tax notes international - Tuck School of Business - Dartmouth College

SPECIAL REPORTS
The second exception is that the differential is due
to extraordinary events beyond the control of the controlled
participants that could not reasonably have been
anticipated as of the date of the trigger PCT.
The third exception is that the periodic trigger
would not have occurred had the PCT payer’s divisional
profits or losses used to calculate its present
value of total profits (PVTP) excluded those profits or
losses attributable to the PCT payer’s routine contributions
to its exploitation of the cost-shared intangibles,
attributable to its operating cost contributions, and attributable
to its nonroutine contributions to the CSA
activity.
In an important narrowing,
the temporary regulations
provide that a periodic
trigger occurs if the AERR
falls outside the PRRR of
between 0.667 and 1.5.
The fourth exception is that the periodic trigger
would not have occurred had the divisional profits or
losses of the PCT payer used to calculate its PVTP
included its reasonably anticipated divisional profits or
losses after the adjustment year from the CSA activity,
including its routine contributions, its operating cost
contributions, and its nonroutine contributions to that
activity, and had the cost contributions and PCT payments
of the PCT payer used to calculate its PVI
(present value of the PCT payer’s investment at the
start date) included its reasonably anticipated cost contributions
and PCT payments after the adjustment year.
Also, a periodic trigger will not be deemed to have
occurred in any year subsequent to the 10-year period
beginning with the first tax year in which there is substantial
exploitation of the cost-shared intangibles resulting
from the CSA, if the AERR is within the
PRRR for each year of the 10-year period. It also will
not be deemed to have occurred in any year of the
five-year period beginning with the first tax year in
which there is exploitation of the cost-shared intangibles
resulting from the CSA if the AERR falls below
the lower bound of the PRRR.
The IRS and Treasury intend to issue by revenue
procedure separate published guidance that provides an
exception to periodic adjustments in the context of an
advance pricing agreement. The guidance would provide
that no periodic adjustments will be made in any
year based on a trigger PCT that is a covered transaction
under the APA. An APA process generally is contemporaneous
with the taxpayer’s original transactions
and involves transparency concerning a taxpayer’s upfront
efforts to conform to the arm’s-length standard.
Treatment of Payments
CST payments generally will be considered the
payer’s cost of developing intangibles at the location
where the development is conducted. For these purposes,
IDCs borne directly by a controlled participant
that are deductible are deemed to be reduced to the
extent of any CST payments owed to it by other controlled
participants under the CSA.
The PCT payer’s payment is deemed to be reduced
to the extent of any payments owed to it from other
controlled participants. PCT payments will be characterized
consistently with the taxpayer’s designation of
the type of transaction. Depending on the designation,
the payments will be treated as either consideration for
a transfer of an interest in intangible property or for
services.
Administrative Requirements
Temp. Treas. reg. section 1.482-7T(k) contains the
CSA administrative requirements. There are four main
sections: contractual; documentation; accounting; and
reporting requirements. This section of the temporary
regulations is lengthy.
The contractual rules are important. CSA agreements
already in effect will need to be modified by
July 6, 2009, by integrating those rules with the transition
rules in temp. Treas. reg. section 1.482-7T(m). A
CSA statement also will need to be filed by September
2, 2009.
Documentation is especially important under the
temporary regulations. For example, careful analysis
and documentation of discount rate choices could be
very important. Also, the periodic adjustment trigger
range is narrower for taxpayers that fail to maintain
adequate documentation.
New Best Method Examples
Example 13. USP and FS enter into a CSA to develop
a new drug. Immediately before entering into the
CSA, USP acquires Company X. X is engaged in research
relevant to the product area, and its only significant
resources and capabilities are its workforce and
sole patent. The patent is associated with a compound
that USP reasonably anticipates will contribute to developing
the CSA product. The acquisition price
method, based on the lump sum price paid by USP for
Company X, is likely to provide a more reliable measure
of an arm’s-length result than any other method.
Example 14. Company X is a publicly traded U.S.
company engaged in pharmaceutical research. Its only
significant resources and capabilities are workforce and
its sole patent. Company X has no marketable products.
Company X enters into a CSA with FS, its newly
formed foreign subsidiary, to develop a new drug. The
new drug will be derived from the compound covered
468 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL
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