Contents - AL-Tax

3.6 Proposed Cost-Sharing Regulations and Coordinated Issue Paper 39Cash flows for capital budgeting purposes are defined as “free operating cashflows minus taxes on free operating cash flows. ...This definition is very differentfrom the accounting definition of net [or operating] income. Cash flows for capitalbudgeting purposes can be thought of as the after-tax cash flows that the firm wouldhave if it had no debt.” 37Interestingly, the drafters of the CIP use precisely this argument in justifying theallocation of all income attributable to jointly developed intangible assets to thecontributor of pre-existing intangible assets:[T]he notion that USP [U.S. parent] would accept a buy-in with an expected net presentvalue significantly less than the expected NPV of the project as a whole in the CFC’s [ControlledForeign Corporation’s] territory would violate an established principle of corporatefinance. USP would in that case be investing an asset (the buy-in intangible as it pertains tothe CFC’s territory) for an anticipated return with a smaller expected NPV than the valueof the asset invested. USP’s investment thus would have a negative anticipated NPV. Ingeneral, however, a corporation will undertake a project only if its NPV is greater than zero[my emph.] ... 38In other words, all income generated through the exploitation of newly developedintangible assets can ultimately be traced back, and is attributable in full, to preexistingintangible assets; hence their fair market value. As such, the buy-in paymentshould be equal to (or greater than) the discounted present value of all such income.By implication, intangible assets created as a result of joint efforts have no value inand of themselves, but only as an extension of the original intellectual property onwhich they build.It is indisputably true that, for the contemplated research undertaking to makeeconomic sense, whether funded solely by the owner of the pre-existing assets orjointly funded through a CSA, the discounted present value of projected after-taxfree cash flows (rather than before-tax operating profits) must exceed the valueof the buy-in assets. That is, the net present value of the project must be positive.However, this does not mean that, having opted to establish a cost-sharingarrangement, all income attributable to pre-existing and yet-to-be-developed intangibleassets should flow to USP. Rather, USP should systematically compare the discountedpresent value of after-tax free cash flows associated with the following twooptions:1. Fund the further development of intangibles independently and exploit the resultingassets directly or through licensing (or a combination thereof) on a worldwidebasis; or2. Contribute the pre-existing intellectual property to a cost-sharing arrangement,receive a buy-in payment, share the costs of further development and exploit theresulting assets in a more limited territory.37 Ibid, pp. 39–40.38 See Internal Revenue Service, Coordinated Issue Paper: Section 482 CSA Buy-In Adjustments,LMSB-04-0907-62, September 27, 2007, “Taxpayer Methods and Positions”.