tax notes international - Tuck School of Business - Dartmouth College

y USP’s patent. All of Company X’s researchers will
be engaged solely in research that is related to developing
that product. Given that Company X’s platform
contributions covered by PCTs relate to its entire economic
value, application of the market capitalization
method provides a reliable measure of an arm’s-length
result.
Example 15 describes a U.S. company (MDI) that
developed a new dental surgical microscope that drastically
shortens many surgical procedures. MDI entered
into a CSA with a wholly owned foreign subsidiary to
develop the next generation of the product. The interests
are divided on a territorial basis. The rights associated
with the current product, as well as MDI’s research
capabilities, are reasonably expected to
contribute to the development of the next generation
product and are therefore platform contributions. At
the time of the PCT, MDI’s only product is the microscope,
although MDI was developing the next generation
microscope. Concurrent with the CSA, MDI separately
transfers exclusive and perpetual exploitation
rights associated with the existing product to FS in the
same territory as assigned to FS in the CSA. The example
states that it is likely to be more reliable to
evaluate the combined effect of the transactions than to
evaluate them in isolation. This is because the combined
transactions relate to all of the economic value
of MDI. The market capitalization method is likely to
produce a reliable measure of an arm’s-length payment
for the aggregated transactions.
Example 16 states the same facts as in Example 13,
except that the acquisition occurred significantly in advance
of the CSA and reliable adjustments cannot be
made for this time difference. Also, Company X has
other valuable molecular patents and associated research
capabilities, apart from Compound X, that are
not reasonably anticipated to contribute to the development
of the CSA product and that cannot be reliably
valued. The CSA divides divisional interests on a territorial
basis. Under the terms of the CSA, USP will
undertake all R&D and manufacturing as well as the
distribution activities for its territory (the United
States). FS will distribute the product in its territory
(the rest of the world). FS’s distribution activities are
routine in nature, and the profitability from its activities
may be reliably determined from third-party comparables.
FS does not furnish any platform intangibles.
At the time of the PCT, reliable financial projections
associated with development of the CSA product and
its separate exploitation in each of the markets are undertaken.
Application of the income method using CPM
is likely to provide a more reliable measure of an
arm’s-length result than application of the acquisition
price method.
Example 17 states the same facts as in Example 13,
except that the acquisition occurred some time before
the CSA, and Company X had some areas of promising
research that are not reasonably anticipated to con-
SPECIAL REPORTS
tribute to developing the CSA product. The CSA divides
divisional interests on a territorial basis. The
Service determines that the acquisition price stated is
useful in forming the arm’s-length price, but not necessarily
determinative. Under the terms of the CSA, USP
will undertake all R&D and manufacturing associated
with the product as well as distribution activity for its
territory (the United States). FS will distribute the CSA
product in its territory (the rest of the world). FS’s activities
are routine in nature, and the profitability from
its activities may be reliably determined from thirdparty
comparables. It is possible that the acquisition
price method or the income method using CPM might
reasonably be applied. Whether the acquisition price
method or the income method provides the most reliable
evidence of an arm’s-length price for USP’s contributions
depends on a number of factors, including
the reliability of the financial projections, the reliability
of the discount rate chosen, and the extent to which
the acquisition price of Company X could be reliably
adjusted to account for changes in value over the period
between the acquisition and the formation of the
CSA and to account for the value of the in-process
research work done by Company X that does not constitute
platform contributions to the CSA.
Example 18 states that the facts are the same in Example
17, except that FS has a patent on Compound
Y, which the parties reasonably anticipate will be useful
in mitigating potential side effects associated with
Compound X and could thereby contribute to the development
of the product. The rights in Compound Y
constitute a platform contribution for which compensation
is due from USP as a part of the PCT. The value
of FS’s platform contribution cannot be reliably measured
by market benchmarks. Under the facts, it is possible
that either the acquisition price or the income
method together or the residual profit-split method
might reasonably be applied to determine the arm’slength
PCT payment due between USP and FS. Under
the first option, the PCT payment for the platform contributions
related to Company X’s workforce, and
Compound X would be determined using the acquisition
price referring to the lump sum price paid by USP
for Company X. Because the value of these platform
contributions can be determined by reference to a market
benchmark, they are considered routine platform
contributions. Accordingly, the platform contribution
related to Compound Y would be the only nonroutine
platform contribution, and the relevant PCT payment
is determined using the income method. Alternatively,
rather than looking to the acquisition price for Company
X, all the platform contributions are considered
nonroutine and the residual profit-split method is applied
to determine the PCT payments for each platform
contribution. Under either option, the PCT payments
will be netted against each other.
Whether the acquisition price method together with
the income method or the residual profit-split method
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 469
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