tax notes international - Tuck School of Business - Dartmouth College

there are differences in market-correlated risks between
the two scenarios, different discount rates should be
used for the two scenarios. 4
Arm’s-Length Range
The temporary regulations provide guidance on the
use of arm’s-length ranges for some methods in computing
PCT payments. Some of the methods specified
in the temporary regulations (for example, the income
method) have a structure in which an arm’s-length result
is estimated by performing calculations that depend
on two or more impute parameters such as the
relevant discount rate, certain financial projections, and
a return for routine activities. The temporary regulations
address the arm’s-length range in the context of
these methods.
CUT Method
The proposed regulations provided for possible use
of the CUT method to determine the arm’s-length
charge in the PCT when appropriate in accordance
with the standards of the intangibles transfer and controlled
services provisions of the section 482 regulations.
Some commentators suggested that any arrangements
that uncontrolled parties may call a cost-sharing
arrangement should serve as a CUT, even though the
arrangement may involve materially different risk allocations
and provisions than addressed in the costsharing
rules.
The temporary regulations, in response, describe the
relevant considerations for purposes of evaluating
whether a potential CUT may reflect the most reliable
measure of an arm’s-length result. Although all of the
factors entering into a best method analysis must be
considered, comparability and reliability under the
CUT method in the CSA context are particularly dependent
on: similarity of contractual terms; degree to
which allocation of risks is proportional to reasonably
anticipated benefits from exploiting the results of intangible
development; similar period of commitment as
to the sharing of intangible development risks; and
similar scope, uncertainty, and profit potential of the
subject intangible development.
This includes a similar allocation of the risks of any
existing resources, capabilities, or rights, as well as of
the risks of developing other resources, capabilities, or
rights that would be reasonably anticipated to contrib-
4 At least, I think this is the conclusion in the example. The
concluding sentence of the analysis states that ‘‘the Commissioner
concludes that the differences in market-correlated risks
between the two scenarios, and therefore the differences in discount
rates between the two scenarios, relate to the differences in
these components of the financial projections.’’ Temp. Treas. reg.
section 1.482-7T(g)(2)(v), Example. Examples illustrating the income
method rules are clearer in illustrating the use of different
discount rates. Temp. Treas. reg. section 1.482-7T(g)(4)(vii), Examples
1-3.
SPECIAL REPORTS
ute to exploitation within the parties’ divisions that are
consistent with the actual allocation of risks between
the controlled participants.
Income Method
The proposed regulations made the income method
a specified method for purposes of evaluating the
arm’s-length charge in a PCT. The arm’s-length charge
was an amount that equated to a controlled participant’s
present value of entering into a CSA with the
present value of the controlled participant’s best realistic
alternative.
In one application, based on a CUT analysis, the
PCT payee’s best realistic alternative was assumed to
be to develop the cost-shared intangible on its own,
bearing all the intangible development costs (IDCs)
itself, and then to license the cost-shared intangibles. In
the second application, based on a comparable profits
method analysis, it was assumed that the PCT payer’s
best realistic alternative would be to acquire the rights
to external contributions (renamed platform contributions
under the temporary regulations) for payments
with a present value equal to the PCT payer’s anticipated
profit, after reward for its routine contributions
to its operations, from the CSA activity in its territory.
Both income method applications provided for a
cost contribution adjustment in order to allocate to the
PCT payer the return for its additional risk, as compared
to its realistic alternative, of bearing its RAB
share of the IDCs.
Commentators criticized the income method because
it strips away risk returns from the PCT payer.
Commentators pointed to the potential risk differentials
between cost sharing and the alternative arrangements.
Cost sharing would generally be more risky for the
PCT payer than licensing as a result of its sharing with
the PCT payee the risks of the IDA. Cost sharing, on
the other hand, would generally be less risky for the
PCT payee than licensing. Those comments observed
that these risk differentials would ordinarily be reflected
in different discount rates being appropriate under
the cost-sharing and licensing alternatives.
The temporary regulations in any event adopt the
income method but provide more guidance. In general,
they provide that the best realistic alternative of the
PCT payer to entering into the CSA would be to license
intangibles to be developed by an uncontrolled
licensor that undertakes the commitment to bear the
entire risk of intangible development that would otherwise
have been shared under the CSA. Similarly, the
best realistic alternative of the PCT payee to entering
into the CSA would be to undertake the commitment
to bear the entire risk of intangible development that
would otherwise have been shared under the CSA and
license the resulting intangibles to an uncontrolled licensee.
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 465
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