Implied Discount rate - NABE

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The 2011 proposed regulations: differential incomestream• The 2011 proposed regulations carry the concept of the temporary regulationsfurther by proposing to use market evidence of discount rates directly in a newlyspecified application of the income method――Determine the PCT obligation as the present discounted value of the differentialincome stream using an appropriate discount rate directly determined usingmarket evidenceWACC for uncontrolled companies developing intangibles similar to the costshared intangibles is suggested as a basis to determine a discount rateappropriate for the differential income stream• Both the temporary and the proposed regulations are designed to provide specificguidance on the selection of different discount rates to prevent what the IRSperceives as inappropriate application of discount rate differentials to produceunderstated PCT values14
The “Implied Discount rate”: in practice• In practice, for a majority of cases it may be extremely difficult to observe directmarket evidence of the “implied discount rate”• An alternative is to derive the discount rate of the non-routine profit stream of thecost shared intangibles from the overall return.• Consider the equality: Operating profit = routine return + non-routine profit• Expressing in present value terms:NPV(Operating profit, R OI ) = NPV(routine return, R R ) + NPV(non-routine return, R NR )where,R OI = discount rate for operating profit (e.g., WACC)R R = discount rate for routine returnR NR = discount rate for non-routine profit• One approach to derive the discount rate of routine return may be to use the WACCsof routine comparables.• Re-arranging terms:NPV(non-routine return, R NR ) = NPV(Operating profit, R OI ) - NPV(routine return, R R )• Thus, implied discount rate for the non-routine profit stream may be derived as ratethat solves the above equality (through iteration)• It is still prudent to perform a sanity check to determine that the derived discount rateis reasonable given market evidence15
Page 2 and 3: NoticeANY TAX ADVICE IN THIS COMMUN
Page 4 and 5: Background• Discount rates reflec
Page 6: Risk vs. Expected ReturnThe least l
Page 9 and 10: Income Method• Under the income m
Page 11 and 12: Financial Projections and Discount
Page 13: The 2011 temporary regulations: dif
Page 17 and 18: 2011 Temporary Regulations - Exampl
Page 19 and 20: Forms of Payment and Discount Rates
Page 22: Discount rate of revenue stream - N

Implied Discount rate - NABE

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