Contents - AL-Tax

34 3 Overview and Critique of Existing Transfer Pricing Methods(d) Co-development agreements may tie the division of actual results to eachparty’s contributions.2. Pre-existing intangible assets contributed to an intercompany cost-sharingarrangement (referred to as external contributions and Preliminary or ContemporaneousTransactions (PCTs) in the proposed regulations) have a useful lifeequal to or greater than the anticipated period of intangibles development andsubsequent exploitation of newly developed intangibles. (Therefore, a decliningroyalty payment, such as that obtained by application of the residual profit splitmethod, would not constitute sufficient consideration for pre-existing intellectualproperty.)3. Third parties would base payments for external contributions purely on ex anteexpectations, and would not renegotiate these terms if actual results differedsignificantly from expectations. As such, affiliated companies participating ina cost-sharing arrangement cannot modify either the amount or the form of paymentfor external contributions over time. (However, the IRS can revisit paymentsfor external contributions due to a divergence between ex ante projectionsand ex poste results annually, through the Periodic Adjustment provision. 29Moreover, absent contemporaneous projections, the IRS may rely on actualresults in lieu of such projections, per the CIP.)4. Third parties would regularly revisit cost-sharing contributions to fund ongoingresearch, however, if anticipated relative benefits diverge from actual relativebenefits. As such, affiliated cost-sharing participants are required to do the same.5. The group member (or members) that possessed pre-existing intellectual propertywould consider the alternatives realistically available to it (or them)—mostnotably, self-development and licensing—in deciding whether to enter into acost-sharing agreement in the first instance. It (or they) would only opt to participateif this course of action yielded an equal or higher expected return thanthe next best alternative (measured in terms of the net present value of before-taxoperating profits).6. The participants that contribute funding alone are performing a routine financingfunction and should receive a rate of return equal to their cost of capital (i.e.,zero economic profits).The proposed regulations differ from the current cost-sharing regulations primarilyin their treatment of buy-in payments. Under both existing and proposedregulations, each cost-sharing participant’s share of pooled costs must reflect theiranticipated relative benefits from exploitation of the developed intangible assets,as measured indirectly by units used, produced or sold, sales, operating profit orother reasonable proxies. Adjustments to cost shares must be made “to accountfor changes in economic conditions, the business operations and practices of the29 See Treas. Reg. Section 1.482-4(f)(2).