Contents - AL-Tax

3.6 Proposed Cost-Sharing Regulations and Coordinated Issue Paper 35participants, and the ongoing development of intangibles under the CSA.” 30 Stockbasedcompensation must be included in the base of costs to be shared. 31The proposed regulations provide much more detailed guidance than the currentcost-sharing regulations as to how one should determine the amount of a buy-inpayment. More particularly, the proposed regulations contain the following specified“valuation” methods: The comparable uncontrolled transaction method; The income method; The acquisition price method; The market capitalization method; and, The residual profit split method.The above methods are referred to as unspecified methods in the CIP, becausethe cost-sharing regulations remain in proposed form at this point. However, theCIP emphasizes that unspecified methods may produce more reliable results thanspecified methods, thus elevating the former’s status for audit purposes. The comparableuncontrolled transaction and residual profit split methods have been discussedelsewhere in this Chapter. Hence, in this discussion, we concentrate on the incomemethod, the acquisition price method and the market capitalization method.3.6.1 Income MethodUnder the 2005 proposed cost-sharing regulations, the income method applies onlywhen a single group member contributes pre-existing intangible property to the costsharingarrangement. However, the more recent CIP relaxes this restriction. Theincome method is based on the aforementioned assumption that the group membercontributing pre-existing intangible assets would only enter into a cost-sharingarrangement if such participation is at least as advantageous as the best feasiblealternative. The income method can be applied in conjunction with the comparableuncontrolled transaction (CUT) method or the comparable profits method.As indicated above, the entity contributing pre-existing intangible assets couldopt instead to incur all intangibles development costs itself, and license the resultingintellectual property to affiliated companies. Under the CUT variant of the incomemethod, one establishes an arm’s length royalty rate for rights to pre-existing intellectualproperty by reference to a sample of third party license agreements. Thisroyalty rate is then reduced by the ratio of (a) the discounted present value of30 See Treas. Reg. Section 1.482-7(e)(1).31 This issue is currently being litigated. Xilinx Inc. challenged an upward adjustment in its U.S.taxable income, predicated on the inclusion of the value of certain employee stock options in thepool of costs to be shared under a CSA, in Tax Court. The Tax Court recently ruled in favor ofXilinx. (See Xilinx v. Comm’r., 125 TC No. 4, 4142-01, 702-03, Filed August 30, 2005.) However,the IRS is appealing the Tax Court’s decision.