Contents - AL-Tax

12.5 Analysis Under 2005 Proposed Cost-Sharing Regulations 17712.5.1.2 In Combination with the CPMThe income method is applied in conjunction with the comparable profits methodin the following steps:1. Determine arm’s length returns to FS’ routine functions;2. Calculate the discounted present value of FS’ projected operating profits, its projectedreturns to routine functions, its projected cost-sharing payments, and itsprojected sales;3. Compute the Alternative Rate, equal to the ratio of (a) the present value of FS’projected operating profits, reduced by the present value of its projected routinereturns, to (b) the present value of FS’ projected sales; and,4. Reduce the Alternative Rate by the cost contribution adjustment, equal to theratio of (a) the present value of FS’ projected cost-sharing contributions to (b)the present value of FS’ projected sales.The percentage of sales calculated in Step 4 above constitutes FS’ ApplicableRate, payable to USP. (Under the Commensurate with Income Standard, the AlternativeRate should, by assumption, be approximately equal to an arm’s length royaltyrate if FS owns no intangible assets in its own right.)As noted, under the CUT variant of the income method, FS is treated as a licenseeof USP’s IT platform (including future versions thereof) and is reimbursed for itsprojected cost-sharing contributions. As such, it has no incentive to participate in thecost-sharing arrangement (and no real opportunity to do so). However, FS retainsintangible income attributable to its independent investments in marketing intangibleassets. In contrast, under the CPM variant of the income method, FS’ incomeis limited to projected routine returns on its tangible assets (or projected returns asmeasured by another profit level indicator). As such, it neither has an incentive toparticipate in the cost-sharing arrangement nor to invest independently in marketingintangible assets. As such, if USP and FS were to enter into a cost-sharing arrangement,USP would have to fund the development of marketing intangible assets innon-U.S. markets single-handedly, and FS would be consigned to the role of servicesprovider.12.5.1.3 On a Genuinely Arm’s Length BasisOn a genuinely arm’s length basis, USP would not enter into a cost-sharing arrangementif it could earn a higher return (as measured by the net present value of itsprojected after-tax free cash flows) by further developing its IT platform internallyand (a) directly exploiting the platform in foreign markets, (b) licensing the platformat arm’s length, or (c) entering into a JV arrangement. In computing the netpresent value associated with the first of these alternatives (the “self-develop andexploit internally” option), USP’s projected after-tax free cash flows in internationalmarkets should incorporate the following components: FS’ projected net revenues (which should be treated as USP’s net revenues);