[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8670]
RIN 1545-AU20
Revision of Section 482 Cost Sharing Regulations
AGENCY:  Internal Revenue Service (IRS), Treasury.
ACTION:  Final regulations.
SUMMARY:  This document contains final regulations relating to
qualified cost sharing arrangements under section 482 of the
Internal Revenue Code.  These regulations reflect technical
changes to the requirements for qualification as a controlled
participant under the final cost sharing regulations published in
the Federal Register on December 20, 1995.
DATES:  These regulations are effective May 13, 1996.
     These regulations are applicable for taxable years beginning
on or after January 1, 1996.
FOR FURTHER INFORMATION CONTACT:  Lisa Sams of the Office of
Associate Chief Counsel (International), IRS (202) 622-3840 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
     Section 482 was amended by the Tax Reform Act of 1986,
Public Law 99-514, 100 Stat. 2085, 2561, et. seq. (1986-3 C.B.
(Vol. 1) 1, 478).  On January 30, 1992, a notice of proposed
rulemaking concerning the section 482 amendment in the context of
cost sharing was published in the Federal Register (INTL-0372-88,
57 FR 3571).
     Written comments were received with respect to the notice of
proposed rulemaking, and a public hearing was held on August 31,
1992.
     On December 20, 1995, final regulations were published in
the Federal Register (INTL-0372-88, 60 FR 65553) as Treasury
Decision 8632.  These final regulations amend the regulations
contained in Treasury Decision 8632 by making technical changes
to the requirements for qualification as a controlled participant
contained in 1.482-7(c).
     The agency has decided not to issue a second notice of
proposed rulemaking with respect to the modifications to TD 8632
contained in these final regulations.  The rules to which the
modifications relate (concerning qualification as a controlled
participant) were the subject of the notice of proposed
rulemaking published on January 30, 1992, and comments on those
rules were received in connection with those proposed
regulations.  Therefore, a further comment period on these rules
is unnecessary.  Taxpayers need prompt guidance on how to conform
their arrangements to the rules set forth in TD 8632, which is
effective for taxable years beginning on or after January 1,
1996, and which provides a one year transition period for
amending arrangements.  The modifications contained in these
final regulations will aid taxpayers in that regard, and any
delay caused by a second notice of proposed rulemaking would be
impracticable and contrary to the public interest.  Unsolicited
comment letters were received in connection with TD 8632 and are
available for public inspection in the FOIA reading room.
Explanation of Provisions
     The purpose of these regulations is to rectify problems in
qualifying as a controlled participant caused by the technical
requirements of the active conduct rule of 1.482-7(c).  This
rule provided that a controlled taxpayer may be a controlled
participant only if it uses or reasonably expects to use covered
intangibles in the active conduct of a trade or business.
     Under the 1992 proposed cost sharing regulations, a member
of a group of controlled taxpayers could participate in a
qualified cost sharing arrangement on behalf of, and could
satisfy the active conduct rule based on activities performed by,
one or more other members of the group (a cost sharing subgroup).
The participating subgroup member would then transfer or license
the intangibles developed under the arrangement to the
nonparticipating subgroup member(s).  The proposed regulations
would have measured benefits in such case on the basis of the
benefits of the entire subgroup from exploiting the intangibles.
TD 8632, in streamlining the participation rules, omitted the
subgroup rules.  Taxpayers commented that the change would force
them to amend existing arrangements to include as a participant
every operating company that predictably would be using covered
intangibles.
     These regulations further streamline the participation
rules.  The principal reason for the active conduct rule was to
ensure that a controlled participant stands to benefit from the
use of covered intangibles in a manner that can be reliably
measured.  The Treasury and Service have concluded that this
purpose can be accomplished without the active conduct rule.  No
distinction need be made based on the nature of a participant's
use of covered intangibles, so long as its benefits from such use
(whether from directly exploiting the intangibles or from
transferring or licensing them to others) can be reliably
measured.
     Accordingly, these regulations eliminate the active conduct
rule of 1.482-7(c) as a requirement for qualification as a
controlled participant in a qualified cost sharing arrangement.
Section 1.482-7(c)(1) of these regulations substitutes a general
rule that a controlled taxpayer may be a controlled participant
in a cost sharing arrangement only if it reasonably anticipates
that it will derive benefits from the use of covered intangibles.
In addition, 1.482-7(f)(3)(ii) provides that if a controlled
participant transfers covered intangibles to another controlled
taxpayer, the participant's benefits will be measured with
reference to the transferee's benefits rather than with reference
to any consideration paid by the transferee.  (This gives rise to
results similar to those under the subgroup rules of the proposed
regulations by different mechanics.)  Finally, 1.482-7(f)(3)(ii)
continues to provide that the amount of benefits that each of the
controlled participants is reasonably anticipated to derive from
covered intangibles must be measured on a basis that is
consistent for all such participants.
     These changes ensure that a controlled participant must
benefit from the arrangement, that the basis for measuring
benefits must be consistent for all controlled participants, and
that, in the event of intragroup transfers, there will be "look
through" treatment for reliably measuring benefits.  These rules
allow a participant to exploit covered intangibles itself or
through transferring or licensing them to others, so long as the
benefits to be derived can be consistently and reliably measured
for all controlled participants.
     These regulations also clarify that the documentation
requirements of 1.482-7(j)(2) will satisfy the principal
document requirement of 1.6662-6(d)(iii)(B) with respect to a
qualified cost sharing arrangement.
Special Analyses
     It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866.  Therefore,
a regulatory assessment is not required.  It also has been
determined that section 553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5
U.S.C. chapter 6) do not apply to these regulations, and,
therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.
Drafting Information
     The principal author of these regulations is Lisa Sams,
Office of Associate Chief Counsel (International), IRS.  However,
other personnel from the IRS and Treasury Department participated
in their development.
List of Subjects in 26 CFR Part 1
     Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
     Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
     Paragraph 1.  The authority for part 1 continues to read in
part as follows:
     Authority:  26 U.S.C. 7805. * * *
     Par. 2.  Section 1.482-0 is amended by revising the entries
for 1.482-7(c) and (j) to read as follows:
1.482-0  Outline of regulations under 482.
* * * * *
1.482-7  Sharing of costs.
* * * * *
(c) Participant.
(1) In general.
(2) Treatment of a controlled taxpayer that is not a controlled
participant.
(i) In general.
(ii) Example.
(3)  Treatment of consolidated group.
* * * * *
(j) Administrative requirements.
(1) In general.
(2) Documentation.
(i) Requirements.
(ii) Coordination with penalty regulation.
(3) Reporting requirements.
* * * * *
     Par. 3.  Section 1.482-7 is amended as follows:
a.   By revising paragraph (c)(1)(i).
b.   By adding paragraph (c)(1)(iv).
c.   By removing paragraphs (c)(2) and (c)(3) and redesignating
paragraphs (c)(4) and (c)(5) as paragraphs (c)(2) and (c)(3),
respectively.
d.   By revising newly designated paragraph (c)(2)(ii).
e.   By adding a sentence after the second sentence in paragraph
(f)(3)(ii).
f.   By revising Example 8 of paragraph (f)(3)(iii)(E).
g.   By redesignating the introductory text of paragraph (j)(2)
following the heading and paragraphs (j)(2)(i) through (j)(2)(v)
as the introductory text of paragraph (j)(2)(i) and paragraphs
(j)(2)(i)(A) through (j)(2)(i)(E), respectively; and adding a
heading for newly designated paragraph (j)(2)(i).h.   By removing the language "(j)(2)" and adding "(j)(2)(i)" in
its place in the first sentence of newly designated paragraph
(j)(2)(i).
i.   By adding a paragraph (j)(2)(ii).
     The additions and revisions read as follows:
1.482-7  Sharing of costs.
* * * * *
     (c) * * *  (1) * * *
     (i)  Reasonably anticipates that it will derive benefits
from the use of covered intangibles;
* * * * *
     (iv) The following example illustrates paragraph (c)(1)(i)
of this section:
     Example.  Foreign Parent (FP) is a foreign corporation
engaged in the extraction of a natural resource.  FP has a U.S.
subsidiary (USS) to which FP sells supplies of this resource for
sale in the United States.  FP enters into a cost sharing
arrangement with USS to develop a new machine to extract the
natural resource.  The machine uses a new extraction process that
will be patented in the United States and in other countries.
The cost sharing arrangement provides that USS will receive the
rights to use the machine in the extraction of the natural
resource in the United States, and FP will receive the rights in
the rest of the world.  This resource does not, however, exist in
the United States.  Despite the fact that USS has received the
right to use this process in the United States, USS is not a
qualified participant because it will not derive a benefit from
the use of the intangible developed under the cost sharing
arrangement.
     (2) * * *
     (ii) Example.  The following example illustrates this
paragraph (c)(2):
     Example.  (i)  U.S. Parent (USP), one foreign subsidiary
(FS), and a second foreign subsidiary constituting the group's
research arm (R+D) enter into a cost sharing agreement to develop
manufacturing intangibles for a new product line A.  USP and FS
are assigned the exclusive rights to exploit the intangibles
respectively in the United States and the rest of the world,
where each presently manufactures and sells various existing
product lines.  R+D is not assigned any rights to exploit the
intangibles.  R+D's activity consists solely in carrying out
research for the group.  It is reliably projected that the shares
of reasonably anticipated benefits of USP and FS will be 66 2/3%
and 33 1/3%, respectively, and the parties' agreement provides
that USP and FS will reimburse 66 2/3% and 33 1/3%, respectively,
of the intangible development costs incurred by R+D with respect
to the new intangible.
     (ii)  R+D does not qualify as a controlled participant
within the meaning of paragraph (c) of this section, because it
will not derive any benefits from the use of covered intangibles.
Therefore, R+D is treated as a service provider for purposes of
this section and must receive arm's length consideration for the
assistance it is deemed to provide to USP and FS, under the rules
of 1.482-4(f)(3)(iii).  Such consideration must be treated as
intangible development costs incurred by USP and FS in proportion
to their shares of reasonably anticipated benefits (i.e., 66 2/3%
and 33 1/3%, respectively).  R+D will not be considered to bear
any share of the intangible development costs under the
arrangement.
* * * * *
     (f)  * * *
     (3)  * * *
     (ii)  * * *  If a controlled participant transfers covered
intangibles to another controlled taxpayer, such participant's
benefits from the transferred intangibles 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). * * *
     (iii) * * *
     (E)  * * *
     Example 8.  U.S. Parent (USP), Foreign Subsidiary 1 (FS1)
and Foreign Subsidiary 2 (FS2) enter into a cost sharing
arrangement to develop computer software that each will market
and install on customers' computer systems.  The participants
divide costs on the basis of projected sales by USP, FS1, and FS2
of the software in their respective geographic areas.  However,
FS1 plans not only to sell but also to license the software to
unrelated customers, and FS1's licensing income (which is a
percentage of the licensees' sales) is not counted in the
projected benefits.  In this case, the basis used for measuring
the benefits of each participant is not the most reliable because
all of the benefits received by participants are not taken into
account.  In order to reliably determine benefit shares, FS1's
projected benefits from licensing must be included in the
measurement on a basis that is the same as that used to measure
its own and the other participants' projected benefits from sales
(e.g., all participants might measure their benefits on the basis
of operating profit).
* * * * *
     (j)  * * *
     (2) Documentation--(i) Requirements.  * * *
     (ii) Coordination with penalty regulation.  The documents
described in paragraph (j)(2)(i) of this section will satisfy the
principal documents requirement under 1.6662-6(d)(2)(iii)(B)
with respect to a qualified cost sharing arrangement.
* * * * *
                                Margaret Milner Richardson
                              Commissioner of Internal Revenue
Approved:  May 2, 1996
                    Leslie Samuels
          Assistant Secretary of the Treasury