Contents - AL-Tax

180 12 Decentralized Ownership of Intellectual Propertydetailed in Chapter 3, apply to the residual profit split method as well. As a resultof these shortcomings, the allocation of income that we obtain in this case under theresidual profit split method is essentially meaningless.Moreover, the fact that USP entered into third party joint venture agreements atabout the same time that it entered into its intercompany joint venture agreementwith FS should be determinative. USP and FS clearly intended that they wouldfunction as JV partners, and in fact did so. Hence, taxing authorities’ disinclinationto use joint venture arrangements between third parties as comparable uncontrolledtransactions is difficult to understand, and harder still to justify. In relying on USP’sarm’s length joint venture agreements, with adjustments for differences in key terms,we are able to establish arm’s length results vis-a-vis the allocation of FS’ incomebetween itself and USP with a reasonable degree of confidence.Under the 2005 proposed cost-sharing regulations, in combination with the CoordinatedIssue Paper addressing buy-in payments released in 2007, the market capitalizationmethod could theoretically be used to establish FS’ arm’s length buy-inpayment. However, this would entail valuing goodwill and going concern explicitly,rather than as a residual.The income method, applied in conjunction with the CUT method, is internallyinconsistent: If USP retains all income attributable to improvements in its ITplatform, FS would have no incentive to join the cost-sharing arrangement on anarm’s length basis. More fundamentally, it would have no real opportunity to do so,because the income method, applied in combination with the CUT method, simplyconverts the cost-sharing arrangement into a licensing arrangement. The incomemethod, applied in conjunction with the comparable profits method, also eliminatesFS’ incentives to develop and promote USP’s brand identity and business modelin non-U.S. markets. Hence, by modifying the way in which USP would be compensatedfor its external contributions, the relationship between USP and FS wouldbe restructured in its entirety. A corrected version of the income method wouldsubstitute after-tax free cash flows for before-tax operating profits in all net presentvalue calculations, and systematically analyze feasible alternatives available to bothparticipants, not just USP. Both participants must be as well or better off under thecost-sharing arrangement than they would be under all feasible alternatives, and thenet present value of participation must be positive for both FS and USP.