 I.R.B. 250

2009-2, 2009-4 I.R.B. 344

2009-3, 2009-2 I.R.B. 250

2009-4, 2009-2 I.R.B. 251

2009-5, 2009-3 I.R.B. 309

2009-6, 2009-3 I.R.B. 311

2009-7, 2009-3 I.R.B. 312

2009-8, 2009-4 I.R.B. 347

2009-9, 2009-5 I.R.B. 419

2009-10, 2009-5 I.R.B. 419

2009-11, 2009-5 I.R.B. 420

2009-12, 2009-6 I.R.B. 446

2009-13, 2009-6 I.R.B. 447

2009-14, 2009-7 I.R.B. 516

2009-15, 2009-6 I.R.B. 449

Proposed Regulations:

REG-144615-02, 2009-7 I.R.B. 561

REG-148568-04, 2009-5 I.R.B. 421

REG-160872-04, 2009-4 I.R.B. 358

REG-158747-06, 2009-4 I.R.B. 362

REG-150670-07, 2009-4 I.R.B. 378

REG-113462-08, 2009-4 I.R.B. 379

REG-150066-08, 2009-5 I.R.B. 423

Revenue Procedures:

2009-1, 2009-1 I.R.B. 1

2009-2, 2009-1 I.R.B. 87

2009-3, 2009-1 I.R.B. 107

2009-4, 2009-1 I.R.B. 118

2009-5, 2009-1 I.R.B. 161

2009-6, 2009-1 I.R.B. 189

2009-7, 2009-1 I.R.B. 226

2009-8, 2009-1 I.R.B. 229

2009-9, 2009-2 I.R.B. 256

2009-10, 2009-2 I.R.B. 267

2009-11, 2009-3 I.R.B. 313

2009-12, 2009-3 I.R.B. 321

2009-13, 2009-3 I.R.B. 323

2009-14, 2009-3 I.R.B. 324

2009-15, 2009-4 I.R.B. 356

2009-16, 2009-6 I.R.B. 449

2009-17, 2009-7 I.R.B. 517

Revenue Rulings:

2009-1, 2009-2 I.R.B. 248

Revenue Rulings— Continued:

2009-2, 2009-2 I.R.B. 245

2009-3, 2009-5 I.R.B. 382

2009-4, 2009-5 I.R.B. 408

2009-5, 2009-6 I.R.B. 432

Treasury Decisions:

9434, 2009-4 I.R.B. 339

9435, 2009-4 I.R.B. 333

9436, 2009-3 I.R.B. 268

9437, 2009-4 I.R.B. 341

9438, 2009-5 I.R.B. 387

9439, 2009-5 I.R.B. 416

9440, 2009-5 I.R.B. 409

9441, 2009-7 I.R.B. 460

9442, 2009-6 I.R.B. 434

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2008–27 through 2008–52 is in Internal Revenue Bulletin2008–52, dated December 29, 2008.

February 17, 2009 ii 2009–7 I.R.B.

Finding List of Current Actions onPreviously Published Items1

Bulletins 2009–1 through 2009–7

Notices:

99-35

Obsoleted by

Notice 2009-15, 2009-6 I.R.B. 449

2001-55

Modified by

Notice 2009-1, 2009-2 I.R.B. 250

2002-27

Modified by

Notice 2009-9, 2009-5 I.R.B. 419

2007-26

Modified by

Notice 2009-15, 2009-6 I.R.B. 449

2007-54

Obsoleted by

T.D. 9436, 2009-3 I.R.B. 268

2008-11

Obsoleted by

T.D. 9436, 2009-3 I.R.B. 268

2008-12

Obsoleted by

T.D. 9436, 2009-3 I.R.B. 268Rev. Proc. 2009-11, 2009-3 I.R.B. 313

2008-13

Obsoleted by

T.D. 9436, 2009-3 I.R.B. 268

List of forms modified and superseded by

Rev. Proc. 2009-11, 2009-3 I.R.B. 313

Modified and clarified by

Notice 2009-5, 2009-3 I.R.B. 309

2008-46

Obsoleted by

T.D. 9436, 2009-3 I.R.B. 268Rev. Proc. 2009-11, 2009-3 I.R.B. 313

2008-100

Amplified and superseded by

Notice 2009-14, 2009-7 I.R.B. 516

Revenue Procedures:

2007-17

Superseded by

Rev. Proc. 2009-14, 2009-3 I.R.B. 324

2007-68

Superseded by

Rev. Proc. 2009-17, 2009-7 I.R.B. 517

2007-71

Modified by

Notice 2009-3, 2009-2 I.R.B. 250

Revenue Procedures— Continued:

2008-1

Superseded by

Rev. Proc. 2009-1, 2009-1 I.R.B. 1

2008-2

Superseded by

Rev. Proc. 2009-2, 2009-1 I.R.B. 87

2008-3

Superseded by

Rev. Proc. 2009-3, 2009-1 I.R.B. 107

2008-4

Superseded by

Rev. Proc. 2009-4, 2009-1 I.R.B. 118

2008-5

Superseded by

Rev. Proc. 2009-5, 2009-1 I.R.B. 161

2008-6

Superseded by

Rev. Proc. 2009-6, 2009-1 I.R.B. 189

2008-7

Superseded by

Rev. Proc. 2009-7, 2009-1 I.R.B. 226

2008-8

Superseded by

Rev. Proc. 2009-8, 2009-1 I.R.B. 229

2008-9

Superseded by

Rev. Proc. 2009-9, 2009-2 I.R.B. 256

2008-61

Superseded by

Rev. Proc. 2009-3, 2009-1 I.R.B. 107

2008-65

Amplified and supplemented by

Rev. Proc. 2009-16, 2009-6 I.R.B. 449

2008-68

Amplified and superseded by

Rev. Proc. 2009-15, 2009-4 I.R.B. 356

Revenue Rulings:

65-286

Obsoleted by

T.D. 9435, 2009-4 I.R.B. 333

76-54

Obsoleted by

T.D. 9435, 2009-4 I.R.B. 333

92-19

Supplemented by

Rev. Rul. 2009-3, 2009-5 I.R.B. 382

2008-19

Modified by

Rev. Rul. 2009-3, 2009-5 I.R.B. 382

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2008–27 through 2008–52 is in Internal Revenue Bulletin 2008–52, dated December 29,2008.

2009–7 I.R.B. iii February 17, 2009

February 17, 2009 2009–7 I.R.B.

INTERNAL REVENUE BULLETINThe Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue

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