--- kind: "range" citation: "26 C.F.R. §§ 1.482-3–1.482-7" title: "26" from: "1.482-3" to: "1.482-7" count: 5 url: "https://uscodex.org/cfr/26/1.482-3..1.482-7" --- # §1.482-3. Methods to determine taxable income in connection with a transfer of tangible property. - (a) **In general.** The arm's length amount charged in a controlled transfer of tangible property must be determined under one of the six methods listed in this [paragraph (a)](#a). Each of the methods must be applied in accordance with all of the provisions of [§ 1.482-1](/cfr/26/1.482-1.md), including the best method rule of [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c), the comparability analysis of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d), and the arm's length range of [§ 1.482-1(e)](/cfr/26/1.482-1.md?p=e). The methods are— - (1) The comparable uncontrolled price method, described in [paragraph (b)](#b) of this section; - (2) The resale price method, described in [paragraph (c)](#c) of this section; - (3) The cost plus method, described in [paragraph (d)](#d) of this section; - (4) The comparable profits method, described in [§ 1.482-5](/cfr/26/1.482-5.md); - (5) The profit split method, described in [§ 1.482-6](/cfr/26/1.482-6.md); and - (6) **Unspecified methods, described in paragraph (e) of this section.** - (b) **Comparable uncontrolled price method—** - (1) **In general.** The comparable uncontrolled price method evaluates whether the amount charged in a controlled transaction is arm's length by reference to the amount charged in a comparable uncontrolled transaction. - (2) **Comparability and reliability considerations—** - (i) **In general.** Whether results derived from applications of this method are the most reliable measure of the arm's length result must be determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). The application of these factors under the comparable uncontrolled price method is discussed in paragraph [(b)(2)(ii)](#b-2-ii) and [(iii)](#b-2-iii) of this section. - (ii) **Comparability—** - (A) **In general.** The degree of comparability between controlled and uncontrolled transactions is determined by applying the provisions of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d). Although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, similarity of products generally will have the greatest effect on comparability under this method. In addition, because even minor differences in contractual terms or economic conditions could materially affect the amount charged in an uncontrolled transaction, comparability under this method depends on close similarity with respect to these factors, or adjustments to account for any differences. The results derived from applying the comparable uncontrolled price method generally will be the most direct and reliable measure of an arm's length price for the controlled transaction if an uncontrolled transaction has no differences with the controlled transaction that would affect the price, or if there are only minor differences that have a definite and reasonably ascertainable effect on price and for which appropriate adjustments are made. If such adjustments cannot be made, or if there are more than minor differences between the controlled and uncontrolled transactions, the comparable uncontrolled price method may be used, but the reliability of the results as a measure of the arm's length price will be reduced. Further, if there are material product differences for which reliable adjustments cannot be made, this method ordinarily will not provide a reliable measure of an arm's length result. - (B) **Adjustments for differences between controlled and uncontrolled transactions.** If there are differences between the controlled and uncontrolled transactions that would affect price, adjustments should be made to the price of the uncontrolled transaction according to the comparability provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). Specific examples of the factors that may be particularly relevant to this method include— (1) Quality of the product; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Level of the market (i.e., wholesale, retail, etc.); (4) Geographic market in which the transaction takes place; (5) Date of the transaction; (6) Intangible property associated with the sale; (7) Foreign currency risks; and (8) Alternatives realistically available to the buyer and seller. - (iii) **Data and assumptions.** The reliability of the results derived from the comparable uncontrolled price method is affected by the completeness and accuracy of the data used and the reliability of the assumptions made to apply the method. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) (Best method rule). - (3) **Arm's length range.** See [§ 1.482-1(e)(2)](/cfr/26/1.482-1.md?p=e-2) for the determination of an arm's length range. - (4) **Examples.** The principles of this [paragraph (b)](#b) are illustrated by the following examples. - (5) **Indirect evidence of comparable uncontrolled transactions—** - (i) **In general.** A comparable uncontrolled price may be derived from data from public exchanges or quotation media, but only if the following requirements are met— - (A) The data is widely and routinely used in the ordinary course of business in the industry to negotiate prices for uncontrolled sales; - (B) The data derived from public exchanges or quotation media is used to set prices in the controlled transaction in the same way it is used by uncontrolled taxpayers in the industry; and - (C) The amount charged in the controlled transaction is adjusted to reflect differences in product quality and quantity, contractual terms, transportation costs, market conditions, risks borne, and other factors that affect the price that would be agreed to by uncontrolled taxpayers. - (ii) **Limitation.** Use of data from public exchanges or quotation media may not be appropriate under extraordinary market conditions. - (iii) **Examples.** The following examples illustrate this [paragraph (b)(5)](#b-5). - (c) **Resale price method—** - (1) **In general.** The resale price method evaluates whether the amount charged in a controlled transaction is arm's length by reference to the gross profit margin realized in comparable uncontrolled transactions. The resale price method measures the value of functions performed, and is ordinarily used in cases involving the purchase and resale of tangible property in which the reseller has not added substantial value to the tangible goods by physically altering the goods before resale. For this purpose, packaging, repackaging, labelling, or minor assembly do not ordinarily constitute physical alteration. Further the resale price method is not ordinarily used in cases where the controlled taxpayer uses its intangible property to add substantial value to the tangible goods. - (2) **Determination of arm's length price—** - (i) **In general.** The resale price method measures an arm's length price by subtracting the appropriate gross profit from the applicable resale price for the property involved in the controlled transaction under review. - (ii) **Applicable resale price.** The applicable resale price is equal to either the resale price of the particular item of property involved or the price at which contemporaneous resales of the same property are made. If the property purchased in the controlled sale is resold to one or more related parties in a series of controlled sales before being resold in an uncontrolled sale, the applicable resale price is the price at which the property is resold to an uncontrolled party, or the price at which contemporaneous resales of the same property are made. In such case, the determination of the appropriate gross profit will take into account the functions of all members of the group participating in the series of controlled sales and final uncontrolled resales, as well as any other relevant factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3). - (iii) **Appropriate gross profit.** The appropriate gross profit is computed by multiplying the applicable resale price by the gross profit margin (expressed as a percentage of total revenue derived from sales) earned in comparable uncontrolled transactions. - (iv) **Arm's length range.** See [§ 1.482-1(e)(2)](/cfr/26/1.482-1.md?p=e-2) for determination of the arm's length range. - (3) **Comparability and reliability considerations—** - (i) **In general.** Whether results derived from applications of this method are the most reliable measure of the arm's length result must be determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). The application of these factors under the resale price method is discussed in [paragraphs (c)(3)](#c-3) (ii) and (iii) of this section. - (ii) **Comparability—** - (A) **Functional comparability.** The degree of comparability between an uncontrolled transaction and a controlled transaction is determined by applying the comparability provisions of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d). A reseller's gross profit provides compensation for the performance of resale functions related to the product or products under review, including an operating profit in return for the reseller's investment of capital and the assumption of risks. Therefore, although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, comparability under this method is particularly dependent on similarity of functions performed, risks borne, and contractual terms, or adjustments to account for the effects of any such differences. If possible, appropriate gross profit margins should be derived from comparable uncontrolled purchases and resales of the reseller involved in the controlled sale, because similar characteristics are more likely to be found among different resales of property made by the same reseller than among sales made by other resellers. In the absence of comparable uncontrolled transactions involving the same reseller, an appropriate gross profit margin may be derived from comparable uncontrolled transactions of other resellers. - (B) **Other comparability factors.** Comparability under this method is less dependent on close physical similarity between the products transferred than under the comparable uncontrolled price method. For example, distributors of a wide variety of consumer durables might perform comparable distribution functions without regard to the specific durable goods distributed. Substantial differences in the products may, however, indicate significant functional differences between the controlled and uncontrolled taxpayers. Thus, it ordinarily would be expected that the controlled and uncontrolled transactions would involve the distribution of products of the same general type (e.g., consumer electronics). Furthermore, significant differences in the value of the distributed goods due, for example, to the value of a trademark, may also affect the reliability of the comparison. Finally, the reliability of profit measures based on gross profit may be adversely affected by factors that have less effect on prices. For example, gross profit may be affected by a variety of other factors, including cost structures (as reflected, for example, in the age of plant and equipment), business experience (such as whether the business is in a start-up phase or is mature), or management efficiency (as indicated, for example, by expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected. - (C) **Adjustments for differences between controlled and uncontrolled transactions.** If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit margin, adjustments should be made to the gross profit margin earned with respect to the uncontrolled transaction according to the comparability provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). For this purpose, consideration of operating expenses associated with functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include— (1) Inventory levels and turnover rates, and corresponding risks, including any price protection programs offered by the manufacturer; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Sales, marketing, advertising programs and services, (including promotional programs, rebates, and co-op advertising); (4) The level of the market (e.g., wholesale, retail, etc.); and (5) Foreign currency risks. - (D) **Sales agent.** If the controlled taxpayer is comparable to a sales agent that does not take title to goods or otherwise assume risks with respect to ownership of such goods, the commission earned by such sales agent, expressed as a percentage of the uncontrolled sales price of the goods involved, may be used as the comparable gross profit margin. - (iii) **Data and assumptions—** - (A) **In general.** The reliability of the results derived from the resale price method is affected by the completeness and accuracy of the data used and the reliability of the assumptions made to apply this method. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) (Best method rule). - (B) **Consistency in accounting.** The degree of consistency in accounting practices between the controlled transaction and the uncontrolled comparables that materially affect the gross profit margin affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect the gross profit margin, the ability to make reliable adjustments for such differences would affect the reliability of the results. Further, the controlled transaction and the uncontrolled comparable should be consistent in the reporting of items (such as discounts, returns and allowances, rebates, transportation costs, insurance, and packaging) between cost of goods sold and operating expenses. - (4) **Examples.** The following examples illustrate the principles of this [paragraph (c)](#c). - (d) **Cost plus method—** - (1) **In general.** The cost plus method evaluates whether the amount charged in a controlled transaction is arm's length by reference to the gross profit markup realized in comparable uncontrolled transactions. The cost plus method is ordinarily used in cases involving the manufacture, assembly, or other production of goods that are sold to related parties. - (2) **Determination of arm's length price—** - (i) **In general.** The cost plus method measures an arm's length price by adding the appropriate gross profit to the controlled taxpayer's costs of producing the property involved in the controlled transaction. - (ii) **Appropriate gross profit.** The appropriate gross profit is computed by multiplying the controlled taxpayer's cost of producing the transferred property by the gross profit markup, expressed as a percentage of cost, earned in comparable uncontrolled transactions. - (iii) **Arm's length range.** See [§ 1.482-1(e)(2)](/cfr/26/1.482-1.md?p=e-2) for determination of an arm's length range. - (3) **Comparability and reliability considerations—** - (i) **In general.** Whether results derived from the application of this method are the most reliable measure of the arm's length result must be determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). - (ii) **Comparability—** - (A) **Functional comparability.** The degree of comparability between controlled and uncontrolled transactions is determined by applying the comparability provisions of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d). A producer's gross profit provides compensation for the performance of the production functions related to the product or products under review, including an operating profit for the producer's investment of capital and assumption of risks. Therefore, although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, comparability under this method is particularly dependent on similarity of functions performed, risks borne, and contractual terms, or adjustments to account for the effects of any such differences. If possible, the appropriate gross profit markup should be derived from comparable uncontrolled transactions of the taxpayer involved in the controlled sale, because similar characteristics are more likely to be found among sales of property by the same producer than among sales by other producers. In the absence of such sales, an appropriate gross profit markup may be derived from comparable uncontrolled sales of other producers whether or not such producers are members of the same controlled group. - (B) **Other comparability factors.** Comparability under this method is less dependent on close physical similarity between the products transferred than under the comparable uncontrolled price method. Substantial differences in the products may, however, indicate significant functional differences between the controlled and uncontrolled taxpayers. Thus, it ordinarily would be expected that the controlled and uncontrolled transactions involve the production of goods within the same product categories. Furthermore, significant differences in the value of the products due, for example, to the value of a trademark, may also affect the reliability of the comparison. Finally, the reliability of profit measures based on gross profit may be adversely affected by factors that have less effect on prices. For example, gross profit may be affected by a variety of other factors, including cost structures (as reflected, for example, in the age of plant and equipment), business experience (such as whether the business is in a start-up phase or is mature), or management efficiency (as indicated, for example, by expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected. - (C) **Adjustments for differences between controlled and uncontrolled transactions.** If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit markup, adjustments should be made to the gross profit markup earned in the comparable uncontrolled transaction according to the provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). For this purpose, consideration of the operating expenses associated with the functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include— (1) The complexity of manufacturing or assembly; (2) Manufacturing, production, and process engineering; (3) Procurement, purchasing, and inventory control activities; (4) Testing functions; (5) Selling, general, and administrative expenses; (6) Foreign currency risks; and (7) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms). - (D) **Purchasing agent.** If a controlled taxpayer is comparable to a purchasing agent that does not take title to property or otherwise assume risks with respect to ownership of such goods, the commission earned by such purchasing agent, expressed as a percentage of the purchase price of the goods, may be used as the appropriate gross profit markup. - (iii) **Data and assumptions—** - (A) **In general.** The reliability of the results derived from the cost plus method is affected by the completeness and accuracy of the data used and the reliability of the assumptions made to apply this method. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) (Best method rule). - (B) **Consistency in accounting.** The degree of consistency in accounting practices between the controlled transaction and the uncontrolled comparables that materially affect the gross profit markup affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect the gross profit markup, the ability to make reliable adjustments for such differences would affect the reliability of the results. Further, the controlled transaction and the comparable uncontrolled transaction should be consistent in the reporting of costs between cost of goods sold and operating expenses. The term cost of producing includes the cost of acquiring property that is held for resale. - (4) **Examples.** The following examples illustrate the principles of this [paragraph (d)](#d). - (e) **Unspecified methods—** - (1) **In general.** Methods not specified in paragraphs [(a)(1)](#a-1), [(2)](#a-2), [(3)](#a-3), [(4)](#a-4), and [(5)](#a-5) of this section may be used to evaluate whether the amount charged in a controlled transaction is arm's length. Any method used under this [paragraph (e)](#e) must be applied in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md). Consistent with the specified methods, an unspecified method should take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction, and only enter into a particular transaction if none of the alternatives is preferable to it. For example, the comparable uncontrolled price method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price to which the parties would have agreed had they resorted directly to a market alternative to the controlled transaction. Therefore, in establishing whether a controlled transaction achieved an arm's length result, an unspecified method should provide information on the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction. As with any method, an unspecified method will not be applied unless it provides the most reliable measure of an arm's length result under the principles of the best method rule. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). Therefore, in accordance with [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d) (Comparability), to the extent that a method relies on internal data rather than uncontrolled comparables, its reliability will be reduced. Similarly, the reliability of a method will be affected by the reliability of the data and assumptions used to apply the method, including any projections used. - (2) **Example.** The following example illustrates an application of the principle of this [paragraph (e)](#e). - (f) **Coordination with intangible property rules.** The value of an item of tangible property may be affected by the value of intangible property, such as a trademark affixed to the tangible property (embedded intangible). Ordinarily, the transfer of tangible property with an embedded intangible will not be considered a transfer of such intangible if the controlled purchaser does not acquire any rights to exploit the intangible property other than rights relating to the resale of the tangible property under normal commercial practices. Pursuant to [§ 1.482-1(d)(3)(v)](/cfr/26/1.482-1.md?p=d-3-v), however, the embedded intangible must be accounted for in evaluating the comparability of the controlled transaction and uncontrolled comparables. For example, because product comparability has the greatest effect on an application of the comparable uncontrolled price method, trademarked tangible property may be insufficiently comparable to unbranded tangible property to permit a reliable application of the comparable uncontrolled price method. The effect of embedded intangibles on comparability will be determined under the principles of [§ 1.482-4](/cfr/26/1.482-4.md). If the transfer of tangible property conveys to the recipient a right to exploit an embedded intangible (other than in connection with the resale of that item of tangible property), it may be necessary to determine the arm's length consideration for such intangible separately from the tangible property, applying methods appropriate to determining the arm's length result for a transfer of intangible property under [§ 1.482-4](/cfr/26/1.482-4.md). For example, if the transfer of a machine conveys the right to exploit a manufacturing process incorporated in the machine, then the arm's length consideration for the transfer of that right must be determined separately under [§ 1.482-4](/cfr/26/1.482-4.md). # §1.482-4. Methods to determine taxable income in connection with a transfer of intangible property. - (a) **In general.** The arm's length amount charged in a controlled transfer of intangible property must be determined under one of the four methods listed in this [paragraph (a)](#a). Each of the methods must be applied in accordance with all of the provisions of [§ 1.482-1](/cfr/26/1.482-1.md), including the best method rule of [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c), the comparability analysis of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d), and the arm's length range of [§ 1.482-1(e)](/cfr/26/1.482-1.md?p=e). The arm's length consideration for the transfer of an intangible determined under this section must be commensurate with the income attributable to the intangible. See [§ 1.482-4(f)(2)](#f-2) (Periodic adjustments). The available methods are— - (1) The comparable uncontrolled transaction method, described in [paragraph (c)](#c) of this section; - (2) The comparable profits method, described in [§ 1.482-5](/cfr/26/1.482-5.md); - (3) The profit split method, described in [§ 1.482-6](/cfr/26/1.482-6.md); and - (4) **Unspecified methods described in paragraph (d) of this section.** - (b) **Definition of intangible.** For purposes of [section 482](/cfr/26/482.md), an intangible is an asset that comprises any of the following items and has substantial value independent of the services of any individual— - (1) Patents, inventions, formulae, processes, designs, patterns, or know-how; - (2) Copyrights and literary, musical, or artistic compositions; - (3) Trademarks, trade names, or brand names; - (4) Franchises, licenses, or contracts; - (5) Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and - (6) **Other similar items.** For purposes of [section 482](/cfr/26/482.md), an item is considered similar to those listed in [paragraph (b)(1) through (5)](#b-1..b-5) of this section if it derives its value not from its physical attributes but from its intellectual content or other intangible properties. - (c) **Comparable uncontrolled transaction method—** - (1) **In general.** The comparable uncontrolled transaction method evaluates whether the amount charged for a controlled transfer of intangible property was arm's length by reference to the amount charged in a comparable uncontrolled transaction. The amount determined under this method may be adjusted as required by [paragraph (f)(2)](#f-2) of this section (Periodic adjustments). - (2) **Comparability and reliability considerations—** - (i) **In general.** Whether results derived from applications of this method are the most reliable measure of an arm's length result is determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). The application of these factors under the comparable uncontrolled transaction method is discussed in paragraphs [(c)(2)(ii)](#c-2-ii), [(iii)](#c-2-iii), and [(iv)](#c-2-iv) of this section. - (ii) **Reliability.** If an uncontrolled transaction involves the transfer of the same intangible under the same, or substantially the same, circumstances as the controlled transaction, the results derived from applying the comparable uncontrolled transaction method will generally be the most direct and reliable measure of the arm's length result for the controlled transfer of an intangible. Circumstances between the controlled and uncontrolled transactions will be considered substantially the same if there are at most only minor differences that have a definite and reasonably ascertainable effect on the amount charged and for which appropriate adjustments are made. If such uncontrolled transactions cannot be identified, uncontrolled transactions that involve the transfer of comparable intangibles under comparable circumstances may be used to apply this method, but the reliability of the analysis will be reduced. - (iii) **Comparability—** - (A) **In general.** The degree of comparability between controlled and uncontrolled transactions is determined by applying the comparability provisions of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d). Although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, specific factors may be particularly relevant to this method. In particular, the application of this method requires that the controlled and uncontrolled transactions involve either the same intangible property or comparable intangible property, as defined in paragraph (c)(2)(iii)(B)(1) of this section. In addition, because differences in contractual terms, or the economic conditions in which transactions take place, could materially affect the amount charged, comparability under this method also depends on similarity with respect to these factors, or adjustments to account for material differences in such circumstances. - (B) **Factors to be considered in determining comparability—** (1) Comparable intangible property. In order for the intangible property involved in an uncontrolled transaction to be considered comparable to the intangible property involved in the controlled transaction, both intangibles must— (i) Be used in connection with similar products or processes within the same general industry or market; and (ii) Have similar profit potential. The profit potential of an intangible is most reliably measured by directly calculating the net present value of the benefits to be realized (based on prospective profits to be realized or costs to be saved) through the use or subsequent transfer of the intangible, considering the capital investment and start-up expenses required, the risks to be assumed, and other relevant considerations. The need to reliably measure profit potential increases in relation to both the total amount of potential profits and the potential rate of return on investment necessary to exploit the intangible. If the information necessary to directly calculate net present value of the benefits to be realized is unavailable, and the need to reliably measure profit potential is reduced because the potential profits are relatively small in terms of total amount and rate of return, comparison of profit potential may be based upon the factors referred to in paragraph (c)(2)(iii)(B)(2) of this section. See Example 3 of [§ 1.482-4(c)(4)](#c-4). Finally, the reliability of a measure of profit potential is affected by the extent to which the profit attributable to the intangible can be isolated from the profit attributable to other factors, such as functions performed and other resources employed. (2) Comparable circumstances. In evaluating the comparability of the circumstances of the controlled and uncontrolled transactions, although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, specific factors that may be particularly relevant to this method include the following— (i) The terms of the transfer, including the exploitation rights granted in the intangible, the exclusive or nonexclusive character of any rights granted, any restrictions on use, or any limitations on the geographic area in which the rights may be exploited; (ii) The stage of development of the intangible (including, where appropriate, necessary governmental approvals, authorizations, or licenses) in the market in which the intangible is to be used; (iii) Rights to receive updates, revisions, or modifications of the intangible; (iv) The uniqueness of the property and the period for which it remains unique, including the degree and duration of protection afforded to the property under the laws of the relevant countries; (v) The duration of the license, contract, or other agreement, and any termination or renegotiation rights; (vi) Any economic and product liability risks to be assumed by the transferee; (vii) The existence and extent of any collateral transactions or ongoing business relationships between the transferee and transferor; and (viii) The functions to be performed by the transferor and transferee, including any ancillary or subsidiary services. - (iv) **Data and assumptions.** The reliability of the results derived from the comparable uncontrolled transaction method is affected by the completeness and accuracy of the data used and the reliability of the assumptions made to apply this method. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) (Best method rule). - (3) **Arm's length range.** See [§ 1.482-1(e)(2)](/cfr/26/1.482-1.md?p=e-2) for the determination of an arm's length range. - (4) **Examples.** The following examples illustrate the principles of this [paragraph (c)](#c). - (d) **Unspecified methods—** - (1) **In general.** Methods not specified in paragraphs [(a)(1)](#a-1), [(2)](#a-2), and [(3)](#a-3) of this section may be used to evaluate whether the amount charged in a controlled transaction is arm's length. Any method used under this [paragraph (d)](#d) must be applied in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md). Consistent with the specified methods, an unspecified method should take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction, and only enter into a particular transaction if none of the alternatives is preferable to it. For example, the comparable uncontrolled transaction method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price the parties would have agreed to had they resorted directly to a market alternative to the controlled transaction. Therefore, in establishing whether a controlled transaction achieved an arm's length result, an unspecified method should provide information on the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction. As with any method, an unspecified method will not be applied unless it provides the most reliable measure of an arm's length result under the principles of the best method rule. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). Therefore, in accordance with [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d) (Comparability), to the extent that a method relies on internal data rather than uncontrolled comparables, its reliability will be reduced. Similarly, the reliability of a method will be affected by the reliability of the data and assumptions used to apply the method, including any projections used. - (2) **Example.** The following example illustrates an application of the principle of this [paragraph (d)](#d). - (e) **Coordination with tangible property rules.** See [§ 1.482-3(f)](/cfr/26/1.482-3.md?p=f) for the provisions regarding the coordination between the tangible property and intangible property rules. - (f) **Special rules for transfers of intangible property—** - (1) **Form of consideration.** If a transferee of an intangible pays nominal or no consideration and the transferor has retained a substantial interest in the property, the arm's length consideration shall be in the form of a royalty, unless a different form is demonstrably more appropriate. - (2) **Periodic adjustments—** - (i) **General rule.** If an intangible is transferred under an arrangement that covers more than one year, the consideration charged in each taxable year may be adjusted to ensure that it is commensurate with the income attributable to the intangible. Adjustments made pursuant to this [paragraph (f)(2)](#f-2) shall be consistent with the arm's length standard and the provisions of [§ 1.482-1](/cfr/26/1.482-1.md). In determining whether to make such adjustments in the taxable year under examination, the district director may consider all relevant facts and circumstances throughout the period the intangible is used. The determination in an earlier year that the amount charged for an intangible was an arm's length amount will not preclude the district director in a subsequent taxable year from making an adjustment to the amount charged for the intangible in the subsequent year. A periodic adjustment under the commensurate with income requirement of [section 482](/cfr/26/482.md) may be made in a subsequent taxable year without regard to whether the taxable year of the original transfer remains open for statute of limitation purposes. For exceptions to this rule see [paragraph (f)(2)(ii)](#f-2-ii) of this section. - (ii) **Exceptions—** - (A) **Transactions involving the same intangible.** If the same intangible was transferred to an uncontrolled taxpayer under substantially the same circumstances as those of the controlled transaction; this transaction serves as the basis for the application of the comparable uncontrolled transaction method in the first taxable year in which substantial periodic consideration was required to be paid; and the amount paid in that year was an arm's length amount, then no allocation in a subsequent year will be made under [paragraph (f)(2)(i)](#f-2-i) of this paragraph for a controlled transfer of intangible property. - (B) **Transactions involving comparable intangible.** If the arm's length result is derived from the application of the comparable uncontrolled transaction method based on the transfer of a comparable intangible under comparable circumstances to those of the controlled transaction, no allocation will be made under [paragraph (f)(2)(i)](#f-2-i) of this section if each of the following facts is established— (1) The controlled taxpayers entered into a written agreement (controlled agreement) that provided for an amount of consideration with respect to each taxable year subject to such agreement, such consideration was an arm's length amount for the first taxable year in which substantial periodic consideration was required to be paid under the agreement, and such agreement remained in effect for the taxable year under review; (2) There is a written agreement setting forth the terms of the comparable uncontrolled transaction relied upon to establish the arm's length consideration (uncontrolled agreement), which contains no provisions that would permit any change to the amount of consideration, a renegotiation, or a termination of the agreement, in circumstances comparable to those of the controlled transaction in the taxable year under review (or that contains provisions permitting only specified, non-contingent, periodic changes to the amount of consideration); (3) The controlled agreement is substantially similar to the uncontrolled agreement, with respect to the time period for which it is effective and the provisions described in paragraph (f)(2)(ii)(B)(2) of this section; (4) The controlled agreement limits use of the intangible to a specified field or purpose in a manner that is consistent with industry practice and any such limitation in the uncontrolled agreement; (5) There were no substantial changes in the functions performed by the controlled transferee after the controlled agreement was executed, except changes required by events that were not foreseeable; and (6) The aggregate profits actually earned or the aggregate cost savings actually realized by the controlled taxpayer from the exploitation of the intangible in the year under examination, and all past years, are not less than 80% nor more than 120% of the prospective profits or cost savings that were foreseeable when the comparability of the uncontrolled agreement was established under [paragraph (c)(2)](#c-2) of this section. - (C) **Methods other than comparable uncontrolled transaction.** If the arm's length amount was determined under any method other than the comparable uncontrolled transaction method, no allocation will be made under [paragraph (f)(2)(i)](#f-2-i) of this section if each of the following facts is established— (1) The controlled taxpayers entered into a written agreement (controlled agreement) that provided for an amount of consideration with respect to each taxable year subject to such agreement, and such agreement remained in effect for the taxable year under review; (2) The consideration called for in the controlled agreement was an arm's length amount for the first taxable year in which substantial periodic consideration was required to be paid, and relevant supporting documentation was prepared contemporaneously with the execution of the controlled agreement; (3) There have been no substantial changes in the functions performed by the transferee since the controlled agreement was executed, except changes required by events that were not foreseeable; and (4) The total profits actually earned or the total cost savings realized by the controlled transferee from the exploitation of the intangible in the year under examination, and all past years, are not less than 80% nor more than 120% of the prospective profits or cost savings that were foreseeable when the controlled agreement was entered into. - (D) **Extraordinary events.** No allocation will be made under [paragraph (f)(2)(i)](#f-2-i) of this section if the following requirements are met— (1) Due to extraordinary events that were beyond the control of the controlled taxpayers and that could not reasonably have been anticipated at the time the controlled agreement was entered into, the aggregate actual profits or aggregate cost savings realized by the taxpayer are less than 80% or more than 120% of the prospective profits or cost savings; and (2) All of the requirements of [paragraph (f)(2)(ii)](#f-2-ii) (B) or (C) of this section are otherwise satisfied. - (E) **Five-year period.** If the requirements of § [1.482-4 (f)(2)(ii)(B)](#f-2-ii-B) or [(f)(2)(ii)(C)](#f-2-ii-C) are met for each year of the five-year period beginning with the first year in which substantial periodic consideration was required to be paid, then no periodic adjustment will be made under [paragraph (f)(2)(i)](#f-2-i) of this section in any subsequent year. - (iii) **Examples.** The following examples illustrate this [paragraph (f)(2)](#f-2). - (3) **Ownership of intangible property—** - (i) **Identification of owner—** - (A) **In general.** The legal owner of intangible property pursuant to the intellectual property law of the relevant jurisdiction, or the holder of rights constituting an intangible property pursuant to contractual terms (such as the terms of a license) or other legal provision, will be considered the sole owner of the respective intangible property for purposes of this section unless such ownership is inconsistent with the economic substance of the underlying transactions. See [§ 1.482-1(d)(3)(ii)(B)](/cfr/26/1.482-1.md?p=d-3-ii-B) (identifying contractual terms). If no owner of the respective intangible property is identified under the intellectual property law of the relevant jurisdiction, or pursuant to contractual terms (including terms imputed pursuant to [§ 1.482-1(d)(3)(ii)(B)](/cfr/26/1.482-1.md?p=d-3-ii-B)) or other legal provision, then the controlled taxpayer who has control of the intangible property, based on all the facts and circumstances, will be considered the sole owner of the intangible property for purposes of this section. - (B) **Cost sharing arrangements.** The rules in this [paragraph (f)(3)](#f-3) regarding ownership with respect to cost shared intangibles and cost sharing arrangements will apply only as provided in [§ 1.482-7](/cfr/26/1.482-7.md). - (ii) **Examples.** The principles of this [paragraph (f)(3)](#f-3) are illustrated by the following examples: - (4) **Contribution to the value of intangible property owned by another—** - (i) **In general.** The arm's length consideration for a contribution by one controlled taxpayer that develops or enhances the value, or may be reasonably anticipated to develop or enhance the value, of intangible property owned by another controlled taxpayer will be determined in accordance with the applicable rules under [section 482](/cfr/26/482.md). If the consideration for such a contribution is embedded within the contractual terms for a controlled transaction that involves such intangible property, then ordinarily no separate allocation will be made with respect to such contribution. In such cases, pursuant to [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3), the contribution must be accounted for in evaluating the comparability of the controlled transaction to uncontrolled comparables, and accordingly in determining the arm's length consideration in the controlled transaction. - (ii) **Examples.** The principles of this [paragraph (f)(4)](#f-4) are illustrated by the following examples: - (5) **Consideration not artificially limited.** The arm's length consideration for the controlled transfer of an intangible is not limited by the consideration paid in any uncontrolled transactions that do not meet the requirements of the comparable uncontrolled transaction method described in [paragraph (c)](#c) of this section. Similarly, the arm's length consideration for an intangible is not limited by the prevailing rates of consideration paid for the use or transfer of intangibles within the same or similar industry. - (6) **Lump sum payments—** - (i) **In general.** If an intangible is transferred in a controlled transaction for a lump sum, that amount must be commensurate with the income attributable to the intangible. A lump sum is commensurate with income in a taxable year if the equivalent royalty amount for that taxable year is equal to an arm's length royalty. The equivalent royalty amount for a taxable year is the amount determined by treating the lump sum as an advance payment of a stream of royalties over the useful life of the intangible (or the period covered by an agreement, if shorter), taking into account the projected sales of the licensee as of the date of the transfer. Thus, determining the equivalent royalty amount requires a present value calculation based on the lump sum, an appropriate discount rate, and the projected sales over the relevant period. The equivalent royalty amount is subject to periodic adjustments under [§ 1.482-4(f)(2)(i)](#f-2-i) to the same extent as an actual royalty payment pursuant to a license agreement. - (ii) **Exceptions.** No periodic adjustment will be made under [paragraph (f)(2)(i)](#f-2-i) of this section if any of the exceptions to periodic adjustments provided in [paragraph (f)(2)(ii)](#f-2-ii) of this section apply. - (iii) **Example.** The following example illustrates the principle of this [paragraph (f)(5)](#f-5). - (g) **Coordination with rules governing cost sharing arrangements.** [Section 1.482-7](/cfr/26/1.482-7.md) provides the specific methods to be used to determine arm's length results of controlled transactions in connection with a cost sharing arrangement. This section provides the specific methods to be used to determine arm's length results of a transfer of intangible property, including in an arrangement for sharing the costs and risks of developing intangibles other than a cost sharing arrangement covered by [§ 1.482-7](/cfr/26/1.482-7.md). In the case of such an arrangement, consideration of the principles, methods, comparability, and reliability considerations set forth in [§ 1.482-7](/cfr/26/1.482-7.md) is relevant in determining the best method, including an unspecified method, under this section, as appropriately adjusted in light of the differences in the facts and circumstances between such arrangement and a cost sharing arrangement. - (h) **Effective/applicability date—** - (1) **In general.** Except as provided in the succeeding sentence, the provisions of paragraphs [(f)(3)](#f-3) and [(4)](#f-4) of this section are generally applicable for taxable years beginning after December 31, 2006. The provisions of paragraphs [(f)(3)(i)(B)](#f-3-i-B) and (g) of this section are generally applicable on January 5, 2009. - (2) **Election to apply regulation to earlier taxable years.** A person may elect to apply the provisions of paragraphs [(f)(3)](#f-3) and [(4)](#f-4) of this section to earlier taxable years in accordance with the rules set forth in [§ 1.482-9(n)(2)](/cfr/26/1.482-9.md?p=n-2). # §1.482-5. Comparable profits method. - (a) **In general.** The comparable profits method evaluates whether the amount charged in a controlled transaction is arm's length based on objective measures of profitability (profit level indicators) derived from uncontrolled taxpayers that engage in similar business activities under similar circumstances. - (b) **Determination of arm's length result—** - (1) **In general.** Under the comparable profits method, the determination of an arm's length result is based on the amount of operating profit that the tested party would have earned on related party transactions if its profit level indicator were equal to that of an uncontrolled comparable (comparable operating profit). Comparable operating profit is calculated by determining a profit level indicator for an uncontrolled comparable, and applying the profit level indicator to the financial data related to the tested party's most narrowly identifiable business activity for which data incorporating the controlled transaction is available (relevant business activity). To the extent possible, profit level indicators should be applied solely to the tested party's financial data that is related to controlled transactions. The tested party's reported operating profit is compared to the comparable operating profits derived from the profit level indicators of uncontrolled comparables to determine whether the reported operating profit represents an arm's length result. - (2) **Tested party—** - (i) **In general.** For purposes of this section, the tested party will be the participant in the controlled transaction whose operating profit attributable to the controlled transactions can be verified using the most reliable data and requiring the fewest and most reliable adjustments, and for which reliable data regarding uncontrolled comparables can be located. Consequently, in most cases the tested party will be the least complex of the controlled taxpayers and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. - (ii) **Adjustments for tested party.** The tested party's operating profit must first be adjusted to reflect all other allocations under [section 482](/cfr/26/482.md), other than adjustments pursuant to this section. - (3) **Arm's length range.** See [§ 1.482-1(e)(2)](/cfr/26/1.482-1.md?p=e-2) for the determination of the arm's length range. For purposes of the comparable profits method, the arm's length range will be established using comparable operating profits derived from a single profit level indicator. - (4) **Profit level indicators.** Profit level indicators are ratios that measure relationships between profits and costs incurred or resources employed. A variety of profit level indicators can be calculated in any given case. Whether use of a particular profit level indicator is appropriate depends upon a number of factors, including the nature of the activities of the tested party, the reliability of the available data with respect to uncontrolled comparables, and the extent to which the profit level indicator is likely to produce a reliable measure of the income that the tested party would have earned had it dealt with controlled taxpayers at arm's length, taking into account all of the facts and circumstances. The profit level indicators should be derived from a sufficient number of years of data to reasonably measure returns that accrue to uncontrolled comparables. Generally, such a period should encompass at least the taxable year under review and the preceding two taxable years. This analysis must be applied in accordance with [§ 1.482-1(f)(2)(iii)(D)](/cfr/26/1.482-1.md?p=f-2-iii-D). Profit level indicators that may provide a reliable basis for comparing operating profits of the tested party and uncontrolled comparables include the following— - (i) **Rate of return on capital employed.** The rate of return on capital employed is the ratio of operating profit to operating assets. The reliability of this profit level indicator increases as operating assets play a greater role in generating operating profits for both the tested party and the uncontrolled comparable. In addition, reliability under this profit level indicator depends on the extent to which the composition of the tested party's assets is similar to that of the uncontrolled comparable. Finally, difficulties in properly valuing operating assets will diminish the reliability of this profit level indicator. - (ii) **Financial ratios.** Financial ratios measure relationships between profit and costs or sales revenue. Since functional differences generally have a greater effect on the relationship between profit and costs or sales revenue than the relationship between profit and operating assets, financial ratios are more sensitive to functional differences than the rate of return on capital employed. Therefore, closer functional comparability normally is required under a financial ratio than under the rate of return on capital employed to achieve a similarly reliable measure of an arm's length result. Financial ratios that may be appropriate include the following— - (A) Ratio of operating profit to sales; and - (B) **Ratio of gross profit to operating expenses.** Reliability under this profit level indicator also depends on the extent to which the composition of the tested party's operating expenses is similar to that of the uncontrolled comparables. - (iii) **Other profit level indicators.** Other profit level indicators not described in this [paragraph (b)(4)](#b-4) may be used if they provide reliable measures of the income that the tested party would have earned had it dealt with controlled taxpayers at arm's length. However, profit level indicators based solely on internal data may not be used under this [paragraph (b)(4)](#b-4) because they are not objective measures of profitability derived from operations of uncontrolled taxpayers engaged in similar business activities under similar circumstances. - (c) **Comparability and reliability considerations—** - (1) **In general.** Whether results derived from application of this method are the most reliable measure of the arm's length result must be determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). - (2) **Comparability—** - (i) **In general.** The degree of comparability between an uncontrolled taxpayer and the tested party is determined by applying the provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). The comparable profits method compares the profitability of the tested party, measured by a profit level indicator (generally based on operating profit), to the profitability of uncontrolled taxpayers in similar circumstances. As with all methods that rely on external market benchmarks, the greater the degree of comparability between the tested party and the uncontrolled taxpayer, the more reliable will be the results derived from the application of this method. The determination of the degree of comparability between the tested party and the uncontrolled taxpayer depends upon all the relevant facts and circumstances, including the relevant lines of business, the product or service markets involved, the asset composition employed (including the nature and quantity of tangible assets, intangible assets and working capital), the size and scope of operations, and the stage in a business or product cycle. - (ii) **Functional, risk and resource comparability.** An operating profit represents a return for the investment of resources and assumption of risks. Therefore, although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, comparability under this method is particularly dependent on resources employed and risks assumed. Moreover, because resources and risks usually are directly related to functions performed, it is also important to consider functions performed in determining the degree of comparability between the tested party and an uncontrolled taxpayer. The degree of functional comparability required to obtain a reliable result under the comparable profits method, however, is generally less than that required under the resale price or cost plus methods. For example, because differences in functions performed often are reflected in operating expenses, taxpayers performing different functions may have very different gross profit margins but earn similar levels of operating profit. - (iii) **Other comparability factors.** Other factors listed in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) also may be particularly relevant under the comparable profits method. Because operating profit usually is less sensitive than gross profit to product differences, reliability under the comparable profits method is not as dependent on product similarity as the resale price or cost plus method. However, the reliability of profitability measures based on operating profit may be adversely affected by factors that have less effect on results under the comparable uncontrolled price, resale price, and cost plus methods. For example, operating profit may be affected by varying cost structures (as reflected, for example, in the age of plant and equipment), differences in business experience (such as whether the business is in a start-up phase or is mature), or differences in management efficiency (as indicated, for example, by objective evidence such as expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected. - (iv) **Adjustments for the differences between the tested party and the uncontrolled taxpayers.** If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable's operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party's accounts payable. As another example, it may be appropriate to adjust the operating profit of a party to account for material differences in the utilization of or accounting for stock-based compensation (as defined by [§ 1.482-7(d)(3)(i)](/cfr/26/1.482-7.md?p=d-3-i)) among the tested party and comparable parties. - (3) **Data and assumptions—** - (i) **In general.** The reliability of the results derived from the comparable profits method is affected by the quality of the data and assumptions used to apply this method. - (ii) **Consistency in accounting.** The degree of consistency in accounting practices between the controlled transaction and the uncontrolled comparables that materially affect operating profit affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect operating profit, the ability to make reliable adjustments for such differences would affect the reliability of the results. - (iii) **Allocations between the relevant business activity and other activities.** The reliability of the allocation of costs, income, and assets between the relevant business activity and other activities of the tested party or an uncontrolled comparable will affect the reliability of the determination of operating profit and profit level indicators. If it is not possible to allocate costs, income, and assets directly based on factual relationships, a reasonable allocation formula may be used. To the extent direct allocations are not made, the reliability of the results derived from the application of this method is reduced relative to the results of a method that requires fewer allocations of costs, income, and assets. Similarly, the reliability of the results derived from the application of this method is affected by the extent to which it is possible to apply the profit level indicator to the tested party's financial data that is related solely to the controlled transactions. For example, if the relevant business activity is the assembly of components purchased from both controlled and uncontrolled suppliers, it may not be possible to apply the profit level indicator solely to financial data related to the controlled transactions. In such a case, the reliability of the results derived from the application of this method will be reduced. - (d) **Definitions.** The definitions set forth in [paragraphs (d)(1) through (6)](#d-1..d-6) of this section apply for purposes of this section. - (1) Sales revenue means the amount of the total receipts from sale of goods and provision of services, less returns and allowances. Accounting principles and conventions that are generally accepted in the trade or industry of the controlled taxpayer under review must be used. - (2) Gross profit means sales revenue less cost of goods sold. - (3) **Operating expenses—** includes all expenses not included in cost of goods sold except for interest expense, foreign income taxes (as defined in [§ 1.901-2(a)](/cfr/26/1.901-2.md?p=a)), domestic income taxes, and any other expenses not related to the operation of the relevant business activity. Operating expenses ordinarily include expenses associated with advertising, promotion, sales, marketing, warehousing and distribution, administration, and a reasonable allowance for depreciation and amortization. - (4) Operating profit means gross profit less operating expenses. Operating profit includes all income derived from the business activity being evaluated by the comparable profits method, but does not include interest and dividends, income derived from activities not being tested by this method, or extraordinary gains and losses that do not relate to the continuing operations of the tested party. - (5) Reported operating profit means the operating profit of the tested party reflected on a timely filed U.S. income tax return. If the tested party files a U.S. income tax return, its operating profit is considered reflected on a U.S. income tax return if the calculation of taxable income on its return for the taxable year takes into account the income attributable to the controlled transaction under review. If the tested party does not file a U.S. income tax return, its operating profit is considered reflected on a U.S. income tax return in any taxable year for which income attributable to the controlled transaction under review affects the calculation of the U.S. taxable income of any other member of the same controlled group. If the comparable operating profit of the tested party is determined from profit level indicators derived from financial statements or other accounting records and reports of comparable parties, adjustments may be made to the reported operating profit of the tested party in order to account for material differences between the tested party's operating profit reported for U.S income tax purposes and the tested party's operating profit for financial statement purposes. In addition, in accordance with [§ 1.482-1(f)(2)(iii)(D)](/cfr/26/1.482-1.md?p=f-2-iii-D), adjustments under [section 482](/cfr/26/482.md) that are finally determined may be taken into account in determining reported operating profit. - (6) **Operating assets.** The term operating assets means the value of all assets used in the relevant business activity of the tested party, including fixed assets and current assets (such as cash, cash equivalents, accounts receivable, and inventories). The term does not include investments in subsidiaries, excess cash, and portfolio investments. Operating assets may be measured by their net book value or by their fair market value, provided that the same method is consistently applied to the tested party and the comparable parties, and consistently applied from year to year. In addition, it may be necessary to take into account recent acquisitions, leased assets, intangibles, currency fluctuations, and other items that may not be explicitly recorded in the financial statements of the tested party or uncontrolled comparable. Finally, operating assets must be measured by the average of the values for the beginning of the year and the end of the year, unless substantial fluctuations in the value of operating assets during the year make this an inaccurate measure of the average value over the year. In such a case, a more accurate measure of the average value of operating assets must be applied. - (e) **Examples.** The following examples illustrate the application of this section. # §1.482-6. Profit split method. - (a) **In general.** The profit split method evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined operating profit or loss. The combined operating profit or loss must be derived from the most narrowly identifiable business activity of the controlled taxpayers for which data is available that includes the controlled transactions (relevant business activity). - (b) **Appropriate share of profits and losses.** The relative value of each controlled taxpayer's contribution to the success of the relevant business activity must be determined in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity, consistent with the comparability provisions of [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3). Such an allocation is intended to correspond to the division of profit or loss that would result from an arrangement between uncontrolled taxpayers, each performing functions similar to those of the various controlled taxpayers engaged in the relevant business activity. The profit allocated to any particular member of a controlled group is not necessarily limited to the total operating profit of the group from the relevant business activity. For example, in a given year, one member of the group may earn a profit while another member incurs a loss. In addition, it may not be assumed that the combined operating profit or loss from the relevant business activity should be shared equally, or in any other arbitrary proportion. The specific method of allocation must be determined under [paragraph (c)](#c) of this section. - (c) **Application—** - (1) **In general.** The allocation of profit or loss under the profit split method must be made in accordance with one of the following allocation methods—(i) The comparable profit split, described in [paragraph (c)(2)](#c-2) of this section; or - (ii) **The residual profit split, described in paragraph (c)(3) of this section.** - (2) **Comparable profit split—** - (i) **In general.** A comparable profit split is derived from the combined operating profit of uncontrolled taxpayers whose transactions and activities are similar to those of the controlled taxpayers in the relevant business activity. Under this method, each uncontrolled taxpayer's percentage of the combined operating profit or loss is used to allocate the combined operating profit or loss of the relevant business activity. - (ii) **Comparability and reliability considerations—(A) In general.** Whether results derived from application of this method are the most reliable measure of the arm's length result is determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). - (B) **Comparability—** (1) In general. The degree of comparability between the controlled and uncontrolled taxpayers is determined by applying the comparability provisions of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d). The comparable profit split compares the division of operating profits among the controlled taxpayers to the division of operating profits among uncontrolled taxpayers engaged in similar activities under similar circumstances. Although all of the factors described in [§ 1.482-1(d)(3)](/cfr/26/1.482-1.md?p=d-3) must be considered, comparability under this method is particularly dependent on the considerations described under the comparable profits method in [§ 1.482-5(c)(2)](/cfr/26/1.482-5.md?p=c-2) or [§ 1.482-9(f)(2)(iii)](/cfr/26/1.482-9.md?p=f-2-iii) because this method is based on a comparison of the operating profit of the controlled and uncontrolled taxpayers. In addition, because the contractual terms of the relationship among the participants in the relevant business activity will be a principal determinant of the allocation of functions and risks among them, comparability under this method also depends particularly on the degree of similarity of the contractual terms of the controlled and uncontrolled taxpayers. Finally, the comparable profit split may not be used if the combined operating profit (as a percentage of the combined assets) of the uncontrolled comparables varies significantly from that earned by the controlled taxpayers. (2) Adjustments for differences between the controlled and uncontrolled taxpayers. If there are differences between the controlled and uncontrolled taxpayers that would materially affect the division of operating profit, adjustments must be made according to the provisions of [§ 1.482-1(d)(2)](/cfr/26/1.482-1.md?p=d-2). - (C) **Data and assumptions.** The reliability of the results derived from the comparable profit split is affected by the quality of the data and assumptions used to apply this method. In particular, the following factors must be considered— (1) The reliability of the allocation of costs, income, and assets between the relevant business activity and the participants' other activities will affect the accuracy of the determination of combined operating profit and its allocation among the participants. If it is not possible to allocate costs, income, and assets directly based on factual relationships, a reasonable allocation formula may be used. To the extent direct allocations are not made, the reliability of the results derived from the application of this method is reduced relative to the results of a method that requires fewer allocations of costs, income, and assets. Similarly, the reliability of the results derived from the application of this method is affected by the extent to which it is possible to apply the method to the parties' financial data that is related solely to the controlled transactions. For example, if the relevant business activity is the assembly of components purchased from both controlled and uncontrolled suppliers, it may not be possible to apply the method solely to financial data related to the controlled transactions. In such a case, the reliability of the results derived from the application of this method will be reduced. (2) The degree of consistency between the controlled and uncontrolled taxpayers in accounting practices that materially affect the items that determine the amount and allocation of operating profit affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect operating profit, the ability to make reliable adjustments for such differences would affect the reliability of the results. Further, accounting consistency among the participants in the controlled transaction is required to ensure that the items determining the amount and allocation of operating profit are measured on a consistent basis. - (D) **Other factors affecting reliability.** Like the methods described in §§ [1.482-3](/cfr/26/1.482-3.md), [1.482-4](/cfr/26/1.482-4.md), [1.482-5](/cfr/26/1.482-5.md), and [1.482-9](/cfr/26/1.482-9.md), the comparable profit split relies exclusively on external market benchmarks. As indicated in [§ 1.482-1(c)(2)(i)](/cfr/26/1.482-1.md?p=c-2-i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the comparable profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results. - (3) **Residual profit split—** - (i) **In general.** Under this method, the combined operating profit or loss from the relevant business activity is allocated between the controlled taxpayers following the two-step process set forth in paragraphs [(c)(3)(i)(A)](#c-3-i-A) and [(B)](#c-3-i-B) of this section. - (A) **Allocate income to routine contributions.** The first step allocates operating income to each party to the controlled transactions to provide a market return for its routine contributions to the relevant business activity. Routine contributions are contributions of the same or a similar kind to those made by uncontrolled taxpayers involved in similar business activities for which it is possible to identify market returns. Routine contributions ordinarily include contributions of tangible property, services and intangible property that are generally owned by uncontrolled taxpayers engaged in similar activities. A functional analysis is required to identify these contributions according to the functions performed, risks assumed, and resources employed by each of the controlled taxpayers. Market returns for the routine contributions should be determined by reference to the returns achieved by uncontrolled taxpayers engaged in similar activities, consistent with the methods described in §§ [1.482-3](/cfr/26/1.482-3.md), [1.482-4](/cfr/26/1.482-4.md), [1.482-5](/cfr/26/1.482-5.md) and [1.482-9](/cfr/26/1.482-9.md). - (B) **Allocate residual profit—** (1) Nonroutine contributions generally. The allocation of income to the controlled taxpayer's routine contributions will not reflect profits attributable to each controlled taxpayer's contributions to the relevant business activity that are not routine (nonroutine contributions). A nonroutine contribution is a contribution that is not accounted for as a routine contribution. Thus, in cases where such nonroutine contributions are present, there normally will be an unallocated residual profit after the allocation of income described in [paragraph (c)(3)(i)(A)](#c-3-i-A) of this section. Under this second step, the residual profit generally should be divided among the controlled taxpayers based upon the relative value of their nonroutine contributions to the relevant business activity. The relative value of the nonroutine contributions of each taxpayer should be measured in a manner that most reliably reflects each nonroutine contribution made to the controlled transaction and each controlled taxpayer's role in the nonroutine contributions. If the nonroutine contribution by one of the controlled taxpayers is also used in other business activities (such as transactions with other controlled taxpayers), an appropriate allocation of the value of the nonroutine contribution must be made among all the business activities in which it is used. (2) Nonroutine contributions of intangible property. In many cases, nonroutine contributions of a taxpayer to the relevant business activity may be contributions of intangible property. For purposes of paragraph (c)(3)(i)(B)(1) of this section, the relative value of nonroutine intangible property contributed by taxpayers may be measured by external market benchmarks that reflect the fair market value of such intangible property. Alternatively, the relative value of nonroutine intangible property contributions may be estimated by the capitalized cost of developing the intangible property and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible property. Finally, if the intangible property development expenditures of the parties are relatively constant over time and the useful life of the intangible property contributed by all parties is approximately the same, the amount of actual expenditures in recent years may be used to estimate the relative value of nonroutine intangible property contributions. - (ii) **Comparability and reliability considerations—** - (A) **In general.** Whether results derived from this method are the most reliable measure of the arm's length result is determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). Thus, comparability and the quality of data and assumptions must be considered in determining whether this method provides the most reliable measure of an arm's length result. The application of these factors to the residual profit split is discussed in paragraph [(c)(3)(ii)(B)](#c-3-ii-B), [(C)](#c-3-ii-C), and [(D)](#c-3-ii-D) of this section. - (B) **Comparability.** The first step of the residual profit split relies on market benchmarks of profitability. Thus, the comparability considerations that are relevant for the first step of the residual profit split are those that are relevant for the methods that are used to determine market returns for the routine contributions. The second step of the residual profit split, however, may not rely so directly on market benchmarks. Thus, the reliability of the results under this method is reduced to the extent that the allocation of profits in the second step does not rely on market benchmarks. - (C) **Data and assumptions.** The reliability of the results derived from the residual profit split is affected by the quality of the data and assumptions used to apply this method. In particular, the following factors must be considered— (1) The reliability of the allocation of costs, income, and assets as described in paragraph (c)(2)(ii)(C)(1) of this section; (2) Accounting consistency as described in paragraph (c)(2)(ii)(C)(2) of this section; (3) The reliability of the data used and the assumptions made in valuing the intangible property contributed by the participants. In particular, if capitalized costs of development are used to estimate the value of intangible property, the reliability of the results is reduced relative to the reliability of other methods that do not require such an estimate, for the following reasons. First, in any given case, the costs of developing the intangible may not be related to its market value. Second, the calculation of the capitalized costs of development may require the allocation of indirect costs between the relevant business activity and the controlled taxpayer's other activities, which may affect the reliability of the analysis. Finally, the calculation of costs may require assumptions regarding the useful life of the intangible property. - (D) **Other factors affecting reliability.** Like the methods described in §§ [1.482-3](/cfr/26/1.482-3.md), [1.482-4](/cfr/26/1.482-4.md), [1.482-5](/cfr/26/1.482-5.md), and [1.482-9](/cfr/26/1.482-9.md), the first step of the residual profit split relies exclusively on external market benchmarks. As indicated in [§ 1.482-1(c)(2)(i)](/cfr/26/1.482-1.md?p=c-2-i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, to the extent the allocation of profits in the second step is not based on external market benchmarks, the reliability of the analysis will be decreased in relation to an analysis under a method that relies on market benchmarks. Finally, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the residual profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results. - (iii) **Example.** The provisions of this [paragraph (c)(3)](#c-3) are illustrated by the following example. - (d) **Effective/applicability date—** - (1) **In general.** The provisions of paragraphs (c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section are generally applicable for taxable years beginning after July 31, 2009. - (2) **Election to apply regulation to earlier taxable years.** A person may elect to apply the provisions of paragraphs (c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section to earlier taxable years in accordance with the rules set forth in [§ 1.482-9(n)(2)](/cfr/26/1.482-9.md?p=n-2). # §1.482-7. Methods to determine taxable income in connection with a cost sharing arrangement. - (a) **In general.** The arm's length amount charged in a controlled transaction reasonably anticipated to contribute to developing intangibles pursuant to a cost sharing arrangement (CSA), as described in [paragraph (b)](#b) of this section, must be determined under a method described in this section. Each method must be applied in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md), except as those provisions are modified in this section. - (1) **RAB share method for cost sharing transactions (CSTs).** See [paragraph (b)(1)(i)](#b-1-i) of this section regarding the requirement that controlled participants, as defined in section (j)(1)(i) of this section, share intangible development costs (IDCs) in proportion to their shares of reasonably anticipated benefits (RAB shares) by entering into cost sharing transactions (CSTs). - (2) **Methods for platform contribution transactions (PCTs).** The arm's length amount charged in a platform contribution transaction (PCT) described in [paragraph (b)(1)(ii)](#b-1-ii) of this section must be determined under the method or methods applicable under the other section or sections of the [section 482](/cfr/26/482.md) regulations, as supplemented by [paragraph (g)](#g) of this section. See [§ 1.482-1(b)(2)(ii)](/cfr/26/1.482-1.md?p=b-2-ii) (Selection of category of method applicable to transaction), [§ 1.482-1(b)(2)(iii)](/cfr/26/1.482-1.md?p=b-2-iii) (Coordination of methods applicable to certain intangible development arrangements), and [paragraph (g)](#g) of this section (Supplemental guidance on methods applicable to PCTs). - (3) **Methods for other controlled transactions—** - (i) **Contribution to a CSA by a controlled taxpayer that is not a controlled participant.** If a controlled taxpayer that is not a controlled participant contributes to developing a cost shared intangible, as defined in section (j)(1)(i) of this section, it must receive consideration from the controlled participants under the rules of [§ 1.482-4(f)(4)](/cfr/26/1.482-4.md?p=f-4) (Contribution to the value of an intangible owned by another). Such consideration will be treated as an intangible development cost for purposes of [paragraph (d)](#d) of this section. - (ii) **Transfer of interest in a cost shared intangible.** If at any time (during the term, or upon or after the termination, of a CSA) a controlled participant transfers an interest in a cost shared intangible to another controlled taxpayer, the controlled participant must receive an arm's length amount of consideration from the transferee under the rules of [§§ 1.482-4 through 1.482-6](/cfr/26/1.482-4..1.482-6.md) as supplemented by [paragraph (f)(4)](#f-4) of this section regarding arm's length consideration for a change in participation. For this purpose, a capability variation described in [paragraph (f)(3)](#f-3) of this section is considered to be a controlled transfer of interests in cost shared intangibles. - (iii) **Other controlled transactions in connection with a CSA.** Controlled transactions between controlled participants that are not PCTs or CSTs and are not described in [paragraph (a)(3)(ii)](#a-3-ii) of this section (for example, provision of a cross operating contribution, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section, or make-or-sell rights, as defined in [paragraph (c)(4)](#c-4) of this section) require arm's length consideration under the rules of §§ [1.482-1 through 1.482-6](/cfr/26/1.482-1..1.482-6.md), and [1.482-9](/cfr/26/1.482-9.md) as supplemented by [paragraph (g)(2)(iv)](#g-2-iv) of this section. - (iv) **Controlled transactions in the absence of a CSA.** If a controlled transaction is reasonably anticipated to contribute to developing intangibles pursuant to an arrangement that is not a CSA described in paragraph [(b)(1)](#b-1) or [(5)](#b-5) of this section, whether the results of any such controlled transaction are consistent with an arm's length result must be determined under the applicable rules of the other sections of the regulations under [section 482](/cfr/26/482.md). For example, an arrangement for developing intangibles in which one controlled taxpayer's costs of developing the intangibles significantly exceeds its share of reasonably anticipated benefits from exploiting the developed intangibles would not in substance be a CSA, as described in [paragraphs (b)(1)(i) through (iii)](#b-1-i..b-1-iii) of this section or [paragraph (b)(5)(i)](#b-5-i) of this section. In such a case, unless the rules of this section are applicable by reason of [paragraph (b)(5)](#b-5) of this section, the arrangement must be analyzed under other applicable sections of regulations under [section 482](/cfr/26/482.md) to determine whether it achieves arm's length results, and if not, to determine any allocations by the Commissioner that are consistent with such other regulations under [section 482](/cfr/26/482.md). See [§ 1.482-1(b)(2)(ii)](/cfr/26/1.482-1.md?p=b-2-ii) (Selection of category of method applicable to transaction) and (iii) (Coordination of methods applicable to certain intangible development arrangements). - (4) **Coordination with the arm's length standard.** A CSA produces results that are consistent with an arm's length result within the meaning of [§ 1.482-1(b)(1)](/cfr/26/1.482-1.md?p=b-1) if, and only if, each controlled participant's IDC share (as determined under [paragraph (d)(4)](#d-4) of this section) equals its RAB share, each controlled participant compensates its RAB share of the value of all platform contributions by other controlled participants, and all other requirements of this section are satisfied. - (b) **Cost sharing arrangement.** A cost sharing arrangement is an arrangement by which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their RAB shares. An arrangement is a CSA if and only if the requirements of [paragraphs (b)(1) through (4)](#b-1..b-4) of this section are met. - (1) **Substantive requirements—** - (i) **CSTs.** All controlled participants must commit to, and in fact, engage in cost sharing transactions. In CSTs, the controlled participants make payments to each other (CST Payments) as appropriate, so that in each taxable year each controlled participant's IDC share is in proportion to its respective RAB share. - (ii) **PCTs.** All controlled participants must commit to, and in fact, engage in platform contributions transactions to the extent that there are platform contributions pursuant to [paragraph (c)](#c) of this section. In a PCT, each other controlled participant (PCT Payor) is obligated to, and must in fact, make arm's length payments (PCT Payments) to each controlled participant (PCT Payee) that provides a platform contribution. For guidance on determining such arm's length obligation, see [paragraph (g)](#g) of this section. - (iii) **Divisional interests.** Each controlled participant must receive a non-overlapping interest in the cost shared intangibles without further obligation to compensate another controlled participant for such interest. - (iv) **Examples.** The following examples illustrate the principles of this [paragraph (b)(1)](#b-1): - (2) **Administrative requirements.** The CSA must meet the requirements of [paragraph (k)](#k) of this section. - (3) **Date of a PCT.** The controlled participants must enter into a PCT as of the earliest date on or after the CSA is entered into on which a platform contribution is reasonably anticipated to contribute to developing cost shared intangibles. - (4) **Divisional interests—** - (i) **In general.** Pursuant to [paragraph (b)(1)(iii)](#b-1-iii) of this section, each controlled participant must receive a non-overlapping interest in the cost shared intangibles without further obligation to compensate another controlled participant for such interest. Each controlled participant must be entitled to the perpetual and exclusive right to the profits from transactions of any member of the controlled group that includes the controlled participant with uncontrolled taxpayers to the extent that such profits are attributable to such interest in the cost shared intangibles. - (ii) **Territorial based divisional interests.** The CSA may divide all interests in cost shared intangibles on a territorial basis as follows. The entire world must be divided into two or more non-overlapping geographic territories. Each controlled participant must receive at least one such territory, and in the aggregate all the participants must receive all such territories. Each controlled participant will be assigned the perpetual and exclusive right to exploit the cost shared intangibles through the use, consumption, or disposition of property or services in its territories. Thus, compensation will be required if other members of the controlled group exploit the cost shared intangibles in such territory. - (iii) **Field of use based divisional interests.** The CSA may divide all interests in cost shared intangibles on the basis of all uses (whether or not known at the time of the division) to which cost shared intangibles are to be put as follows. All anticipated uses of cost shared intangibles must be identified. Each controlled participant must be assigned at least one such anticipated use, and in the aggregate all the participants must be assigned all such anticipated uses. Each controlled participant will be assigned the perpetual and exclusive right to exploit the cost shared intangibles through the use or uses assigned to it and one controlled participant must be assigned the exclusive and perpetual right to exploit cost shared intangibles through any unanticipated uses. - (iv) **Other divisional bases.** - (A) In the event that the CSA does not divide interests in the cost shared intangibles on the basis of exclusive territories or fields of use as described in paragraphs [(b)(4)(ii)](#b-4-ii) and [(iii)](#b-4-iii) of this section, the CSA may adopt some other basis on which to divide all interests in the cost shared intangibles among the controlled participants, provided that each of the following criteria is met: (1) The basis clearly and unambiguously divides all interests in cost shared intangibles among the controlled participants. (2) The consistent use of such basis for the division of all interests in the cost shared intangibles can be dependably verified from the records maintained by the controlled participants. (3) The rights of the controlled participants to exploit cost shared intangibles are non-overlapping, exclusive, and perpetual. (4) The resulting benefits associated with each controlled participant's interest in cost shared intangibles are predictable with reasonable reliability. - (B) See [paragraph (f)(3)](#f-3) of this section for rules regarding the requirement of arm's length consideration for changes in participation in CSAs involving divisions of interest described in this [paragraph (b)(4)(iv)](#b-4-iv). - (v) **Examples.** The following examples illustrate the principles of this [paragraph (b)(4)](#b-4): - (5) **Treatment of certain arrangements as CSAs—** - (i) **Situation in which Commissioner must treat arrangement as a CSA.** The Commissioner must apply the rules of this section to an arrangement among controlled taxpayers if the administrative requirements of [paragraph (b)(2)](#b-2) of this section are met with respect to such arrangement and the controlled taxpayers reasonably concluded that such arrangement was a CSA meeting the requirements of paragraphs [(b)(1)](#b-1), [(3)](#b-3), and [(4)](#b-4) of this section. - (ii) **Situation in which Commissioner may treat arrangement as a CSA.** For arrangements among controlled taxpayers not described in [paragraph (b)(5)(i)](#b-5-i) of this section, the Commissioner may apply the provisions of this section if the Commissioner concludes that the administrative requirements of [paragraph (b)(2)](#b-2) of this section are met, and, notwithstanding technical failure to meet the substantive requirements of paragraph [(b)(1)](#b-1), [(3)](#b-3), or [(4)](#b-4) of this section, the rules of this section will provide the most reliable measure of an arm's length result. See [§ 1.482-1(c)(1)](/cfr/26/1.482-1.md?p=c-1) (the best method rule). For purposes of applying this [paragraph (b)(5)(ii)](#b-5-ii), any such arrangement shall be interpreted by reference to [paragraph (k)(1)(iv)](#k-1-iv) of this section. - (iii) **Examples.** The following examples illustrate the principles of this [paragraph (b)(5)](#b-5). In the examples, assume that Companies P and S are both members of the same controlled group. - (6) **Entity classification of CSAs.** See [§ 301.7701-1(c)](/cfr/26/301.7701-1.md?p=c) of this chapter for the classification of CSAs for purposes of the Internal Revenue Code. - (c) **Platform contributions—** - (1) **In general.** A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity (whether prior to or during the course of the CSA) that is reasonably anticipated to contribute to developing cost shared intangibles. The determination whether a resource, capability, or right is reasonably anticipated to contribute to developing cost shared intangibles is ongoing and based on the best available information. Therefore, a resource, capability, or right reasonably determined not to be a platform contribution as of an earlier point in time, may be reasonably determined to be a platform contribution at a later point in time. The PCT obligation regarding a resource or capability or right once determined to be a platform contribution does not terminate merely because it may later be determined that such resource or capability or right has not contributed, and no longer is reasonably anticipated to contribute, to developing cost shared intangibles. Notwithstanding the other provisions of this [paragraph (c)](#c), platform contributions do not include rights in land or depreciable tangible property, and do not include rights in other resources acquired by IDCs. See [paragraph (d)(1)](#d-1) of this section. - (2) **Terms of platform contributions—** - (i) **Presumed to be exclusive.** For purposes of a PCT, the PCT Payee's provision of a platform contribution is presumed to be exclusive. Thus, it is presumed that the platform resource, capability, or right is not reasonably anticipated to be committed to any business activities other than the CSA Activity, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section, whether carried out by the controlled participants, other controlled taxpayers, or uncontrolled taxpayers. - (ii) **Rebuttal of exclusivity.** The controlled participants may rebut the presumption set forth in [paragraph (c)(2)(i)](#c-2-i) of this section to the satisfaction of the Commissioner. For example, if the platform resource is a research tool, then the controlled participants could rebut the presumption by establishing to the satisfaction of the Commissioner that, as of the date of the PCT, the tool is reasonably anticipated not only to contribute to the CSA Activity but also to be licensed to an uncontrolled taxpayer. In such case, the PCT Payments may need to be prorated as described in [paragraph (c)(2)(iii)](#c-2-iii) of this section. - (iii) **Proration of PCT Payments to the extent allocable to other business activities—** - (A) **In general.** Some transfer pricing methods employed to determine the arm's length amount of the PCT Payments do so by considering the overall value of the platform contributions as opposed to, for example, the value of the anticipated use of the platform contributions in the CSA Activity. Such a transfer pricing method is consistent with the presumption that the platform contribution is exclusive (that is, that the resources, capabilities or rights that are the subject of a platform contribution are reasonably anticipated to contribute only to the CSA Activity). See [paragraph (c)(2)(i)](#c-2-i) (Terms of platform contributions—Presumed to be exclusive) of this section. The PCT Payments determined under such transfer pricing method may have to be prorated if the controlled participants can rebut the presumption that the platform contribution is exclusive to the satisfaction of the Commissioner as provided in [paragraph (c)(2)(ii)](#c-2-ii) of this section. In the case of a platform contribution that also contributes to lines of business of a PCT Payor that are not reasonably anticipated to involve exploitation of the cost shared intangibles, the need for explicit proration may in some cases be avoided through aggregation of transactions. See [paragraph (g)(2)(iv)](#g-2-iv) of this section (Aggregation of transactions). - (B) **Determining the proration of PCT Payments.** Proration will be done on a reasonable basis in proportion to the relative economic value, as of the date of the PCT, reasonably anticipated to be derived from the platform contribution by the CSA Activity as compared to the value reasonably anticipated to be derived from the platform contribution by other business activities. In the case of an aggregate valuation done under the principles of [paragraph (g)(2)(iv)](#g-2-iv) of this section that addresses payment for resources, capabilities, or rights used for business activities other than the CSA Activity (for example, the right to exploit an existing intangible without further development), the proration of the aggregate payments may have to reflect the economic value attributable to such resources, capabilities, or rights as well. For purposes of the best method rule under [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c), the reliability of the analysis under a method that requires proration pursuant to this paragraph is reduced relative to the reliability of an analysis under a method that does not require proration. - (3) **Categorization of the PCT.** For purposes of [§ 1.482-1(b)(2)(ii)](/cfr/26/1.482-1.md?p=b-2-ii) and [paragraph (a)(2)](#a-2) of this section, a PCT must be identified by the controlled participants as a particular type of transaction (for example, a license for royalty payments). See [paragraph (k)(2)(ii)(H)](#k-2-ii-H) of this section. Such designation must be consistent with the actual conduct of the controlled participants. If the conduct is consistent with different, economically equivalent types of transactions then the controlled participants may designate the PCT as being any of such types of transactions. If the controlled participants fail to make such designation in their documentation, the Commissioner may make a designation consistent with the principles of [paragraph (k)(1)(iv)](#k-1-iv) of this section. - (4) **Certain make-or-sell rights excluded—** - (i) **In general.** Any right to exploit an existing resource, capability, or right without further development of such item, such as the right to make, replicate, license, or sell existing products, does not constitute a platform contribution to a CSA (and the arm's length compensation for such rights (make-or-sell rights) does not satisfy the compensation obligation under a PCT) unless exploitation without further development of such item is reasonably anticipated to contribute to developing or further developing a cost shared intangible. - (ii) **Examples.** The following examples illustrate the principles of this [paragraph (c)(4)](#c-4): - (5) **Examples.** The following examples illustrate the principles of this [paragraph (c)](#c). In each example, Companies P and S are members of the same controlled group, and execute a CSA providing that each will have the exclusive right to exploit cost shared intangibles in its own territory. See [paragraph (b)(4)(ii)](#b-4-ii) of this section (Territorial based divisional interests). - (d) **Intangible development costs—** - (1) **Determining whether costs are IDCs.** Costs included in IDCs are determined by reference to the scope of the intangible development activity (IDA). - (i) **Definition and scope of the IDA.** For purposes of this section, the IDA means the activity under the CSA of developing or attempting to develop reasonably anticipated cost shared intangibles. The scope of the IDA includes all of the controlled participants' activities that could reasonably be anticipated to contribute to developing the reasonably anticipated cost shared intangibles. The IDA cannot be described merely by a list of particular resources, capabilities, or rights that will be used in the CSA, because such a list would not identify reasonably anticipated cost shared intangibles. Also, the scope of the IDA may change as the nature or identity of the reasonably anticipated cost shared intangibles changes or the nature of the activities necessary for their development become clearer. For example, the relevance of certain ongoing work to developing reasonably anticipated cost shared intangibles or the need for additional work may only become clear over time. - (ii) **Reasonably anticipated cost shared intangible.** For purposes of this section, reasonably anticipated cost shared intangible means any intangible, within the meaning of [§ 1.482-4(b)](/cfr/26/1.482-4.md?p=b), that, at the applicable point in time, the controlled participants intend to develop under the CSA. Reasonably anticipated cost shared intangibles may change over the course of the CSA. The controlled participants may at any time change the reasonably anticipated cost shared intangibles but must document any such change pursuant to paragraph (k)(2)(ii)(A)(1) of this section. Removal of reasonably anticipated cost shared intangibles does not affect the controlled participants' interests in cost shared intangibles already developed under the CSA. In addition, the reasonably anticipated cost shared intangibles automatically expand to include the intended result of any further development of a cost shared intangible already developed under the CSA, or applications of such an intangible. However, the controlled participants may override this automatic expansion in a particular case if they separately remove specified further development of such intangible (or specified applications of such intangible) from the IDA, and document such separate removal pursuant to paragraph (k)(2)(ii)(A)(3) of this section. - (iii) **Costs included in IDCs.** For purposes of this section, IDCs mean all costs, in cash or in kind (including stock-based compensation, as described in [paragraph (d)(3)](#d-3) of this section), but excluding acquisition costs for land or depreciable property, in the ordinary course of business after the formation of a CSA that, based on analysis of the facts and circumstances, are directly identified with, or are reasonably allocable to, the IDA. Thus, IDCs include costs incurred in attempting to develop reasonably anticipated cost shared intangibles regardless of whether such costs ultimately lead to development of those intangibles, other intangibles developed unexpectedly, or no intangibles. IDCs shall also include the arm's length rental charge for the use of any land or depreciable tangible property (as determined under [§ 1.482-2(c)](/cfr/26/1.482-2.md?p=c) (Use of tangible property)) directly identified with, or reasonably allocable to, the IDA. Reference to generally accepted accounting principles or Federal income tax accounting rules may provide a useful starting point but will not be conclusive regarding inclusion of costs in IDCs. IDCs do not include interest expense, foreign income taxes (as defined in [§ 1.901-2(a)](/cfr/26/1.901-2.md?p=a)), or domestic income taxes. - (iv) **Examples.** The following examples illustrate the principles of this [paragraph (d)(1)](#d-1): - (2) **Allocation of costs.** If a particular cost is directly identified with, or reasonably allocable to, a function the results of which will benefit both the IDA and other business activities, the cost must be allocated on a reasonable basis between the IDA and such other business activities in proportion to the relative economic value that the IDA and such other business activities are anticipated to derive from such results. - (3) **Stock-based compensation—** - (i) **In general.** As used in this section, the term stock-based compensation means any compensation provided by a controlled participant to an employee or independent contractor in the form of equity instruments, options to acquire stock (stock options), or rights with respect to (or determined by reference to) equity instruments or stock options, including but not limited to property to which [section 83](/cfr/26/83.md) applies and stock options to which [section 421](/cfr/26/421.md) applies, regardless of whether ultimately settled in the form of cash, stock, or other property. - (ii) **Identification of stock-based compensation with the IDA.** The determination of whether stock-based compensation is directly identified with, or reasonably allocable to, the IDA is made as of the date that the stock-based compensation is granted. Accordingly, all stock-based compensation that is granted during the term of the CSA and, at date of grant, is directly identified with, or reasonably allocable to, the IDA is included as an IDC under [paragraph (d)(1)](#d-1) of this section. In the case of a repricing or other modification of a stock option, the determination of whether the repricing or other modification constitutes the grant of a new stock option for purposes of this [paragraph (d)(3)(ii)](#d-3-ii) will be made in accordance with the rules of [section 424(h)](/cfr/26/424.md?p=h) and related regulations. - (iii) **Measurement and timing of stock-based compensation IDC—** - (A) **In general.** Except as otherwise provided in this [paragraph (d)(3)(iii)](#d-3-iii), the cost attributable to stock-based compensation is equal to the amount allowable to the controlled participant as a deduction for federal income tax purposes with respect to that stock-based compensation (for example, under [section 83(h)](/cfr/26/83.md?p=h)) and is taken into account as an IDC under this section for the taxable year for which the deduction is allowable. (1) Transfers to which [section 421](/cfr/26/421.md) applies. Solely for purposes of this [paragraph (d)(3)(iii)(A)](#d-3-iii-A), [section 421](/cfr/26/421.md) does not apply to the transfer of stock pursuant to the exercise of an option that meets the requirements of section [422(a)](/cfr/26/422.md?p=a) or [423(a)](/cfr/26/423.md?p=a). (2) Deductions of foreign controlled participants. Solely for purposes of this [paragraph (d)(3)(iii)(A)](#d-3-iii-A), an amount is treated as an allowable deduction of a foreign controlled participant to the extent that a deduction would be allowable to a United States taxpayer. (3) Modification of stock option. Solely for purposes of this [paragraph (d)(3)(iii)(A)](#d-3-iii-A), if the repricing or other modification of a stock option is determined, under [paragraph (d)(3)(ii)](#d-3-ii) of this section, to constitute the grant of a new stock option not identified with, or reasonably allocable to, the IDA, the stock option that is repriced or otherwise modified will be treated as being exercised immediately before the modification, provided that the stock option is then exercisable and the fair market value of the underlying stock then exceeds the price at which the stock option is exercisable. Accordingly, the amount of the deduction that would be allowable (or treated as allowable under this [paragraph (d)(3)(iii)(A)](#d-3-iii-A)) to the controlled participant upon exercise of the stock option immediately before the modification must be taken into account as an IDC as of the date of the modification. (4) Expiration or termination of CSA. Solely for purposes of this [paragraph (d)(3)(iii)(A)](#d-3-iii-A), if an item of stock-based compensation identified with, or reasonably allocable to, the IDA is not exercised during the term of a CSA, that item of stock-based compensation will be treated as being exercised immediately before the expiration or termination of the CSA, provided that the stock-based compensation is then exercisable and the fair market value of the underlying stock then exceeds the price at which the stock-based compensation is exercisable. Accordingly, the amount of the deduction that would be allowable (or treated as allowable under this [paragraph (d)(3)(iii)(A)](#d-3-iii-A)) to the controlled participant upon exercise of the stock-based compensation must be taken into account as an IDC as of the date of the expiration or termination of the CSA. - (B) **Election with respect to options on publicly traded stock—** (1) In general. With respect to stock-based compensation in the form of options on publicly traded stock, the controlled participants in a CSA may elect to take into account all IDCs attributable to those stock options in the same amount, and as of the same time, as the fair value of the stock options reflected as a charge against income in audited financial statements or disclosed in footnotes to such financial statements, provided that such statements are prepared in accordance with United States generally accepted accounting principles by or on behalf of the company issuing the publicly traded stock. (2) Publicly traded stock. As used in this [paragraph (d)(3)(iii)(B)](#d-3-iii-B), the term publicly traded stock means stock that is regularly traded on an established United States securities market and is issued by a company whose financial statements are prepared in accordance with United States generally accepted accounting principles for the taxable year. (3) Generally accepted accounting principles. For purposes of this [paragraph (d)(3)(iii)(B)](#d-3-iii-B), a financial statement prepared in accordance with a comprehensive body of generally accepted accounting principles other than United States generally accepted accounting principles is considered to be prepared in accordance with United States generally accepted accounting principles provided that either— (i) The fair value of the stock options under consideration is reflected in the reconciliation between such other accounting principles and United States generally accepted accounting principles required to be incorporated into the financial statement by the securities laws governing companies whose stock is regularly traded on United States securities markets; or (ii) In the absence of a reconciliation between such other accounting principles and United States generally accepted accounting principles that reflects the fair value of the stock options under consideration, such other accounting principles require that the fair value of the stock options under consideration be reflected as a charge against income in audited financial statements or disclosed in footnotes to such statements. (4) Time and manner of making the election. The election described in this [paragraph (d)(3)(iii)(B)](#d-3-iii-B) is made by an explicit reference to the election in the written contract required by [paragraph (k)(1)](#k-1) of this section or in a written amendment to the CSA entered into with the consent of the Commissioner pursuant to [paragraph (d)(3)(iii)(C)](#d-3-iii-C) of this section. In the case of a CSA in existence on August 26, 2003, the election by written amendment to the CSA may be made without the consent of the Commissioner if such amendment is entered into not later than the latest due date (with regard to extensions) of a federal income tax return of any controlled participant for the first taxable year beginning after August 26, 2003. - (C) **Consistency.** Generally, all controlled participants in a CSA taking options on publicly traded stock into account under paragraph [(d)(3)(ii)](#d-3-ii), [(d)(3)(iii)(A)](#d-3-iii-A), or [(d)(3)(iii)(B)](#d-3-iii-B) of this section must use that same method of identification, measurement and timing for all options on publicly traded stock with respect to that CSA. Controlled participants may change their method only with the consent of the Commissioner and only with respect to stock options granted during taxable years subsequent to the taxable year in which the Commissioner's consent is obtained. All controlled participants in the CSA must join in requests for the Commissioner's consent under this [paragraph (d)(3)(iii)(C)](#d-3-iii-C). Thus, for example, if the controlled participants make the election described in [paragraph (d)(3)(iii)(B)](#d-3-iii-B) of this section upon the formation of the CSA, the election may be revoked only with the consent of the Commissioner, and the consent will apply only to stock options granted in taxable years subsequent to the taxable year in which consent is obtained. Similarly, if controlled participants already have granted stock options that have been or will be taken into account under the general rule of [paragraph (d)(3)(iii)(A)](#d-3-iii-A) of this section, then except in cases specified in the last sentence of paragraph (d)(3)(iii)(B)(4) of this section, the controlled participants may make the election described in [paragraph (d)(3)(iii)(B)](#d-3-iii-B) of this section only with the consent of the Commissioner, and the consent will apply only to stock options granted in taxable years subsequent to the taxable year in which consent is obtained. - (4) **IDC share.** A controlled participant's IDC share for a taxable year is equal to the controlled participant's cost contribution for the taxable year, divided by the sum of all IDCs for the taxable year. A controlled participant's cost contribution for a taxable year means all of the IDCs initially borne by the controlled participant, plus all of the CST Payments that the participant makes to other controlled participants, minus all of the CST Payments that the participant receives from other controlled participants. - (5) **Examples.** The following examples illustrate this [paragraph (d)](#d): - (e) **Reasonably anticipated benefits share—** - (1) **Definition—** - (i) **In general.** A controlled participant's share of reasonably anticipated benefits is equal to its reasonably anticipated benefits divided by the sum of the reasonably anticipated benefits, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section, of all the controlled participants. RAB shares must be updated to account for changes in economic conditions, the business operations and practices of the participants, and the ongoing development of intangibles under the CSA. For purposes of determining RAB shares at any given time, reasonably anticipated benefits must be estimated over the entire period, past and future, of exploitation of the cost shared intangibles, and must reflect appropriate updates to take into account the most reliable data regarding past and projected future results available at such time. RAB shares determined for a particular purpose shall not be further updated for that purpose based on information not available at the time that determination needed to be made. For example, RAB shares determined in order to determine IDC shares for a particular taxable year (as set forth in paragraphs [(b)(1)(i)](#b-1-i) and (d)(4) of this section) shall not be recomputed based on information not available at that time. Similarly, RAB shares determined for the purpose of using a particular method such as the acquisition price method (as set forth in [paragraph (g)(5)(ii)](#g-5-ii) of this section) to evaluate the arm's length amount charged in a PCT shall not be recomputed based on information not available at the date of that PCT. However, nothing in this [paragraph (e)(1)(i)](#e-1-i) shall limit the Commissioner's use of subsequently available information for purposes of its allocation determinations in accordance with the provisions of paragraph (i) (Allocations by the Commissioner in connection with a CSA) of this section. - (ii) **Reliability.** A controlled participant's RAB share must be determined by using the most reliable estimate. In determining which of two or more available estimates is most reliable, the quality of the data and assumptions used in the analysis must be taken into account, consistent with [§ 1.482-1(c)(2)(ii)](/cfr/26/1.482-1.md?p=c-2-ii) (Data and assumptions). Thus, the reliability of an estimate will depend largely on the completeness and accuracy of the data, the soundness of the assumptions, and the relative effects of particular deficiencies in data or assumptions on different estimates. If two estimates are equally reliable, no adjustment should be made based on differences between the estimates. The following factors will be particularly relevant in determining the reliability of an estimate of RAB shares: - (A) **The basis used for measuring benefits, as described in paragraph (e)(2)(ii) of this section.** - (B) **The projections used to estimate benefits, as described in paragraph (e)(2)(iii) of this section.** - (iii) **Examples.** The following examples illustrate the principles of this [paragraph (e)(1)](#e-1): - (2) **Measure of benefits—** - (i) **In general.** In order to estimate a controlled participant's RAB share, the amount of each controlled participant's reasonably anticipated benefits must be measured on a basis that is consistent for all such participants. See [paragraph (e)(2)(ii)(E)](#e-2-ii-E) Example 9 of this section. If a controlled participant transfers a cost shared intangible to another controlled taxpayer, other than by way of a transfer described in [paragraph (f)](#f) of this section, that controlled participant's benefits from the transferred intangible must be measured by reference to the transferee's benefits, disregarding any consideration paid by the transferee to the controlled participant (such as a royalty pursuant to a license agreement). Reasonably anticipated benefits are measured either on a direct basis, by reference to estimated benefits to be generated by the use of cost shared intangibles (generally based on additional revenues plus cost savings less any additional costs incurred), or on an indirect basis, by reference to certain measurements that reasonably can be assumed to relate to benefits to be generated. Such indirect bases of measurement of anticipated benefits are described in [paragraph (e)(2)(ii)](#e-2-ii) of this section. A controlled participant's reasonably anticipated benefits must be measured on the basis, whether direct or indirect, that most reliably determines RAB shares. In determining which of two bases of measurement is most reliable, the factors set forth in [§ 1.482-1(c)(2)(ii)](/cfr/26/1.482-1.md?p=c-2-ii) (Data and assumptions) must be taken into account. It normally will be expected that the basis that provided the most reliable estimate for a particular year will continue to provide the most reliable estimate in subsequent years, absent a material change in the factors that affect the reliability of the estimate. Regardless of whether a direct or indirect basis of measurement is used, adjustments may be required to account for material differences in the activities that controlled participants undertake to exploit their interests in cost shared intangibles. See Examples 4 and 7 of [paragraph (e)(2)(ii)(E)](#e-2-ii-E) of this section. - (ii) **Indirect bases for measuring anticipated benefits.** Indirect bases for measuring anticipated benefits from participation in a CSA include the following: - (A) **Units used, produced, or sold.** Units of items used, produced, or sold by each controlled participant in the business activities in which cost shared intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to the cost shared intangibles per unit of the item or items used, produced, or sold. This circumstance is most likely to arise when the cost shared intangibles are exploited by the controlled participants in the use, production, or sale of substantially uniform items under similar economic conditions. - (B) **Sales.** Sales by each controlled participant in the business activities in which cost shared intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to cost shared intangibles per dollar of sales. This circumstance is most likely to arise if the costs of exploiting cost shared intangibles are not substantial relative to the revenues generated, or if the principal effect of using cost shared intangibles is to increase the controlled participants' revenues (for example, through a price premium on the products they sell) without affecting their costs substantially. Sales by each controlled participant are unlikely to provide a reliable basis for measuring RAB shares unless each controlled participant operates at the same market level (for example, manufacturing, distribution, etc.). - (C) **Operating profit.** Operating profit of each controlled participant from the activities in which cost shared intangibles are exploited, as determined before any expense (including amortization) on account of IDCs, may be used as an indirect basis for measuring anticipated benefits. This basis of measurement will more reliably determine RAB shares to the extent that such profit is largely attributable to the use of cost shared intangibles, or if the share of profits attributable to the use of cost shared intangibles is expected to be similar for each controlled participant. This circumstance is most likely to arise when cost shared intangibles are closely associated with the activity that generates the profit and the activity could not be carried on or would generate little profit without use of those intangibles. - (D) **Other bases for measuring anticipated benefits.** Other bases for measuring anticipated benefits may in some circumstances be appropriate, but only to the extent that there is expected to be a reasonably identifiable relationship between the basis of measurement used and additional revenue generated or net costs saved by the use of cost shared intangibles. For example, a division of costs based on employee compensation would be considered unreliable unless there were a relationship between the amount of compensation and the expected additional revenue generated or net costs saved by the controlled participants from using the cost shared intangibles. - (E) **Examples.** The following examples illustrates this [paragraph (e)(2)(ii)](#e-2-ii): - (iii) **Projections used to estimate benefits—** - (A) **In general.** The reliability of an estimate of RAB shares also depends upon the reliability of projections used in making the estimate. Projections required for this purpose generally include a determination of the time period between the inception of the research and development activities under the CSA and the receipt of benefits, a projection of the time over which benefits will be received, and a projection of the benefits anticipated for each year in which it is anticipated that the cost shared intangible will generate benefits. A projection of the relevant basis for measuring anticipated benefits may require a projection of the factors that underlie it. For example, a projection of operating profits may require a projection of sales, cost of sales, operating expenses, and other factors that affect operating profits. If it is anticipated that there will be significant variation among controlled participants in the timing of their receipt of benefits, and consequently benefit shares are expected to vary significantly over the years in which benefits will be received, it normally will be necessary to use the present value of the projected benefits to reliably determine RAB shares. See [paragraph (g)(2)(v)](#g-2-v) of this section for best method considerations regarding discount rates used for this purpose. If it is not anticipated that benefit shares will significantly change over time, current annual benefit shares may provide a reliable projection of RAB shares. This circumstance is most likely to occur when the CSA is a long-term arrangement, the arrangement covers a wide variety of intangibles, the composition of the cost shared intangibles is unlikely to change, the cost shared intangibles are unlikely to generate unusual profits, and each controlled participant's share of the market is stable. - (B) **Examples.** The following examples illustrate the principles of this [paragraph (e)(2)(iii)](#e-2-iii): - (f) **Changes in participation under a CSA—** - (1) **In general.** A change in participation under a CSA occurs when there is either a controlled transfer of interests or a capability variation. A change in participation requires arm's length consideration under [paragraph (a)(3)(ii)](#a-3-ii) of this section, and as more fully described in this [paragraph (f)](#f). - (2) **Controlled transfer of interests.** A controlled transfer of interests occurs when a participant in a CSA transfers all or part of its interests in cost shared intangibles under the CSA in a controlled transaction, and the transferee assumes the associated obligations under the CSA. For example, a change in the territorial based divisional interests or field of use based divisional interests, as described in [paragraph (b)(4)](#b-4), is a controlled transfer of interests. After the controlled transfer of interests occurs, the CSA will still exist if at least two controlled participants still have interests in the cost shared intangibles. In such a case, the transferee will be treated as succeeding to the transferor's prior history under the CSA as pertains to the transferred interests, including the transferor's cost contributions, benefits derived, and PCT Payments attributable to such rights or obligations. A transfer that would otherwise constitute a controlled transfer of interests for purposes of this [paragraph (f)(2)](#f-2) shall not constitute a controlled transfer of interests if it also constitutes a capability variation for purposes of [paragraph (f)(3)](#f-3) of this section. - (3) **Capability variation.** A capability variation occurs when, in a CSA in which interests in cost shared intangibles are divided as described in [paragraph (b)(4)(iv)](#b-4-iv) of this section, the controlled participants' division of interests or their relative capabilities or capacities to benefit from the cost shared intangibles are materially altered. For purposes of [paragraph (a)(3)(ii)](#a-3-ii) of this section, a capability variation is considered to be a controlled transfer of interests in cost shared intangibles, in which any controlled participant whose RAB share decreases as a result of the capability variation is a transferor, and any controlled participant whose RAB share thus increases is the transferee of the interests in cost shared intangibles. - (4) **Arm's length consideration for a change in participation.** In the event of a change in participation, the arm's length amount of consideration from the transferee, under the rules of §§ [1.482-1](/cfr/26/1.482-1.md) and [1.482-4 through 1.482-6](/cfr/26/1.482-4..1.482-6.md) and [paragraph (a)(3)(ii)](#a-3-ii) of this section, will be determined consistent with the reasonably anticipated incremental change in the returns to the transferee and transferor resulting from such change in participation. Such changes in returns will themselves depend on the reasonably anticipated incremental changes in the benefits from exploiting the cost shared intangibles, IDCs borne, and PCT Payments (if any). However, any arm's length consideration required under this [paragraph (f)(4)](#f-4) with respect to a capability variation shall be reduced as necessary to prevent duplication of an adjustment already performed under paragraph (i)(2)(ii)(A) of this section that resulted from the same capability variation. If an adjustment has been performed already under this [paragraph (f)(4)](#f-4) with respect to a capability variation, then for purposes of any adjustment to be performed under paragraph (i)(2)(ii)(A) of this section, the controlled participants' projected benefit shares referred to in paragraph (i)(2)(ii)(A) of this section shall be considered to be the controlled participants' respective RAB shares after the capability variation occurred. - (5) **Examples.** The following examples illustrate the principles of this [paragraph (f)](#f): - (g) **Supplemental guidance on methods applicable to PCTs—** - (1) **In general.** This [paragraph (g)](#g) provides supplemental guidance on applying the methods listed in this [paragraph (g)(1)](#g-1) for purposes of evaluating the arm's length amount charged in a PCT. Each method will yield a value for the compensation obligation of each PCT Payor consistent with the product of the combined pre-tax value to all controlled participants of the platform contribution that is the subject of the PCT and the PCT Payor's RAB share. Each method must yield results consistent with measuring the value of a platform contribution by reference to the future income anticipated to be generated by the resulting cost shared intangibles. The methods are— - (i) The comparable uncontrolled transaction method described in [§ 1.482-4(c)](/cfr/26/1.482-4.md?p=c), or the comparable uncontrolled services price method described in [§ 1.482-9(c)](/cfr/26/1.482-9.md?p=c), as further described in [paragraph (g)(3)](#g-3) of this section; - (ii) The income method, described in [paragraph (g)(4)](#g-4) of this section; - (iii) The acquisition price method, described in [paragraph (g)(5)](#g-5) of this section; - (iv) The market capitalization method, described in [paragraph (g)(6)](#g-6) of this section; - (v) The residual profit split method, described in [paragraph (g)(7)](#g-7) of this section; and - (vi) **Unspecified methods, described in paragraph (g)(8) of this section.** - (2) **Best method analysis applicable for evaluation of a PCT pursuant to a CSA—** - (i) **In general.** Each method must be applied in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md), including the best method rule of [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c), the comparability analysis of [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d), and the arm's length range of [§ 1.482-1(e)](/cfr/26/1.482-1.md?p=e), except as those provisions are modified in this [paragraph (g)](#g). - (ii) **Consistency with upfront contractual terms and risk allocation—the investor model—** - (A) **In general.** Although all of the factors entering into a best method analysis described in § [1.482-1(c)](/cfr/26/1.482-1.md?p=c) and [(d)](/cfr/26/1.482-1.md?p=d) must be considered, specific factors may be particularly relevant in the context of a CSA. In particular, the relative reliability of an application of any method depends on the degree of consistency of the analysis with the applicable contractual terms and allocation of risk under the CSA and this section among the controlled participants as of the date of the PCT, unless a change in such terms or allocation has been made in return for arm's length consideration. In this regard, a CSA involves an upfront division of the risks as to both reasonably anticipated obligations and reasonably anticipated benefits over the reasonably anticipated term of the CSA Activity. Accordingly, the relative reliability of an application of a method also depends on the degree of consistency of the analysis with the assumption that, as of the date of the PCT, each controlled participant's aggregate net investment in the CSA Activity (including platform contributions, operating contributions, as such term is defined in [paragraph (j)(1)(i)](#j-1-i) of this section, operating cost contributions, as such term is defined in [paragraph (j)(1)(i)](#j-1-i) of this section, and cost contributions) is reasonably anticipated to earn a rate of return (which might be reflected in a discount rate used in applying a method) appropriate to the riskiness of the controlled participant's CSA Activity over the entire period of such CSA Activity. If the cost shared intangibles themselves are reasonably anticipated to contribute to developing other intangibles, then the period described in the preceding sentence includes the period, reasonably anticipated as of the date of the PCT, of developing and exploiting such indirectly benefited intangibles. - (B) **Example.** The following example illustrates the principles of this [paragraph (g)(2)(ii)](#g-2-ii): - (iii) **Consistency of evaluation with realistic alternatives—** - (A) **In general.** The relative reliability of an application of a method also depends on the degree of consistency of the analysis with the assumption that uncontrolled taxpayers dealing at arm's length would have evaluated the terms of the transaction, and only entered into such transaction, if no alternative is preferable. This condition is not met, therefore, where for any controlled participant the total anticipated present value of its income attributable to its entering into the CSA, as of the date of the PCT, is less than the total anticipated present value of its income that could be achieved through an alternative arrangement realistically available to that controlled participant. In principle, this comparison is made on a post-tax basis but, in many cases, a comparison made on a pre-tax basis will yield equivalent results. See also paragraph (g)(2)(v)(B)(1) of this section (Discount rate variation between realistic alternatives). - (B) **Examples.** The following examples illustrate the principles of this [paragraph (g)(2)(iii)](#g-2-iii): - (iv) **Aggregation of transactions.** The combined effect of multiple contemporaneous transactions, consisting either of multiple PCTs, or of one or more PCT and one or more other transactions in connection with a CSA that are not governed by this section (such as transactions involving cross operating contributions or make-or-sell rights), may require evaluation in accordance with the principles of aggregation described in [§ 1.482-1(f)(2)(i)](/cfr/26/1.482-1.md?p=f-2-i). In such cases, it may be that the multiple transactions are reasonably anticipated, as of the date of the PCT(s), to be so interrelated that the method that provides the most reliable measure of an arm's length charge is a method under this section applied on an aggregate basis for the PCT(s) and other transactions. A [section 482](/cfr/26/482.md) adjustment may be made by comparing the aggregate arm's length charge so determined to the aggregate payments actually made for the multiple transactions. In such a case, it generally will not be necessary to allocate separately the aggregate arm's length charge as between various PCTs or as between PCTs and such other transactions. However, such an allocation may be necessary for other purposes, such as applying paragraph (i)(6) (Periodic adjustments) of this section. An aggregate determination of the arm's length charge for multiple transactions will often yield a payment for a controlled participant that is equal to the aggregate value of the platform contributions and other resources, capabilities, and rights covered by the multiple transactions multiplied by that controlled participant's RAB share. Because RAB shares only include benefits from cost shared intangibles, the reliability of an aggregate determination of payments for multiple transactions may be reduced to the extent that it includes transactions covering resources, capabilities, and rights for which the controlled participants' expected benefit shares differ substantially from their RAB shares. - (v) **Discount rate—** - (A) **In general.** The best method analysis in connection with certain methods or forms of payment may depend on a rate or rates of return used to convert projected results of transactions to present value, or to otherwise convert monetary amounts at one or more points in time to equivalent amounts at a different point or points in time. For this purpose, a discount rate or rates should be used that most reliably reflect the market-correlated risks of activities or transactions and should be applied to the best estimates of the relevant projected results, based on all the information potentially available at the time for which the present value calculation is to be performed. Depending on the particular facts and circumstances, the market-correlated risk involved and thus, the discount rate, may differ among a company's various activities or transactions. Normally, discount rates are most reliably determined by reference to market information. - (B) **Considerations in best method analysis of discount rate—** (1) Discount rate variation between realistic alternatives. Realistic alternatives may involve varying risk exposure and, thus, may be more reliably evaluated using different discount rates. See paragraphs [(g)(4)(i)(F)](#g-4-i-F) and [(vi)(F)](#g-4-vi-F) of this section. In some circumstances, a party may have less risk as a licensee of intangibles needed in its operations, and so require a lower discount rate, than it would have by entering into a CSA to develop such intangibles, which may involve the party's assumption of additional risk in funding its cost contributions to the IDA. Similarly, self-development of intangibles and licensing out may be riskier for the licensor, and so require a higher discount rate, than entering into a CSA to develop such intangibles, which would relieve the licensor of the obligation to fund a portion of the IDCs of the IDA. (2) Implied discount rates. In some circumstances, the particular discount rate or rates used for certain activities or transactions logically imply that certain other activities will have a particular discount rate or set of rates (implied discount rates). To the extent that an implied discount rate is inappropriate in light of the facts and circumstances, which may include reliable direct evidence of the appropriate discount rate applicable for such other activities, the reliability of any method is reduced where such method is based on the discount rates from which such an inappropriate implied discount rate is derived. See paragraphs (g)(4)(vi)(F)(2) and (g)(4)(viii), Example 8 of this section. (3) Discount rate variation between forms of payment. Certain forms of payment may involve different risks than others. For example, ordinarily a royalty computed on a profits base would be more volatile, and so require a higher discount rate to discount projected payments to present value, than a royalty computed on a sales base. (4) Post-tax rate. In general, discount rate estimates that may be inferred from the operations of the capital markets are post-tax discount rates. Therefore, an analysis would in principle apply post-tax discount rates to income net of expense items including taxes (post-tax income). However, in certain circumstances the result of applying a post-tax discount rate to post-tax income is equivalent to the product of the result of applying a post-tax discount rate to income net of expense items other than taxes (pre-tax income), and the difference of one minus the tax rate (as defined in [paragraph (j)(1)(i)](#j-1-i) of this section). Therefore, in such circumstances, calculation of pre-tax income, rather than post-tax income, may be sufficient. See, for example, [paragraph (g)(4)(i)(G)](#g-4-i-G) of this section. - (C) **Example.** The following example illustrates the principles of this [paragraph (g)(2)(v)](#g-2-v): - (vi) **Financial projections.** The reliability of an estimate of the value of a platform or operating contribution in connection with a PCT will often depend upon the reliability of projections used in making the estimate. Such projections should reflect the best estimates of the items projected (normally reflecting a probability weighted average of possible outcomes and thus also reflecting non-market-correlated risk). Projections necessary for this purpose may include a projection of sales, IDCs, costs of developing operating contributions, routine operating expenses, and costs of sales. Some method applications directly estimate projections of items attributable to separate development and exploitation by the controlled participants within their respective divisions. Other method applications indirectly estimate projections of items from the perspective of the controlled group as a whole, rather than from the perspective of a particular participant, and then apportion the items so estimated on some assumed basis. For example, in some applications, sales might be directly projected by division, but worldwide projections of other items such as operating expenses might be apportioned among divisions in the same ratio as the divisions' respective sales. Which approach is more reliable depends on which provides the most reliable measure of an arm's length result, considering the competing perspectives under the facts and circumstances in light of the completeness and accuracy of the underlying data, the reliability of the assumptions, and the sensitivity of the results to possible deficiencies in the data and assumptions. For these purposes, projections that have been prepared for non-tax purposes are generally more reliable than projections that have been prepared solely for purposes of meeting the requirements in this [paragraph (g)](#g). - (vii) **Accounting principles—** - (A) **In general.** Allocations or other valuations done for accounting purposes may provide a useful starting point but will not be conclusive for purposes of the best method analysis in evaluating the arm's length charge in a PCT, particularly where the accounting treatment of an asset is inconsistent with its economic value. - (B) **Examples.** The following examples illustrate the principles of this [paragraph (g)(2)(vii)](#g-2-vii): - (viii) **Valuations of subsequent PCTs—** - (A) **Date of subsequent PCT.** The date of a PCT may occur subsequent to the inception of the CSA. For example, an intangible initially developed outside the IDA may only subsequently become a platform contribution because that later time is the earliest date on which it is reasonably anticipated to contribute to developing cost shared intangibles within the IDA. In such case, the date of the PCT, and the analysis of the arm's length amount charged in the subsequent PCT, is as of such later time. - (B) **Best method analysis for subsequent PCT.** In cases where PCTs occur on different dates, the determination of the arm's length amount charged, respectively, in the prior and subsequent PCTs must be coordinated in a manner that provides the most reliable measure of an arm's length result. In some circumstances, a subsequent PCT may be reliably evaluated independently of other PCTs, as may be possible for example, under the acquisition price method. In other circumstances, the results of prior and subsequent PCTs may be interrelated and so a subsequent PCT may be most reliably evaluated under the residual profit split method of [paragraph (g)(7)](#g-7) of this section. In those cases, for purposes of allocating the present value of nonroutine residual divisional profit or loss, and so determining the present value of the subsequent PCT Payments, in accordance with [paragraph (g)(7)(iii)(C)](#g-7-iii-C) of this section, the PCT Payor's interest in cost shared intangibles, both already developed and in process, are treated as additional PCT Payor operating contributions as of the date of the subsequent PCT. - (ix) **Arm's length range—** - (A) **In general.** The guidance in [§ 1.482-1(e)](/cfr/26/1.482-1.md?p=e) regarding determination of an arm's length range, as modified by this section, applies in evaluating the arm's length amount charged in a PCT under a transfer pricing method provided in this section (applicable method). [Section 1.482-1(e)(2)(i)](/cfr/26/1.482-1.md?p=e-2-i) provides that the arm's length range is ordinarily determined by applying a single pricing method selected under the best method rule to two or more uncontrolled transactions of similar comparability and reliability although use of more than one method may be appropriate for the purposes described in [§ 1.482-1(c)(2)(iii)](/cfr/26/1.482-1.md?p=c-2-iii). The rules provided in [§ 1.482-1(e)](/cfr/26/1.482-1.md?p=e) and this section for determining an arm's length range shall not override the rules provided in paragraph (i)(6) of this section for periodic adjustments by the Commissioner. The provisions in paragraphs [(g)(2)(ix)(C)](#g-2-ix-C) and [(D)](#g-2-ix-D) of this section apply only to applicable methods that are based on two or more input parameters as described in [paragraph (g)(2)(ix)(B)](#g-2-ix-B) of this section. For an example of how the rules of this section for determining an arm's length range of PCT Payments are applied, see [paragraph (g)(4)(viii)](#g-4-viii) of this section. - (B) **Methods based on two or more input parameters.** An applicable method may determine PCT Payments based on calculations involving two or more parameters whose values depend on the facts and circumstances of the case (input parameters). For some input parameters (market-based input parameters), the value is most reliably determined by reference to data that derives from uncontrolled transactions (market data). For example, the value of the return to a controlled participant's routine contributions, as such term is defined in [paragraph (j)(1)(i)](#j-1-i) of this section, to the CSA Activity (which value is used as an input parameter in the income method described in [paragraph (g)(4)](#g-4) of this section) may in some cases be most reliably determined by reference to the profit level of a company with rights, resources, and capabilities comparable to those routine contributions. See [§ 1.482-5](/cfr/26/1.482-5.md). As another example, the value for the discount rate that reflects the riskiness of a controlled participant's role in the CSA (which value is used as an input parameter in the income method described in [paragraph (g)(4)](#g-4) of this section) may in some cases be most reliably determined by reference to the stock beta of a company whose overall risk is comparable to the riskiness of the controlled participant's role in the CSA. - (C) **Variable input parameters.** For some market-based input parameters (variable input parameters), the parameter's value is most reliably determined by considering two or more observations of market data that have, or with adjustment can be brought to, a similar reliability and comparability, as described in [§ 1.482-1(e)(2)(ii)](/cfr/26/1.482-1.md?p=e-2-ii) (for example, profit levels or stock betas of two or more companies). See [paragraph (g)(2)(ix)(B)](#g-2-ix-B) of this section. - (D) **Determination of arm's length PCT Payment.** For purposes of applying this [paragraph (g)(2)(ix)](#g-2-ix), each input parameter is assigned a single most reliable value, unless it is a variable input parameter as described in [paragraph (g)(2)(ix)(C)](#g-2-ix-C) of this section. The determination of the arm's length payment depends on the number of variable input parameters. (1) No variable input parameters. If there are no variable input parameters, the arm's length PCT Payment is a single value determined by using the single most reliable value determined for each input parameter. (2) One variable input parameter. If there is exactly one variable input parameter, then under the applicable method, the arm's length range of PCT Payments is the interquartile range, as described in [§ 1.482-1(e)(2)(iii)(C)](/cfr/26/1.482-1.md?p=e-2-iii-C), of the set of PCT Payment values calculated by selecting— (i) Iteratively, the value of the variable input parameter that is based on each observation as described in [paragraph (g)(2)(ix)(C)](#g-2-ix-C) of this section; and (ii) The single most reliable values for each other input parameter. (3) More than one variable input parameter. If there are two or more variable input parameters, then under the applicable method, the arm's length range of PCT Payments is the interquartile range, as described in [§ 1.482-1(e)(2)(iii)(C)](/cfr/26/1.482-1.md?p=e-2-iii-C), of the set of PCT Payment values calculated iteratively using every possible combination of permitted choices of values for the input parameters. For input parameters other than a variable input parameter, the only such permitted choice is the single most reliable value. For variable input parameters, such permitted choices include any value that is— (i) Based on one of the observations described in [paragraph (g)(2)(ix)(C)](#g-2-ix-C) of this section; and (ii) Within the interquartile range (as described in [§ 1.482-1(e)(2)(iii)(C)](/cfr/26/1.482-1.md?p=e-2-iii-C)) of the set of all values so based. - (E) **Adjustments.** [Section 1.482-1(e)(3)](/cfr/26/1.482-1.md?p=e-3), applied as modified by this [paragraph (g)(2)(ix)](#g-2-ix), determines when the Commissioner may make an adjustment to a PCT Payment due to the taxpayer's results being outside the arm's length range. Adjustment will be to the median, as defined in [§ 1.482-1(e)(3)](/cfr/26/1.482-1.md?p=e-3). Thus, the Commissioner is not required to establish an arm's length range prior to making an allocation under [section 482](/cfr/26/482.md). - (x) **Valuation undertaken on a pre-tax basis.** PCT Payments in general may increase the PCT Payee's tax liability and decrease the PCT Payor's tax liability. The arm's length amount of a PCT Payment determined under the methods in this [paragraph (g)](#g) is the value of the PCT Payment itself, without regard to such tax effects. Therefore, the methods under this section must be applied, with suitable adjustments if needed, to determine the PCT Payments on a pre-tax basis. See paragraphs [(g)(2)(v)(B)](#g-2-v-B) and [(4)(i)(G)](#g-4-i-G) of this section. - (3) **Comparable uncontrolled transaction method.** The comparable uncontrolled transaction (CUT) method described in [§ 1.482-4(c)](/cfr/26/1.482-4.md?p=c), and the comparable uncontrolled services price (CUSP) method described in [§ 1.482-9(c)](/cfr/26/1.482-9.md?p=c), may be applied to evaluate whether the amount charged in a PCT is arm's length by reference to the amount charged in a comparable uncontrolled transaction. Although all of the factors entering into a best method analysis described in § [1.482-1(c)](/cfr/26/1.482-1.md?p=c) and [(d)](/cfr/26/1.482-1.md?p=d) must be considered, comparability and reliability under this method are particularly dependent on similarity of contractual terms, degree to which allocation of risks is proportional to reasonably anticipated benefits from exploiting the results of intangible development, similar period of commitment as to the sharing of intangible development risks, and similar scope, uncertainty, and profit potential of the subject intangible development, including a similar allocation of the risks of any existing resources, capabilities, or rights, as well as of the risks of developing other resources, capabilities, or rights that would be reasonably anticipated to contribute to exploitation within the parties' divisions, that is consistent with the actual allocation of risks between the controlled participants as provided in the CSA in accordance with this section. When applied in the manner described in § [1.482-4(c)](/cfr/26/1.482-4.md?p=c) or [1.482-9(c)](/cfr/26/1.482-9.md?p=c), the CUT or CUSP method will typically yield an arm's length total value for the platform contribution that is the subject of the PCT. That value must then be multiplied by each PCT Payor's respective RAB share in order to determine the arm's length PCT Payment due from each PCT Payor. The reliability of a CUT or CUSP that yields a value for the platform contribution only in the PCT Payor's division will be reduced to the extent that value is not consistent with the total worldwide value of the platform contribution multiplied by the PCT Payor's RAB share. - (4) **Income method—** - (i) **In general—** - (A) **Equating cost sharing and licensing alternatives.** The income method evaluates whether the amount charged in a PCT is arm's length by reference to a controlled participant's best realistic alternative to entering into a CSA. Under this method, the arm's length charge for a PCT Payment will be an amount such that a controlled participant's present value, as of the date of the PCT, of its cost sharing alternative of entering into a CSA equals the present value of its best realistic alternative. In general, the best realistic alternative of the PCT Payor to entering into the CSA would be to license intangibles to be developed by an uncontrolled licensor that undertakes the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA. Similarly, the best realistic alternative of the PCT Payee to entering into the CSA would be to undertake the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA and license the resulting intangibles to an uncontrolled licensee. [Paragraphs (g)(4)(i)(B) through (vi)](#g-4-i-B..g-4-i-vi) of this section describe specific applications of the income method, but do not exclude other possible applications of this method. - (B) **Cost sharing alternative.** The PCT Payor's cost sharing alternative corresponds to the actual CSA in accordance with this section, with the PCT Payor's obligation to make the PCT Payments to be determined and its commitment for the duration of the IDA to bear cost contributions. - (C) **Licensing alternative.** The licensing alternative is derived on the basis of a functional and risk analysis of the cost sharing alternative, but with a shift of the risk of cost contributions to the licensor. Accordingly, the PCT Payor's licensing alternative consists of entering into a license with an uncontrolled party, for a term extending for what would be the duration of the CSA Activity, to license the make-or-sell rights in to-be-developed resources, capabilities, or rights of the licensor. Under such license, the licensor would undertake the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA. Apart from any difference in the allocation of the risks of the IDA, the licensing alternative should assume contractual provisions with regard to non-overlapping divisional intangible interests, and with regard to allocations of other risks, that are consistent with the actual CSA in accordance with this section. For example, the analysis under the licensing alternative should assume a similar allocation of the risks of any existing resources, capabilities, or rights, as well as of the risks of developing other resources, capabilities, or rights that would be reasonably anticipated to contribute to exploitation within the parties' divisions, that is consistent with the actual allocation of risks between the controlled participants as provided in the CSA in accordance with this section. Accordingly, the financial projections associated with the licensing and cost sharing alternatives are necessarily the same except for the licensing payments to be made under the licensing alternative and the cost contributions and PCT Payments to be made under the CSA. - (D) **Only one controlled participant with nonroutine platform contributions.** This method involves only one of the controlled participants providing nonroutine platform contributions as the PCT Payee. For a method under which more than one controlled participant may be a PCT Payee, see the application of the residual profit method pursuant to [paragraph (g)(7)](#g-7) of this section. - (E) **Income method payment forms.** The income method may be applied to determine PCT Payments in any form of payment (for example, lump sum, royalty on sales, or royalty on divisional profit). For converting to another form of payment, see generally [paragraph (h)](#h) (Form of payment rules) of this section. - (F) **Discount rates appropriate to cost sharing and licensing alternatives.** The present value of the cost sharing and licensing alternatives, respectively, should be determined using the appropriate discount rates in accordance with paragraphs [(g)(2)(v)](#g-2-v) and [(g)(4)(vi)(F)](#g-4-vi-F) of this section. See, for example, [§ 1.482-7(g)(2)(v)(B)(1)](#g-2-v-B-1) (Discount rate variation between realistic alternatives). In circumstances where the market-correlated risks as between the cost sharing and licensing alternatives are not materially different, a reliable analysis may be possible by using the same discount rate with respect to both alternatives. - (G) **The effect of taxation on determining the arm's length amount.** (1) In principle, the present values of the cost sharing and licensing alternatives should be determined by applying post-tax discount rates to post-tax income (including the post-tax value to the controlled participant of the PCT Payments). If such approach is adopted, then the post-tax value of the PCT Payments must be appropriately adjusted in order to determine the arm's length amount of the PCT Payments on a pre-tax basis. See [paragraph (g)(2)(x)](#g-2-x) of this section. (2) In certain circumstances, post-tax income may be derived as the product of the result of applying a post-tax discount rate to pre-tax income, and a factor equal to one minus the tax rate (as defined in (j)(1)(i)). See [paragraph (g)(2)(v)(B)](#g-2-v-B) of this section. (3) To the extent that a controlled participant's tax rate is not materially affected by whether it enters into the cost sharing or licensing alternative (or reliable adjustments may be made for varying tax rates), the factor (that is, one minus the tax rate) may be cancelled from both sides of the equation of the cost sharing and licensing alternative present values. Accordingly, in such circumstance it is sufficient to apply post-tax discount rates to projections of pre-tax income for the purpose of equating the cost sharing and licensing alternatives. The specific applications of the income method described in [paragraphs (g)(4)(ii) through (iv)](#g-4-ii..g-4-iv) of this section and the examples set forth in [paragraph (g)(4)(viii)](#g-4-viii) of this section assume that a controlled participant's tax rate is not materially affected by whether it enters into the cost sharing or licensing alternative. - (ii) **Evaluation of PCT Payor's cost sharing alternative.** The present value of the PCT Payor's cost sharing alternative is the present value of the stream of the reasonably anticipated residuals over the duration of the CSA Activity of divisional profits or losses, minus operating cost contributions, minus cost contributions, minus PCT Payments. - (iii) **Evaluation of PCT Payor's licensing alternative—** - (A) **Evaluation based on CUT.** The present value of the PCT Payor's licensing alternative may be determined using the comparable uncontrolled transaction method, as described in § [1.482-4(c)(1)](/cfr/26/1.482-4.md?p=c-1) and [(2)](/cfr/26/1.482-4.md?p=c-2). In this case, the present value of the PCT Payor's licensing alternative is the present value of the stream, over what would be the duration of the CSA Activity under the cost sharing alternative, of the reasonably anticipated residuals of the divisional profits or losses that would be achieved under the cost sharing alternative, minus operating cost contributions that would be made under the cost sharing alternative, minus the licensing payments as determined under the comparable uncontrolled transaction method. - (B) **Evaluation based on CPM.** The present value of the PCT Payor's licensing alternative may be determined using the comparable profits method, as described in [§ 1.482-5](/cfr/26/1.482-5.md). In this case, the present value of the licensing alternative is determined as in [paragraph (g)(4)(iii)(A)](#g-4-iii-A) of this section, except that the PCT Payor's licensing payments, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section, are determined in each period to equal the reasonably anticipated residuals of the divisional profits or losses that would be achieved under the cost sharing alternative, minus operating cost contributions that would be made under the cost sharing alternative, minus market returns for routine contributions, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section. However, treatment of net operating contributions as operating cost contributions shall be coordinated with the treatment of other routine contributions pursuant to this paragraph so as to avoid duplicative market returns to such contributions. - (iv) **Lump sum payment form.** Where the form of PCT Payment is a lump sum as of the date of the PCT, then, based on [paragraphs (g)(4)(i) through (iii)](#g-4-i..g-4-iii) of this section, the PCT Payment equals the difference between— - (A) The present value, using the discount rate appropriate for the cost sharing alternative, of the stream of the reasonably anticipated residuals over the duration of the CSA Activity of divisional profits or losses, minus cost contributions and operating cost contributions; and - (B) **The present value of the licensing alternative.** - (v) **Application of income method using differential income stream.** In some cases, the present value of an arm's length PCT Payment may be determined as the present value, discounted at the appropriate rate, of the PCT Payor's reasonably anticipated stream of additional positive or negative income over the duration of the CSA Activity that would result (before PCT Payments) from undertaking the cost sharing alternative rather than the licensing alternative (differential income stream). See Example 9 of [paragraph (g)(4)(viii)](#g-4-viii) of this section. - (vi) **Best method analysis considerations.** - (A) **Coordination with § 1.482-1(c).** Whether results derived from this method are the most reliable measure of an arm's length result is determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). Thus, comparability and the quality of data, the reliability of the assumptions, and the sensitivity of the results to possible deficiencies in the data and assumptions, must be considered in determining whether this method provides the most reliable measure of an arm's length result. - (B) **Assumptions Concerning Tax Rates.** This method will be more reliable to the extent that the controlled participants' respective tax rates are not materially affected by whether they enter into the cost sharing or licensing alternative. Even if this assumption of invariant tax rates across alternatives does not hold, this method may still be reliable to the extent that reliable adjustments can be made to reflect the variation in tax rates. - (C) **Coordination with § 1.482-4(c)(2).** If the licensing alternative is evaluated using the comparable uncontrolled transactions method, as described in [paragraph (g)(4)(iii)(A)](#g-4-iii-A) of this section, any additional comparability and reliability considerations stated in [§ 1.482-4(c)(2)](/cfr/26/1.482-4.md?p=c-2) may apply. - (D) **Coordination with § 1.482-5(c).** If the licensing alternative is evaluated using the comparable profits method, as described in [paragraph (g)(4)(iii)(B)](#g-4-iii-B) of this section, any additional comparability and reliability considerations stated in [§ 1.482-5(c)](/cfr/26/1.482-5.md?p=c) may apply. - (E) **Certain Circumstances Concerning PCT Payor.** This method may be used even if the PCT Payor furnishes significant operating contributions, or commits to assume the risk of significant operating cost contributions, to the PCT Payor's division. However, in such a case, any comparable uncontrolled transactions described in [paragraph (g)(4)(iii)(A)](#g-4-iii-A) of this section, and any comparable transactions used under [§ 1.482-5(c)](/cfr/26/1.482-5.md?p=c) as described in [paragraphs (g)(4)(iii)(B)](#g-4-iii-B) of this section, should be consistent with such contributions (or reliable adjustments must be made for material differences). - (F) **Discount rates—** (1) Reflection of similar risk profiles of cost sharing alternative and licensing alternative. Because the financial projections associated with the licensing and cost sharing alternatives are the same, except for the licensing payments to be made under the licensing alternative and the cost contributions and PCT Payments to be made under the cost sharing alternative, the analysis of the risk profile and financial projections for a realistic alternative to the cost sharing alternative must be closely associated with the risk profile and financial projections associated with the cost sharing alternative, differing only in the treatment of licensing payments, cost contributions, and PCT Payments. When using discount rates in applying the income method, this means that even if different discount rates are warranted for the two alternatives, the risk profiles for the two discount rates are closely related to each other because the discount rate for the licensing alternative and the discount rate for the cost sharing alternative are both derived from the single probability-weighted financial projections associated with the CSA Activity. The difference, if any, in market-correlated risks between the licensing and cost sharing alternatives is due solely to the different effects on risks of the PCT Payor making licensing payments under the licensing alternative, on the one hand, and the PCT Payor making cost contributions and PCT Payments under the cost sharing alternative, on the other hand. That is, the difference in the risk profile between the two scenarios solely reflects the incremental risk, if any, associated with the cost contributions taken on by the PCT Payor in developing the cost shared intangible under the cost sharing alternative, and the difference, if any, in risk associated with the particular payment forms of the licensing payments and the PCT Payments, in light of the fact that the licensing payments in the licensing alternative are partially replaced by cost contributions and partially replaced by PCT Payments in the cost sharing alternative, each with its own payment form. An analysis under the income method that uses a different discount rate for the cost sharing alternative than for the licensing alternative will be more reliable the greater the extent to which the difference, if any, between the two discount rates reflects solely these differences in the risk profiles of these two alternatives. See, for example, [paragraph (g)(2)(iii)](#g-2-iii), Example 2 of this section. (2) Use of differential income stream as a consideration in assessing the best method. An analysis under the income method that uses a different discount rate for the cost sharing alternative than for the licensing alternative will be more reliable the greater the extent to which the implied discount rate for the projected present value of the differential income stream is consistent with reliable direct evidence of the appropriate discount rate applicable for activities reasonably anticipated to generate an income stream with a similar risk profile to the differential income stream. Such differential income stream is defined as the stream of the reasonably anticipated residuals of the PCT Payor's licensing payments to be made under the licensing alternative, minus the PCT Payor's cost contributions to be made under the cost sharing alternative. See Example 8 of [paragraph (g)(4)(viii)](#g-4-viii) of this section. - (vii) **Routine platform and operating contributions.** For purposes of this [paragraph (g)(4)](#g-4), any routine contributions that are platform or operating contributions, the valuation and PCT Payments for which are determined and made independently of the income method, are treated similarly to cost contributions and operating cost contributions, respectively. Accordingly, wherever used in this [paragraph (g)(4)](#g-4), the term “routine contributions” shall not include routine platform or operating contributions, and wherever the terms “cost contributions” and “operating cost contributions” appear in this paragraph, they shall include net routine platform contributions and net routine operating contributions, respectively. Net routine platform contributions are the value of a controlled participant's total reasonably anticipated routine platform contributions, plus its reasonably anticipated PCT Payments to other controlled participants in respect of their routine platform contributions, minus the reasonably anticipated PCT Payments it is to receive from other controlled participants in respect of its routine platform contributions. Net routine operating contributions are the value of a controlled participant's total reasonably anticipated routine operating contributions, plus its reasonably anticipated arm's length compensation to other controlled participants in respect of their routine operating contributions, minus the reasonably anticipated arm's length compensation it is to receive from other controlled participants in respect of its routine operating contributions. - (viii) **Examples.** The following examples illustrate the principles of this [paragraph (g)(4)](#g-4): - (5) **Acquisition price method—** - (i) **In general.** The acquisition price method applies the comparable uncontrolled transaction method of [§ 1.482-4(c)](/cfr/26/1.482-4.md?p=c), or the comparable uncontrolled services price method described in [§ 1.482-9(c)](/cfr/26/1.482-9.md?p=c), to evaluate whether the amount charged in a PCT, or group of PCTs, is arm's length by reference to the amount charged (the acquisition price) for the stock or asset purchase of an entire organization or portion thereof (the target) in an uncontrolled transaction. The acquisition price method is ordinarily used where substantially all the target's nonroutine contributions, as such term is defined in [paragraph (j)(1)(i)](#j-1-i) of this section, made to the PCT Payee's business activities are covered by a PCT or group of PCTs. - (ii) **Determination of arm's length charge.** Under this method, the arm's length charge for a PCT or group of PCTs covering resources, capabilities, and rights of the target is equal to the adjusted acquisition price, as divided among the controlled participants according to their respective RAB shares. - (iii) **Adjusted acquisition price.** The adjusted acquisition price is the acquisition price of the target increased by the value of the target's liabilities on the date of the acquisition, other than liabilities not assumed in the case of an asset purchase, and decreased by the value of the target's tangible property on that date and by the value on that date of any other resources, capabilities, and rights not covered by a PCT or group of PCTs. - (iv) **Best method analysis considerations.** The comparability and reliability considerations stated in [§ 1.482-4(c)(2)](/cfr/26/1.482-4.md?p=c-2) apply. Consistent with those considerations, the reliability of applying the acquisition price method as a measure of the arm's length charge for the PCT Payment normally is reduced if— - (A) A substantial portion of the target's nonroutine contributions to the PCT Payee's business activities is not required to be covered by a PCT or group of PCTs, and that portion of the nonroutine contributions cannot reliably be valued; - (B) A substantial portion of the target's assets consists of tangible property that cannot reliably be valued; or - (C) **The date on which the target is acquired and the date of the PCT are not contemporaneous.** - (v) **Example.** The following example illustrates the principles of this [paragraph (g)(5)](#g-5): - (6) **Market capitalization method—** - (i) **In general.** The market capitalization method applies the comparable uncontrolled transaction method of [§ 1.482-4(c)](/cfr/26/1.482-4.md?p=c), or the comparable uncontrolled services price method described in [§ 1.482-9(c)](/cfr/26/1.482-9.md?p=c), to evaluate whether the amount charged in a PCT, or group of PCTs, is arm's length by reference to the average market capitalization of a controlled participant (PCT Payee) whose stock is regularly traded on an established securities market. The market capitalization method is ordinarily used where substantially all of the PCT Payee's nonroutine contributions to the PCT Payee's business are covered by a PCT or group of PCTs. - (ii) **Determination of arm's length charge.** Under the market capitalization method, the arm's length charge for a PCT or group of PCTs covering resources, capabilities, and rights of the PCT Payee is equal to the adjusted average market capitalization, as divided among the controlled participants according to their respective RAB shares. - (iii) **Average market capitalization.** The average market capitalization is the average of the daily market capitalizations of the PCT Payee over a period of time beginning 60 days before the date of the PCT and ending on the date of the PCT. The daily market capitalization of the PCT Payee is calculated on each day its stock is actively traded as the total number of shares outstanding multiplied by the adjusted closing price of the stock on that day. The adjusted closing price is the daily closing price of the stock, after adjustments for stock-based transactions (dividends and stock splits) and other pending corporate (combination and spin-off) restructuring transactions for which reliable arm's length adjustments can be made. - (iv) **Adjusted average market capitalization.** The adjusted average market capitalization is the average market capitalization of the PCT Payee increased by the value of the PCT Payee's liabilities on the date of the PCT and decreased by the value on such date of the PCT Payee's tangible property and of any other resources, capabilities, or rights of the PCT Payee not covered by a PCT or group of PCTs. - (v) **Best method analysis considerations.** The comparability and reliability considerations stated in [§ 1.482-4(c)(2)](/cfr/26/1.482-4.md?p=c-2) apply. Consistent with those considerations, the reliability of applying the comparable uncontrolled transaction method using the adjusted market capitalization of a company as a measure of the arm's length charge for the PCT Payment normally is reduced if— - (A) A substantial portion of the PCT Payee's nonroutine contributions to its business activities is not required to be covered by a PCT or group of PCTs, and that portion of the nonroutine contributions cannot reliably be valued; - (B) A substantial portion of the PCT Payee's assets consists of tangible property that cannot reliably be valued; or - (C) Facts and circumstances demonstrate the likelihood of a material divergence between the average market capitalization of the PCT Payee and the value of its resources, capabilities, and rights for which reliable adjustments cannot be made. - (vi) **Examples.** The following examples illustrate the principles of this [paragraph (g)(6)](#g-6): - (7) **Residual profit split method—** - (i) **In general.** The residual profit split method evaluates whether the allocation of combined operating profit or loss attributable to one or more platform contributions subject to a PCT is arm's length by reference to the relative value of each controlled participant's contribution to that combined operating profit or loss. The combined operating profit or loss must be derived from the most narrowly identifiable business activity (relevant business activity) of the controlled participants for which data are available that include the CSA Activity. The residual profit split method may not be used where only one controlled participant makes significant nonroutine contributions (including platform or operating contributions) to the CSA Activity. The provisions of [§ 1.482-6](/cfr/26/1.482-6.md) shall apply to CSAs only to the extent provided and as modified in this [paragraph (g)(7)](#g-7). Any other application to a CSA of a residual profit method not described in paragraphs [(g)(7)(ii)](#g-7-ii) and [(iii)](#g-7-iii) of this section will constitute an unspecified method for purposes of sections [482](/cfr/26/482.md) and [6662(e)](/cfr/26/6662.md?p=e) and the regulations under those sections. - (ii) **Appropriate share of profits and losses.** The relative value of each controlled participant's contribution to the success of the relevant business activity must be determined in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity, consistent with the best method analysis described in § [1.482-1(c)](/cfr/26/1.482-1.md?p=c) and [(d)](/cfr/26/1.482-1.md?p=d). Such an allocation is intended to correspond to the division of profit or loss that would result from an arrangement between uncontrolled taxpayers, each performing functions similar to those of the various controlled participants engaged in the relevant business activity. The profit allocated to any particular controlled participant is not necessarily limited to the total operating profit of the group from the relevant business activity. For example, in a given year, one controlled participant may earn a profit while another controlled participant incurs a loss. In addition, it may not be assumed that the combined operating profit or loss from the relevant business activity should be shared equally, or in any other arbitrary proportion. - (iii) **Profit split—** - (A) **In general.** Under the residual profit split method, the present value of each controlled participant's residual divisional profit or loss attributable to nonroutine contributions (nonroutine residual divisional profit or loss) is allocated between the controlled participants that each furnish significant nonroutine contributions (including platform or operating contributions) to the relevant business activity in that division. - (B) **Determine nonroutine residual divisional profit or loss.** The present value of each controlled participant's nonroutine residual divisional profit or loss must be determined to reflect the most reliable measure of an arm's length result. The present value of nonroutine residual divisional profit or loss equals the present value of the stream of the reasonably anticipated residuals over the duration of the CSA Activity of divisional profit or loss, minus market returns for routine contributions, minus operating cost contributions, minus cost contributions, using a discount rate appropriate to such residuals in accordance with [paragraph (g)(2)(v)](#g-2-v) of this section. As used in this [paragraph (g)(7)](#g-7), the phrase “market returns for routine contributions” includes market returns for operating cost contributions and excludes market returns for cost contributions. - (C) **Allocate nonroutine residual divisional profit or loss—** (1) In general. The present value of nonroutine residual divisional profit or loss in each controlled participant's division must be allocated among all of the controlled participants based upon the relative values, determined as of the date of the PCTs, of the PCT Payor's as compared to the PCT Payee's nonroutine contributions to the PCT Payor's division. For this purpose, the PCT Payor's nonroutine contribution consists of the sum of the PCT Payor's nonroutine operating contributions and the PCT Payor's RAB share of the PCT Payor's nonroutine platform contributions. For this purpose, the PCT Payee's nonroutine contribution consists of the PCT Payor's RAB share of the PCT Payee's nonroutine platform contributions. (2) Relative value determination. The relative values of the controlled participants' nonroutine contributions must be determined so as to reflect the most reliable measure of an arm's length result. Relative values may be measured by external market benchmarks that reflect the fair market value of such nonroutine contributions. Alternatively, the relative value of nonroutine contributions may be estimated by the capitalized cost of developing the nonroutine contributions and updates, as appropriately grown or discounted so that all contributions may be valued on a comparable dollar basis as of the same date. If the nonroutine contributions by a controlled participant are also used in other business activities (such as the exploitation of make-or-sell rights described in [paragraph (c)(4)](#c-4) of this section), an allocation of the value of the nonroutine contributions must be made on a reasonable basis among all the business activities in which they are used in proportion to the relative economic value that the relevant business activity and such other business activities are anticipated to derive over time as the result of such nonroutine contributions. (3) Determination of PCT Payments. Any amount of the present value of a controlled participant's nonroutine residual divisional profit or loss that is allocated to another controlled participant represents the present value of the PCT Payments due to that other controlled participant for its platform contributions to the relevant business activity in the relevant division. For purposes of [paragraph (j)(3)(ii)](#j-3-ii) of this section, the present value of a PCT Payor's PCT Payments under this paragraph shall be deemed reduced to the extent of the present value of any PCT Payments owed to it from other controlled participants under this [paragraph (g)(7)](#g-7). The resulting remainder may be converted to a fixed or contingent form of payment in accordance with [paragraph (h)](#h) (Form of payment rules) of this section. (4) Routine platform and operating contributions. For purposes of this [paragraph (g)(7)](#g-7), any routine platform or operating contributions, the valuation and PCT Payments for which are determined and made independently of the residual profit split method, are treated similarly to cost contributions and operating cost contributions, respectively. Accordingly, wherever used in this [paragraph (g)(7)](#g-7), the term “routine contributions” shall not include routine platform or operating contributions, and wherever the terms “cost contributions” and “operating cost contributions” appear in this [paragraph (g)(7)](#g-7), they shall include net routine platform contributions and net routine operating contributions, respectively, as defined in [paragraph (g)(4)(vii)](#g-4-vii) of this section. However, treatment of net operating contributions as operating cost contributions shall be coordinated with the treatment of other routine contributions pursuant to paragraphs [(g)(4)(iii)(B)](#g-4-iii-B) and [(7)(iii)(B)](#g-7-iii-B) of this section so as to avoid duplicative market returns to such contributions. - (iv) **Best method analysis considerations—** - (A) **In general.** Whether results derived from this method are the most reliable measure of the arm's length result is determined using the factors described under the best method rule in [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c). Thus, comparability and quality of data, reliability of assumptions, and sensitivity of results to possible deficiencies in the data and assumptions, must be considered in determining whether this method provides the most reliable measure of an arm's length result. The application of these factors to the residual profit split in the context of the relevant business activity of developing and exploiting cost shared intangibles is discussed in [paragraphs (g)(7)(iv)(B) through (D)](#g-7-iv-B..g-7-iv-D) of this section. - (B) **Comparability.** The derivation of the present value of nonroutine residual divisional profit or loss includes a carveout on account of market returns for routine contributions. Thus, the comparability considerations that are relevant for that purpose include those that are relevant for the methods that are used to determine market returns for the routine contributions. - (C) **Data and assumptions.** The reliability of the results derived from the residual profit split is affected by the quality of the data and assumptions used to apply this method. In particular, the following factors must be considered: (1) The reliability of the allocation of costs, income, and assets between the relevant business activity and the controlled participants' other activities that will affect the reliability of the determination of the divisional profit or loss and its allocation among the controlled participants. See [§ 1.482-6(c)(2)(ii)(C)(1)](/cfr/26/1.482-6.md?p=c-2-ii-C-1). (2) The degree of consistency between the controlled participants and uncontrolled taxpayers in accounting practices that materially affect the items that determine the amount and allocation of operating profit or loss affects the reliability of the result. See [§ 1.482-6(c)(2)(ii)(C)(2)](/cfr/26/1.482-6.md?p=c-2-ii-C-2). (3) The reliability of the data used and the assumptions made in estimating the relative value of the nonroutine contributions by the controlled participants. In particular, if capitalized costs of development are used to estimate the relative value of nonroutine contributions, the reliability of the results is reduced relative to the reliability of other methods that do not require such an estimate. This is because, in any given case, the costs of developing a nonroutine contribution may not be related to its market value and because the calculation of the capitalized costs of development may require the allocation of indirect costs between the relevant business activity and the controlled participant's other activities, which may affect the reliability of the analysis. - (D) **Other factors affecting reliability.** Like the methods described in [§§ 1.482-3 through 1.482-5](/cfr/26/1.482-3..1.482-5.md) and [§ 1.482-9(c)](/cfr/26/1.482-9.md?p=c), the carveout on account of market returns for routine contributions relies exclusively on external market benchmarks. As indicated in [§ 1.482-1(c)(2)(i)](/cfr/26/1.482-1.md?p=c-2-i), as the degree of comparability between the controlled participants and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, to the extent the allocation of nonroutine residual divisional profit or loss is not based on external market benchmarks, the reliability of the analysis will be decreased in relation to an analysis under a method that relies on market benchmarks. Finally, the reliability of the analysis under this method may be enhanced by the fact that all the controlled participants are evaluated under the residual profit split. However, the reliability of the results of an analysis based on information from all the controlled participants is affected by the reliability of the data and the assumptions pertaining to each controlled participant. Thus, if the data and assumptions are significantly more reliable with respect to one of the controlled participants than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results. - (v) **Examples.** The following examples illustrate the principles of this [paragraph (g)(7)](#g-7): - (8) **Unspecified methods.** Methods not specified in [paragraphs (g)(3) through (7)](#g-3..g-7) of this section may be used to evaluate whether the amount charged for a PCT is arm's length. Any method used under this [paragraph (g)(8)](#g-8) must be applied in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md) and of [paragraph (g)(2)](#g-2) of this section. Consistent with the specified methods, an unspecified method should take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction, and only enter into a particular transaction if none of the alternatives is preferable to it. Therefore, in establishing whether a PCT achieved an arm's length result, an unspecified method should provide information on the prices or profits that the controlled participant could have realized by choosing a realistic alternative to the CSA. See [paragraph (k)(2)(ii)(J)](#k-2-ii-J) of this section. As with any method, an unspecified method will not be applied unless it provides the most reliable measure of an arm's length result under the principles of the best method rule. See [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) (Best method rule). In accordance with [§ 1.482-1(d)](/cfr/26/1.482-1.md?p=d) (Comparability), to the extent that an unspecified method relies on internal data rather than uncontrolled comparables, its reliability will be reduced. Similarly, the reliability of a method will be affected by the reliability of the data and assumptions used to apply the method, including any projections used. - (h) **Form of payment rules—** - (1) **CST Payments.** CST Payments may not be paid in shares of stock in the payor (or stock in any member of the controlled group that includes the controlled participants). - (2) **PCT Payments—** - (i) **In general.** The consideration under a PCT for a platform contribution may take one or a combination of both of the following forms: - (A) Payments of a fixed amount (fixed payments), either paid in a lump sum payment or in installment payments spread over a specified period, with interest calculated in accordance with [§ 1.482-2(a)](/cfr/26/1.482-2.md?p=a) (Loans or advances). - (B) Payments contingent on the exploitation of cost shared intangibles by the PCT Payor (contingent payments). Accordingly, controlled participants have flexibility to adopt a form and period of payment, provided that such form and period of payment are consistent with an arm's length charge as of the date of the PCT. See also paragraphs [(h)(2)(iv)](#h-2-iv) and (3) of this section. - (ii) **No PCT Payor Stock.** PCT Payments may not be paid in shares of stock in the PCT Payor (or stock in any member of the controlled group that includes the controlled participants). - (iii) **Specified form of payment—** - (A) **In general.** The form of payment selected (subject to the rules of this [paragraph (h)](#h)) for any PCT, including, in the case of contingent payments, the contingent base and structure of the payments as set forth in [paragraph (h)(2)(iii)(B)](#h-2-iii-B) of this section, must be specified no later than the due date of the applicable tax return (including extensions) for the later of the taxable year of the PCT Payor or PCT Payee that includes the date of that PCT. - (B) **Contingent payments.** In accordance with [paragraph (k)(1)(iv)(A)](#k-1-iv-A) of this section, a provision of a written contract described in [paragraph (k)(1)](#k-1) of this section, or of the additional documentation described in [paragraph (k)(2)](#k-2) of this section, that provides for payments for a PCT (or group of PCTs) to be contingent on the exploitation of cost shared intangibles will be respected as consistent with economic substance only if the allocation between the controlled participants of the risks attendant on such form of payment is determinable before the outcomes of such allocation that would have materially affected the PCT pricing are known or reasonably knowable. A contingent payment provision must clearly and unambiguously specify the basis on which the contingent payment obligations are to be determined. In particular, the contingent payment provision must clearly and unambiguously specify the events that give rise to an obligation to make PCT Payments, the royalty base (such as sales or revenues), and the computation used to determine the PCT Payments. The royalty base specified must be one that permits verification of its proper use by reference to books and records maintained by the controlled participants in the normal course of business (for example, books and records maintained for financial accounting or business management purposes). - (C) **Examples.** The following examples illustrate the principles of this [paragraph (h)(2)](#h-2). - (iv) **Conversion from fixed to contingent form of payment.** With regard to a conversion of a fixed present value to a contingent form of payment, see [paragraphs (g)(2)(v)](#g-2-v) (Discount rate) and (vi) (Financial projections) of this section. - (3) **Coordination of best method rule and form of payment.** A method described in [paragraph (g)(1)](#g-1) of this section evaluates the arm's length amount charged in a PCT in terms of a form of payment (method payment form). For example, the method payment form for the acquisition price method described in [paragraph (g)(5)](#g-5) of this section, and for the market capitalization method described in [paragraph (g)(6)](#g-6) of this section, is fixed payment. Applications of the income method provide different method payment forms. See paragraphs [(g)(4)(i)(E)](#g-4-i-E) and (iv) of this section. The method payment form may not necessarily correspond to the form of payment specified pursuant to paragraphs [(h)(2)(iii)](#h-2-iii) and (k)(2)(ii)(l) of this section (specified payment form). The determination under [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) of the method that provides the most reliable measure of an arm's length result is to be made without regard to whether the respective method payment forms under the competing methods correspond to the specified payment form. If the method payment form of the method determined under [§ 1.482-1(c)](/cfr/26/1.482-1.md?p=c) to provide the most reliable measure of an arm's length result differs from the specified payment form, then the conversion from such method payment form to such specified payment form will be made to the satisfaction of the Commissioner. - (i) **Allocations by the Commissioner in connection with a CSA—** - (1) **In general.** The Commissioner may make allocations to adjust the results of a controlled transaction in connection with a CSA so that the results are consistent with an arm's length result, in accordance with the provisions of this paragraph (i). - (2) **CST allocations—** - (i) **In general.** The Commissioner may make allocations to adjust the results of a CST so that the results are consistent with an arm's length result, including any allocations to make each controlled participant's IDC share, as determined under [paragraph (d)(4)](#d-4) of this section, equal to that participant's RAB share, as determined under [paragraph (e)(1)](#e-1) of this section. Such allocations may result from, for purposes of CST determinations, adjustments to— - (A) Redetermine IDCs by adding any costs (or cost categories) that are directly identified with, or are reasonably allocable to, the IDA, or by removing any costs (or cost categories) that are not IDCs; - (B) Reallocate costs between the IDA and other business activities; - (C) Improve the reliability of the selection or application of the basis used for measuring benefits for purposes of estimating a controlled participant's RAB share; - (D) Improve the reliability of the projections used to estimate RAB shares, including adjustments described in paragraph (i)(2)(ii) of this section; and - (E) **Allocate among the controlled participants any unallocated interests in cost shared intangibles.** - (ii) **Adjustments to improve the reliability of projections used to estimate RAB shares—** - (A) **Unreliable projections.** A significant divergence between projected benefit shares and benefit shares adjusted to take into account any available actual benefits to date (adjusted benefit shares) may indicate that the projections were not reliable for purposes of estimating RAB shares. In such a case, the Commissioner may use adjusted benefit shares as the most reliable measure of RAB shares and adjust IDC shares accordingly. The projected benefit shares will not be considered unreliable, as applied in a given taxable year, based on a divergence from adjusted benefit shares for every controlled participant that is less than or equal to 20% of the participant's projected benefits share. Further, the Commissioner will not make an allocation based on such divergence if the difference is due to an extraordinary event, beyond the control of the controlled participants, which could not reasonably have been anticipated at the time that costs were shared. The Commissioner generally may adjust projections of benefits used to calculate benefit shares in accordance with the provisions of [§ 1.482-1](/cfr/26/1.482-1.md). In particular, if benefits are projected over a period of years, and the projections for initial years of the period prove to be unreliable, this may indicate that the projections for the remaining years of the period are also unreliable and thus should be adjusted. For purposes of this paragraph (i)(2)(ii)(A), all controlled participants that are not U.S. persons are treated as a single controlled participant. Therefore, an adjustment based on an unreliable projection of RAB shares will be made to the IDC shares of foreign controlled participants only if there is a matching adjustment to the IDC shares of controlled participants that are U.S. persons. Nothing in this paragraph (i)(2)(ii)(A) prevents the Commissioner from making an allocation if a taxpayer did not use the most reliable basis for measuring anticipated benefits. For example, if the taxpayer measures its anticipated benefits based on units sold, and the Commissioner determines that another basis is more reliable for measuring anticipated benefits, then the fact that actual units sold were within 20% of the projected unit sales will not preclude an allocation under this section. - (B) **Foreign-to-foreign adjustments.** Adjustments to IDC shares based on an unreliable projection also may be made among foreign controlled participants if the variation between actual and projected benefits has the effect of substantially reducing U.S. tax. - (C) **Correlative adjustments to PCTs.** Correlative adjustments will be made to any PCT Payments of a fixed amount that were determined based on RAB shares that are subsequently adjusted on a finding that they were based on unreliable projections. No correlative adjustments will be made to contingent PCT Payments regardless of whether RAB shares were used as a parameter in the valuation of those payments. - (D) **Examples.** The following examples illustrate the principles of this paragraph (i)(2)(ii): - (iii) **Timing of CST allocations.** If the Commissioner makes an allocation to adjust the results of a CST, the allocation must be reflected for tax purposes in the year in which the IDCs were incurred. When a CST payment is owed by one controlled participant to another controlled participant, the Commissioner may make appropriate allocations to reflect an arm's length rate of interest for the time value of money, consistent with the provisions of [§ 1.482-2(a)](/cfr/26/1.482-2.md?p=a) (Loans or advances). - (3) **PCT allocations.** The Commissioner may make allocations to adjust the results of a PCT so that the results are consistent with an arm's length result in accordance with the provisions of the applicable sections of the regulations under [section 482](/cfr/26/482.md), as determined pursuant to [paragraph (a)(2)](#a-2) of this section. - (4) **Allocations regarding changes in participation under a CSA.** The Commissioner may make allocations to adjust the results of any controlled transaction described in [paragraph (f)](#f) of this section if the controlled participants do not reflect arm's length results in relation to any such transaction. - (5) **Allocations when CSTs are consistently and materially disproportionate to RAB shares.** If a controlled participant bears IDC shares that are consistently and materially greater or lesser than its RAB share, then the Commissioner may conclude that the economic substance of the arrangement between the controlled participants is inconsistent with the terms of the CSA. In such a case, the Commissioner may disregard such terms and impute an agreement that is consistent with the controlled participants' course of conduct, under which a controlled participant that bore a disproportionately greater IDC share received additional interests in the cost shared intangibles. See [§§ 1.482-1(d)(3)(ii)(B)](/cfr/26/1.482-1.md?p=d-3-ii-B) (Identifying contractual terms) and 1.482-4(f)(3)(ii) (Identification of owner). Such additional interests will consist of partial undivided interests in the other controlled participant's interest in the cost shared intangible. Accordingly, that controlled participant must receive arm's length consideration from any controlled participant whose IDC share is less than its RAB share over time, under the provisions of §§ [1.482-1](/cfr/26/1.482-1.md) and [1.482-4 through 1.482-6](/cfr/26/1.482-4..1.482-6.md) to provide compensation for the latter controlled participants' use of such partial undivided interest. - (6) **Periodic adjustments—** - (i) **In general.** Subject to the exceptions in paragraph (i)(6)(vi) of this section, the Commissioner may make periodic adjustments for an open taxable year (the Adjustment Year) and for all subsequent taxable years for the duration of the CSA Activity with respect to all PCT Payments, if the Commissioner determines that, for a particular PCT (the Trigger PCT), a particular controlled participant that owes or owed a PCT Payment relating to that PCT (such controlled participant being referred to as the PCT Payor for purposes of this paragraph (i)(6)) has realized an Actually Experienced Return Ratio (AERR) that is outside the Periodic Return Ratio Range (PRRR). The satisfaction of the condition stated in the preceding sentence is referred to as a Periodic Trigger. See [paragraphs (i)(6)(ii) through (vi)](#h-i-6-ii..h-i-6-vi) of this section regarding the PRRR, the AERR, and periodic adjustments. In determining whether to make such adjustments, the Commissioner may consider whether the outcome as adjusted more reliably reflects an arm's length result under all the relevant facts and circumstances, including any information known as of the Determination Date. The Determination Date is the date of the relevant determination by the Commissioner. The failure of the Commissioner to determine for an earlier taxable year that a PCT Payment was not arm's length will not preclude the Commissioner from making a periodic adjustment for a subsequent year. A periodic adjustment under this paragraph (i)(6) may be made without regard to whether the taxable year of the Trigger PCT or any other PCT remains open for statute of limitations purposes or whether a periodic adjustment has previously been made with respect to any PCT Payment. - (ii) **PRRR.** Except as provided in the next sentence, the PRRR will consist of return ratios that are not less than .667 nor more than 1.5. Alternatively, if the controlled participants have not substantially complied with the documentation requirements referenced in [paragraph (k)](#k) of this section, as modified, if applicable, by paragraphs [(m)(2)](#m-2) and [(3)](#m-3) of this section, the PRRR will consist of return ratios that are not less than .8 nor more than 1.25. - (iii) **AERR—** - (A) **In general.** The AERR is the present value of total profits (PVTP) divided by the present value of investment (PVI). In computing PVTP and PVI, present values are computed using the applicable discount rate (ADR), and all information available as of the Determination Date is taken into account. - (B) **PVTP.** The PVTP is the present value, as of the CSA Start Date, as defined in section (j)(1)(i) of this section, of the PCT Payor's actually experienced divisional profits or losses from the CSA Start Date through the end of the Adjustment Year. - (C) **PVI.** The PVI is the present value, as of the CSA Start Date, of the PCT Payor's investment associated with the CSA Activity, defined as the sum of its cost contributions and its PCT Payments, from the CSA Start Date through the end of the Adjustment Year. For purposes of computing the PVI, PCT Payments means all PCT Payments due from a PCT Payor before netting against PCT Payments due from other controlled participants pursuant to [paragraph (j)(3)(ii)](#j-3-ii) of this section. - (iv) **ADR—** - (A) **In general.** Except as provided in paragraph (i)(6)(iv)(B) of this section, the ADR is the discount rate pursuant to [paragraph (g)(2)(v)](#g-2-v) of this section, subject to such adjustments as the Commissioner determines appropriate. - (B) **Publicly traded companies.** If the PCT Payor meets the conditions of paragraph (i)(6)(iv)(C) of this section, the ADR is the PCT Payor WACC as of the date of the Trigger PCT. However, if the Commissioner determines, or the controlled participants establish to the satisfaction of the Commissioner, that a discount rate other than the PCT Payor WACC better reflects the degree of risk of the CSA Activity as of such date, the ADR is such other discount rate. - (C) **Publicly traded.** A PCT Payor meets the conditions of this paragraph (i)(6)(iv)(C) if— (1) Stock of the PCT Payor is publicly traded; or (2) Stock of the PCT Payor is not publicly traded, provided the PCT Payor is included in a group of companies for which consolidated financial statements are prepared; and a publicly traded company in such group owns, directly or indirectly, stock in PCT Payor. Stock of a company is publicly traded within the meaning of this paragraph (i)(6)(iv)(C) if such stock is regularly traded on an established United States securities market and the company issues financial statements prepared in accordance with United States generally accepted accounting principles for the taxable year. - (D) **PCT Payor WACC.** The PCT Payor WACC is the WACC, as defined in [paragraph (j)(1)(i)](#j-1-i) of this section, of the PCT Payor or the publicly traded company described in paragraph (i)(6)(iv)(C)(2)(ii) of this section, as the case may be. - (E) **Generally accepted accounting principles.** For purposes of paragraph (i)(6)(iv)(C) of this section, a financial statement prepared in accordance with a comprehensive body of generally accepted accounting principles other than United States generally accepted accounting principles is considered to be prepared in accordance with United States generally accepted accounting principles provided that the amounts of debt, equity, and interest expense are reflected in any reconciliation between such other accounting principles and United States generally accepted accounting principles required to be incorporated into the financial statement by the securities laws governing companies whose stock is regularly traded on United States securities markets. - (v) **Determination of periodic adjustments.** In the event of a Periodic Trigger, subject to paragraph (i)(6)(vi) of this section, the Commissioner may make periodic adjustments with respect to all PCT Payments between all PCT Payors and PCT Payees for the Adjustment Year and all subsequent years for the duration of the CSA Activity pursuant to the residual profit split method as provided in [paragraph (g)(7)](#g-7) of this section, subject to the further modifications in this paragraph (i)(6)(v). A periodic adjustment may be made for a particular taxable year without regard to whether the taxable years of the Trigger PCT or other PCTs remain open for statute of limitation purposes. - (A) **In general.** Periodic adjustments are determined by the following steps: (1) First, determine the present value, as of the date of the Trigger PCT, of the PCT Payments under paragraph (g)(7)(iii)(C)(3) of this section pursuant to the Adjusted RPSM as defined in paragraph (i)(6)(v)(B) of this section (first step result). (2) Second, convert the first step result into a stream of contingent payments on a base of reasonably anticipated divisional profits or losses over the entire duration of the CSA Activity, using a level royalty rate (second step rate). See [paragraph (h)(2)(iv)](#h-2-iv) of this section (Conversion from fixed to contingent form of payment). This conversion is made based on all information known as of the Determination Date. (3) Third, apply the second step rate to the actual divisional profit or loss for taxable years preceding and including the Adjustment Year to yield a stream of contingent payments for such years, and convert such stream to a present value as of the CSA Start Date under the principles of [paragraph (g)(2)(v)](#g-2-v) of this section (third step result). For this purpose, the second step rate applied to a loss for a particular year will yield a negative contingent payment for that year. (4) Fourth, convert any actual PCT Payments up through the Adjustment Year to a present value as of the CSA Start Date under the principles of [paragraph (g)(2)(v)](#g-2-v) of this section. Then subtract such amount from the third step result. Determine the nominal amount in the Adjustment Year that would have a present value as of the CSA Start Date equal to the present value determined in the previous sentence to determine the periodic adjustment in the Adjustment Year. (5) Fifth, apply the second step rate to the actual divisional profit or loss for each taxable year after the Adjustment Year up to and including the taxable year that includes the Determination Date to yield a stream of contingent payments for such years. For this purpose, the second step rate applied to a loss will yield a negative contingent payment for that year. Then subtract from each such payment any actual PCT Payment made for the same year to determine the periodic adjustment for such taxable year. (6) For each taxable year subsequent to the year that includes the Determination Date, the periodic adjustment for such taxable year (which is in lieu of any PCT Payment that would otherwise be payable for that year under the taxpayer's position) equals the second step rate applied to the actual divisional profit or loss for that year. For this purpose, the second step rate applied to a loss for a particular year will yield a negative contingent payment for that year. (7) If the periodic adjustment for any taxable year is a positive amount, then it is an additional PCT Payment owed from the PCT Payor to the PCT Payee for such year. If the periodic adjustment for any taxable year is a negative amount, then it is an additional PCT Payment owed by the PCT Payee to the PCT Payor for such year. - (B) **Adjusted RPSM as of Determination Date.** The Adjusted RPSM is the residual profit split method pursuant to [paragraph (g)(7)](#g-7) of this section applied to determine the present value, as of the date of the Trigger PCT, of the PCT Payments under paragraph (g)(7)(iii)(C)(3) of this section, with the following modifications. (1) Actual results up through the Determination Date shall be substituted for what otherwise were the projected results over such period, as reasonably anticipated as of the date of the Trigger PCT. (2) Projected results for the balance of the CSA Activity after the Determination Date, as reasonably anticipated as of the Determination Date, shall be substituted for what otherwise were the projected results over such period, as reasonably anticipated as of the date of the Trigger PCT. (3) The requirement in [paragraph (g)(7)(i)](#g-7-i) of this section, that at least two controlled participants make significant nonroutine contributions, does not apply. - (vi) **Exceptions to periodic adjustments—** - (A) **Controlled participants establish periodic adjustment not warranted.** No periodic adjustment will be made under paragraphs (i)(6)(i) and (v) of this section if the controlled participants establish to the satisfaction of the Commissioner that all the conditions described in one of [paragraphs (i)(6)(vi)(A)(1) through (4)](#h-i-6-vi-A-1..h-i-6-vi-A-4) of this section apply with respect to the Trigger PCT. (1) Transactions involving the same platform contribution as in the Trigger PCT. (i) The same platform contribution is furnished to an uncontrolled taxpayer under substantially the same circumstances as those of the relevant Trigger PCT and with a similar form of payment as the Trigger PCT; (ii) This transaction serves as the basis for the application of the comparable uncontrolled transaction method described in [paragraph (g)(3)](#g-3) of this section, in the first year and all subsequent years in which substantial PCT Payments relating to the Trigger PCT were required to be paid; and (iii) The amount of those PCT Payments in that first year was arm's length. (2) Results not reasonably anticipated. The differential between the AERR and the nearest bound of the PRRR is due to extraordinary events beyond the control of the controlled participants that could not reasonably have been anticipated as of the date of the Trigger PCT. (3) Reduced AERR does not cause Periodic Trigger. The Periodic Trigger would not have occurred had the PCT Payor's divisional profits or losses used to calculate its PVTP both taken into account expenses on account of operating cost contributions and routine platform contributions, and excluded those profits or losses attributable to the PCT Payor's routine contributions to its exploitation of cost shared intangibles, nonroutine contributions to the CSA Activity, operating cost contributions, and routine platform contributions. (4) Increased AERR does not cause Periodic Trigger—(i) The Periodic Trigger would not have occurred had the divisional profits or losses of the PCT Payor used to calculate its PVTP included its reasonably anticipated divisional profits or losses after the Adjustment Year from the CSA Activity, including from its routine contributions, its operating cost contributions, and its nonroutine contributions to that activity, and had the cost contributions and PCT Payments of the PCT Payor used to calculate its PVI included its reasonably anticipated cost contributions and PCT Payments after the Adjustment Year. The reasonably anticipated amounts in the previous sentence are determined based on all information available as of the Determination Date. (ii) For purposes of this paragraph (i)(6)(vi)(A)(4), the controlled participants may, if they wish, assume that the average yearly divisional profits or losses for all taxable years prior to and including the Adjustment Year, in which there has been substantial exploitation of cost shared intangibles resulting from the CSA (exploitation years), will continue to be earned in each year over a period of years equal to 15 minus the number of exploitation years prior to and including the Determination Date. - (B) **Circumstances in which Periodic Trigger deemed not to occur.** No Periodic Trigger will be deemed to have occurred at the times and in the circumstances described in paragraph (i)(6)(vi)(B)(1) or (2) of this section. (1) 10-year period. In any year subsequent to the 10-year period beginning with the first taxable year in which there is substantial exploitation of cost shared intangibles resulting from the CSA, if the AERR determined is within the PRRR for each year of such 10-year period. (2) 5-year period. In any year of the 5-year period beginning with the first taxable year in which there is substantial exploitation of cost shared intangibles resulting from the CSA, if the AERR falls below the lower bound of the PRRR. - (vii) **Examples.** The following examples illustrate the rules of this paragraph (i)(6): - (j) **Definitions and special rules—** - (1) **Definitions—** - (i) **In general.** For purposes of this section— - (ii) **Examples.** The following examples illustrate certain definitions in [paragraph (j)(1)(i)](#j-1-i) of this section: - (2) **Special rules—** - (i) **Consolidated group.** For purposes of this section, all members of the same consolidated group shall be treated as one taxpayer. For these purposes, the term consolidated group means all members of a group of controlled entities created or organized within a single country and subjected to an income tax by such country on the basis of their combined income. - (ii) **Trade or business.** A participant that is a foreign corporation or nonresident alien individual will not be treated as engaged in a trade or business within the United States solely by reason of its participation in a CSA. See generally [§ 1.864-2(a)](/cfr/26/1.864-2.md?p=a). - (iii) **Partnership.** A CSA, or an arrangement to which the Commissioner applies the rules of this section, will not be treated as a partnership to which the rules of subchapter K of the Internal Revenue Code apply. See [§ 301.7701-1(c)](/cfr/26/301.7701-1.md?p=c) of this chapter. - (3) **Character—** - (i) **CST Payments.** CST Payments generally will be considered the payor's costs of developing intangibles at the location where such development is conducted. For these purposes, IDCs borne directly by a controlled participant that are deductible are deemed to be reduced to the extent of any CST Payments owed to it by other controlled participants pursuant to the CSA. Each cost sharing payment received by a payee will be treated as coming pro rata from payments made by all payors and will be applied pro rata against the deductions for the taxable year that the payee is allowed in connection with the IDCs. Payments received in excess of such deductions will be treated as in consideration for use of the land and tangible property furnished for purposes of the CSA by the payee. For purposes of the research credit determined under [section 41](/cfr/26/41.md), CST Payments among controlled participants will be treated as provided for intra-group transactions in [§ 1.41-6(i)](/cfr/26/1.41-6.md?p=i). Any payment made or received by a taxpayer pursuant to an arrangement that the Commissioner determines not to be a CSA will be subject to the provisions of §§ [1.482-1 through 1.482-6](/cfr/26/1.482-1..1.482-6.md) and [1.482-9](/cfr/26/1.482-9.md). Any payment that in substance constitutes a cost sharing payment will be treated as such for purposes of this section, regardless of its characterization under foreign law. - (ii) **PCT Payments.** A PCT Payor's payment required under [paragraph (b)(1)(ii)](#b-1-ii) of this section is deemed to be reduced to the extent of any payments owed to it under such paragraph from other controlled participants. Each PCT Payment received by a PCT Payee will be treated as coming pro rata out of payments made by all PCT Payors. PCT Payments will be characterized consistently with the designation of the type of transaction pursuant to paragraphs [(c)(3)](#c-3) and [(k)(2)(ii)(H)](#k-2-ii-H) of this section. Depending on such designation, such payments will be treated as either consideration for a transfer of an interest in intangible property or for services. - (iii) **Examples.** The following examples illustrate this [paragraph (j)(3)](#j-3): - (k) **CSA administrative requirements.** A controlled participant meets the requirements of this paragraph if it substantially complies, respectively, with the CSA contractual, documentation, accounting, and reporting requirements of [paragraphs (k)(1) through (4)](#k-1..k-4) of this section. - (1) **CSA contractual requirements—** - (i) **In general.** A CSA must be recorded in writing in a contract that is contemporaneous with the formation (and any revision) of the CSA and that includes the contractual provisions described in this [paragraph (k)(1)](#k-1). - (ii) **Contractual provisions.** The written contract described in this [paragraph (k)(1)](#k-1) must include provisions that— - (A) List the controlled participants and any other members of the controlled group that are reasonably anticipated to benefit from the use of the cost shared intangibles, including the address of each domestic entity and the country of organization of each foreign entity; - (B) Describe the scope of the IDA to be undertaken and each reasonably anticipated cost shared intangible or class of reasonably anticipated cost shared intangibles; - (C) Specify the functions and risks that each controlled participant will undertake in connection with the CSA; - (D) Divide among the controlled participants all divisional interests in cost shared intangibles and specify each controlled participant's divisional interest in the cost shared intangibles, as described in paragraphs [(b)(1)(iii)](#b-1-iii) and (4) of this section, that it will own and exploit without any further obligation to compensate any other controlled participant for such interest; - (E) Provide a method to calculate the controlled participants' RAB shares, based on factors that can reasonably be expected to reflect the participants' shares of anticipated benefits, and require that such RAB shares must be updated, as described in [paragraph (e)(1)](#e-1) of this section (see also [paragraph (k)(2)(ii)(F)](#k-2-ii-F) of this section); - (F) Enumerate all categories of IDCs to be shared under the CSA; - (G) Specify that the controlled participant must use a consistent method of accounting to determine IDCs and RAB shares, as described in paragraphs [(d)](#d) and [(e)](#e) of this section, respectively, and must translate foreign currencies on a consistent basis; - (H) Require the controlled participant to enter into CSTs covering all IDCs, as described in [paragraph (b)(1)(i)](#b-1-i) of this section, in connection with the CSA; - (I) Require the controlled participants to enter into PCTs covering all platform contributions, as described in [paragraph (b)(1)(ii)](#b-1-ii) of this section, in connection with the CSA; - (J) Specify the form of payment due under each PCT (or group of PCTs) in existence at the formation (and any revision) of the CSA, including information and explanation that reasonably supports an analysis of applicable provisions of [paragraph (h)](#h) of this section; and - (K) Specify the date on which the CSA is entered into (CSA Start Date) and the duration of the CSA, the conditions under which the CSA may be modified or terminated, and the consequences of a modification or termination (including consequences described under the rules of [paragraph (f)](#f) of this section). - (iii) **Meaning of contemporaneous—** - (A) **In general.** For purposes of this [paragraph (k)(1)](#k-1), a written contractual agreement is contemporaneous with the formation (or revision) of a CSA if, and only if, the controlled participants record the CSA, in its entirety, in a document that they sign and date no later than 60 days after the first occurrence of any IDC described in [paragraph (d)](#d) of this section to which such agreement (or revision) is to apply. - (B) **Example.** The following example illustrates the principles of this [paragraph (k)(1)(iii)](#k-1-iii): - (iv) **Interpretation of contractual provisions—** - (A) **In general.** The provisions of a written contract described in this [paragraph (k)(1)](#k-1) and of the additional documentation described in [paragraph (k)(2)](#k-2) of this section must be clear and unambiguous. The provisions will be interpreted by reference to the economic substance of the transaction and the actual conduct of the controlled participants. See [§ 1.482-1(d)(3)(ii)(B)](/cfr/26/1.482-1.md?p=d-3-ii-B) (Identifying contractual terms). Accordingly, the Commissioner may impute contractual terms in a CSA consistent with the economic substance of the CSA and may disregard contractual terms that lack economic substance. An allocation of risk between controlled participants after the outcome of such risk is known or reasonably knowable lacks economic substance. See [§ 1.482-1(d)(3)(iii)(B)](/cfr/26/1.482-1.md?p=d-3-iii-B) (Identification of taxpayer that bears risk). A contractual term that is disregarded due to a lack of economic substance does not satisfy a contractual requirement set forth in this [paragraph (k)(1)](#k-1) or documentation requirement set forth in [paragraph (k)(2)](#k-2) of this section. See [paragraph (b)(5)](#b-5) of this section for the treatment of an arrangement among controlled taxpayers that fails to comply with the requirements of this section. - (B) **Examples.** The following examples illustrate the principles of this [paragraph (k)(1)(iv)](#k-1-iv). In each example, it is assumed that the Commissioner will exercise the discretion granted pursuant to [paragraph (b)(5)(ii)](#b-5-ii) of this section to apply the provisions of this section to the arrangement that purports to be a CSA. - (2) **CSA documentation requirements—** - (i) **In general.** The controlled participants must timely update and maintain sufficient documentation to establish that the participants have met the CSA contractual requirements of [paragraph (k)(1)](#k-1) of this section and the additional CSA documentation requirements of this [paragraph (k)(2)](#k-2). - (ii) **Additional CSA documentation requirements.** The controlled participants to a CSA must timely update and maintain documentation sufficient to— - (A) **Describe the current scope of the IDA and identify—** (1) Any additions or subtractions from the list of reasonably anticipated cost shared intangibles reported pursuant to [paragraph (k)(1)(ii)(B)](#k-1-ii-B) of this section; (2) Any cost shared intangible, together with each controlled participant's interest therein; and (3) Any further development of intangibles already developed under the CSA or of specified applications of such intangible which has been removed from the IDA (see paragraphs [(d)(1)(ii)](#d-1-ii) and [(j)(1)(i)](#j-1-i) of this section for the definitions of reasonably anticipated cost shared intangible and cost shared intangible) and the steps (including any accounting classifications and allocations) taken to implement such removal; - (B) Establish that each controlled participant reasonably anticipates that it will derive benefits from exploiting cost shared intangibles; - (C) Describe the functions and risks that each controlled participant has undertaken during the term of the CSA; - (D) Provide an overview of each controlled participant's business segments, including an analysis of the economic and legal factors that affect CST and PCT pricing; - (E) Establish the amount of each controlled participant's IDCs for each taxable year under the CSA, including all IDCs attributable to stock-based compensation, as described in [paragraph (d)(3)](#d-3) of this section (including the method of measurement and timing used in determining such IDCs, and the data, as of the date of grant, used to identify stock-based compensation with the IDA); - (F) Describe the method used to estimate each controlled participant's RAB share for each year during the course of the CSA, including— (1) All projections used to estimate benefits; (2) All updates of the RAB shares in accordance with [paragraph (e)(1)](#e-1) of this section; and (3) An explanation of why that method was selected and why the method provides the most reliable measure for estimating RAB shares; - (G) Describe all platform contributions; - (H) Designate the type of transaction involved for each PCT or group of PCTs; - (I) Specify, within the time period provided in [paragraph (h)(2)(iii)](#h-2-iii) of this section, the form of payment due under each PCT or group of PCTs, including information and explanation that reasonably supports an analysis of applicable provisions of [paragraph (h)](#h) of this section; - (J) Describe and explain the method selected to determine the arm's length payment due under each PCT, including— (1) An explanation of why the method selected constitutes the best method, as described in [§ 1.482-1(c)(2)](/cfr/26/1.482-1.md?p=c-2), for measuring an arm's length result; (2) The economic analyses, data, and projections relied upon in developing and selecting the best method, including the source of the data and projections used; (3) Each alternative method that was considered, and the reason or reasons that the alternative method was not selected; (4) Any data that the controlled participant obtains, after the CSA takes effect, that would help determine if the controlled participant's method selected has been applied in a reasonable manner; (5) The discount rate or rates, where applicable, used for purposes of evaluating PCT Payments, including information and explanation that reasonably supports an analysis of applicable provisions of [paragraph (g)(2)(v)](#g-2-v) of this section; (6) The estimated arm's length values of any platform contributions as of the dates of the relevant PCTs, in accordance with [paragraph (g)(2)(ii)](#g-2-ii) of this section; (7) A discussion, where applicable, of why transactions were or were not aggregated under the principles of [paragraph (g)(2)(iv)](#g-2-iv) of this section; (8) The method payment form and any conversion made from the method payment form to the specified payment form, as described in [paragraph (h)(3)](#h-3) of this section; and (9) If applicable under paragraph (i)(6)(iv) of this section, the WACC of the parent of the controlled group that includes the controlled participants. - (iii) **Coordination rules and production of documents—** - (A) **Coordination with penalty regulations.** See [§ 1.6662-6(d)(2)(iii)(D)](/cfr/26/1.6662-6.md?p=d-2-iii-D) regarding coordination of the rules of this [paragraph (k)](#k) with the documentation requirements for purposes of the accuracy-related penalty under section [6662(e)](/cfr/26/6662.md?p=e) and [(h)](/cfr/26/6662.md?p=h). - (B) **Production of documentation.** Each controlled participant must provide to the Commissioner, within 30 days of a request, the items described in this [paragraph (k)(2)](#k-2) and [paragraph (k)(3)](#k-3) of this section. The time for compliance described in this [paragraph (k)(2)(iii)(B)](#k-2-iii-B) may be extended at the discretion of the Commissioner. - (3) **CSA accounting requirements—** - (i) **In general.** The controlled participants must maintain books and records (and related or underlying data and information) that are sufficient to— - (A) Establish that the controlled participants have used (and are using) a consistent method of accounting to measure costs and benefits; - (B) Permit verification that the amount of any contingent PCT Payments due have been (and are being) properly determined; - (C) Translate foreign currencies on a consistent basis; and - (D) To the extent that the method of accounting used materially differs from U.S. generally accepted accounting principles, explain any such material differences. - (ii) **Reliance on financial accounting.** For purposes of this section, the controlled participants may not rely solely upon financial accounting to establish satisfaction of the accounting requirements of this [paragraph (k)(3)](#k-3). Rather, the method of accounting must clearly reflect income. Thor Power Tools Co. v. Commissioner, 439 U.S. 522 (1979). - (4) **CSA reporting requirements—** - (i) **CSA Statement.** Each controlled participant must file with the Internal Revenue Service, in the manner described in this [paragraph (k)(4)](#k-4), a “Statement of Controlled Participant to § 1.482-7 Cost Sharing Arrangement” (CSA Statement) that complies with the requirements of this [paragraph (k)(4)](#k-4). - (ii) **Content of CSA Statement.** The CSA Statement of each controlled participant must— - (A) State that the participant is a controlled participant in a CSA; - (B) Provide the controlled participant's taxpayer identification number; - (C) List the other controlled participants in the CSA, the country of organization of each such participant, and the taxpayer identification number of each such participant; - (D) Specify the earliest date that any IDC described in [paragraph (d)(1)](#d-1) of this section occurred; and - (E) Indicate the date on which the controlled participants formed (or revised) the CSA and, if different from such date, the date on which the controlled participants recorded the CSA (or any revision) contemporaneously in accordance with paragraphs [(k)(1)(i)](#k-1-i) and [(iii)](#k-1-iii) of this section. - (iii) **Time for filing CSA Statement—** - (A) **90-day rule.** Each controlled participant must file its original CSA Statement with the Internal Revenue Service Ogden Campus (addressed as follows: “Attn: CSA Statements, Mail Stop 4912, Internal Revenue Service, 1973 North Rulon White Blvd., Ogden, Utah 84404-0040”), no later than 90 days after the first occurrence of an IDC to which the newly-formed CSA applies, as described in [paragraph (k)(1)(iii)(A)](#k-1-iii-A) of this section, or, in the case of a taxpayer that became a controlled participant after the formation of the CSA, no later than 90 days after such taxpayer became a controlled participant. A CSA Statement filed in accordance with this [paragraph (k)(4)(iii)(A)](#k-4-iii-A) must be dated and signed, under penalties of perjury, by an officer of the controlled participant who is duly authorized (under local law) to sign the statement on behalf of the controlled participant. - (B) **Annual return requirement—** (1) In general. Each controlled participant must attach to its U.S. income tax return, for each taxable year for the duration of the CSA, a copy of the original CSA Statement that the controlled participant filed in accordance with the 90-day rule of [paragraph (k)(4)(iii)(A)](#k-4-iii-A) of this section. In addition, the controlled participant must update the information reflected on the original CSA Statement annually by attaching a schedule that documents changes in such information over time. (2) Special filing rule for annual return requirement. If a controlled participant is not required to file a U.S. income tax return, the participant must ensure that the copy or copies of the CSA Statement and any updates are attached to Schedule M of any Form 5471, any Form 5472 “Information Return of a Foreign Owned Corporation,” or any Form 8865 “Return of U.S. Persons With Respect to Certain Foreign Partnerships,” filed with respect to that participant. - (iv) **Examples.** The following examples illustrate this [paragraph (k)(4)](#k-4). In each example, Companies A and B are members of the same controlled group. - (l) **Effective/applicability dates.** Except as otherwise provided in this [paragraph (l)](#l), this section applies on December 16, 2011. Paragraphs (g)(2)(v)(B)(2), (g)(4)(vi)(F)(2), and (g)(4)(viii), Example 8 of this section apply to taxable years beginning on or after December 19, 2011. Paragraphs [(g)(4)(v)](#g-4-v) and [(g)(4)(viii)](#g-4-viii), Example 9 apply to taxable years beginning on or after August 27, 2013. - (m) **Transition rule—** - (1) **In general.** An arrangement in existence on January 5, 2009, will be considered a CSA, as described under [paragraph (b)](#b) of this section, if, prior to such date, it was a qualified cost sharing arrangement under the provisions of § 1.482-7 (as contained in the [26 CFR part 1](/cfr/26/part1.md) edition revised as of January 1, 1996, hereafter referred to as “former § 1.482-7”), but only if the written contract, as described in [paragraph (k)(1)](#k-1) of this section, is amended, if necessary, to conform with, and only if the activities of the controlled participants substantially comply with, the provisions of this section, as modified by paragraphs [(m)(2)](#m-2) and [(m)(3)](#m-3) of this section, by July 6, 2009. - (2) **Transitional modification of applicable provisions.** For purposes of this [paragraph (m)](#m), conformity and substantial compliance with the provisions of this section shall be determined with the following modifications: - (i) CSTs and PCTs occurring prior to January 5, 2009, shall be subject to the provisions of former § 1.482-7 rather than this section. - (ii) Except to the extent provided in [paragraph (m)(3)](#m-3) of this section, PCTs that occur under a CSA that was a qualified cost sharing arrangement under the provisions of former § 1.482-7 and remained in effect on January 5, 2009, shall be subject to the periodic adjustment rules of [§ 1.482-4(f)(2)](/cfr/26/1.482-4.md?p=f-2) rather than the rules of paragraph (i)(6) of this section. - (iii) Paragraphs [(b)(1)(iii)](#b-1-iii) and (b)(4) of this section shall not apply. - (iv) [Paragraph (k)(1)(ii)(D)](#k-1-ii-D) of this section shall not apply. - (v) Paragraphs [(k)(1)(ii)(H)](#k-1-ii-H) and [(I)](#k-1-ii-I) of this section shall be construed as applying only to transactions entered into on or after January 5, 2009. - (vi) The deadline for recordation of the revised written contractual agreement pursuant to [paragraph (k)(1)(iii)](#k-1-iii) of this section shall be no later than July 6, 2009. - (vii) [Paragraphs (k)(2)(ii)(G) through (J)](#k-2-ii-G..k-2-ii-J) of this section shall be construed as applying only with reference to PCTs entered into on or after January 5, 2009. - (viii) [Paragraph (k)(4)(iii)(A)](#k-4-iii-A) of this section shall be construed as requiring a CSA Statement with respect to the revised written contractual agreement described in [paragraph (m)(2)(vi)](#m-2-vi) of this section no later than September 2, 2009. - (ix) [Paragraph (k)(4)(iii)(B)](#k-4-iii-B) of this section shall be construed as only applying for taxable years ending after the filing of the CSA Statement described in [paragraph (m)(2)(viii)](#m-2-viii) of this section. - (3) **Special rule for certain periodic adjustments.** The periodic adjustment rules in paragraph (i)(6) of this section (rather than the rules of [§ 1.482-4(f)(2)](/cfr/26/1.482-4.md?p=f-2)) shall apply to PCTs that occur on or after the date of a material change in the scope of the CSA from its scope as of January 5, 2009. A material change in scope would include a material expansion of the activities undertaken beyond the scope of the intangible development area, as described in former [§ 1.482-7(b)(4)(iv)](#b-4-iv). For this purpose, a contraction of the scope of a CSA, absent a material expansion into one or more lines of research and development beyond the scope of the intangible development area, does not constitute a material change in scope of the CSA. Whether a material change in scope has occurred is determined on a cumulative basis. Therefore, a series of expansions, any one of which is not a material expansion by itself, may collectively constitute a material expansion.