Contents - AL-Tax

176 12 Decentralized Ownership of Intellectual Propertyresidual profit split and CUT methods (applied to these facts previously), and theacquisition price method (which does not apply given the assumed facts).12.5.1 Income MethodUnder the income method, one would first establish the equivalent of an arm’s lengthroyalty rate for FS’ rights to use USP’s existing IT platform (and rights to potentialfuture improvements), either by application of the CUT method or an intertemporalvariant of the CPM. This rate is referred to as the “Alternative Rate”. Secondly,the Alternative Rate would be reduced by FS’ “Cost Contribution Adjustment” (ameans of reimbursing FS for its projected cost-sharing payments). The resultingpercentage, effectively a discounted royalty rate, would then be applied to FS’ actualrevenues (on an ongoing basis) to determine its per-period buy-in payment. As discussedin Chapter 3, under the income method, FS would be treated as the licenseeof both (a) USP’s pre-existing IT platform, and (b) all future refinements and newversions thereof, developed under the aegis of the cost-sharing arrangement.12.5.1.1 In Combination with the CUT MethodThe income method is applied in conjunction with the CUT method in the followingsteps:1. Establish an arm’s length royalty rate for FS’ rights to use USP’s IT platform inits markets, expressed as a percentage of FS’ sales, based on third party CUTs;2. Separately calculate the discounted present value of (a) FS’ projected costsharingpayments (as determined by USP’s IT research budget and FS’ anticipatedrelative benefits therefrom), and (b) FS’ projected sales; and,3. Reduce the arm’s length royalty rate by the ratio of (a) the present value of FS’projected cost-sharing payments to (b) the present value of FS’ projected sales.The percentage of sales calculated in Step 3 above constitutes FS’ ApplicableRate, payable to USP. This Applicable Rate, applied to FS’ actual sales, determinesits per annum buy-in payment. Depending on the magnitude of R&D expendituresto be shared, it is easy to imagine a situation in which the Applicable Rate wouldbe negative. For example, suppose a third party would pay 10.0% of net sales forrights to use USP’s IT platform in non-U.S. markets. (The upper bound of this ratewould be determined by the cost of reproducing the IT platform, divided by FS’ revenues,but the market-determined rate might be significantly lower.) FS’ projectedcost-sharing payments, discounted to the start date of the cost-sharing arrangement,are $15 million. FS’ projected sales, similarly discounted, are $120 million. Underthese assumed facts, FS would pay an Applicable Rate (or, equivalently, an adjustedrunning royalty rate) equal to 10% less 12.5%, or –2.5%.