66502 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

taxpayer determines its tax liability

under § 1.469–4, rather than under the

rules of Project PS–1–89, the taxpayer

may regroup its activities without regard

to the manner in which the activities

were grouped in the preceding taxable

year and must regroup its activities if

the grouping in the preceding taxable

year is inconsistent with the rules of

§ 1.469–4.

(iii) Regrouping when taxpayer is first

subject to section 469(c)(7). For the first

taxable year beginning after December

31, 1993, a taxpayer may regroup its

activities to the extent necessary or

appropriate to avail itself of the

provisions of section 469(c)(7) and

without regard to the manner in which

the activities were grouped in the

preceding taxable year.

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: December 12, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury (Tax

Policy).

[FR Doc. 95–30872 Filed 12–21–95; 8:45 am]

BILLING CODE 4830–01-U

26 CFR Part 1

[TD 8646]

RIN 1545–AT49

Allocation and Apportionment of

Research and Experimental

Expenditures

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document provides

guidance concerning the allocation and

apportionment of research and

experimental expenditures for purposes

of determining taxable income from

sources within and without the United

States. This document affects taxpayers

that have income from United States

and foreign sources and that have made

expenditures for research and

experimentation that the taxpayer

deducts under section 174 of the

Internal Revenue Code of 1986.

EFFECTIVE DATE: January 1, 1996.

FOR FURTHER INFORMATION CONTACT: Carl

Cooper at (202) 622–3840 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of

Provisions

On May 24, 1995, the IRS published

a notice of proposed rulemaking and

notice of public hearing in the Federal

Register (60 FR 27453) proposing

amendments to the Income Tax

Regulations (26 CFR part 1) under

section 861 of the Internal Revenue

Code of 1986. Section 1.861–8(e)(3) of

the Income Tax Regulations provides

rules regarding the allocation and

apportionment of research and

experimental expenditures for purposes

of determining taxable income from

sources inside and outside the United

States.

The notice of proposed rulemaking

proposed three principal changes to the

existing regulations. First, allocation of

research and experimental expenditures

to three-digit SIC code product

categories of gross income would be

permitted. Second, the percentage of

research and experimental expenditures

that may be exclusively apportioned to

United States source income under the

sales method of apportionment under

§ 1.861–8(e)(3)(ii) would be increased

from 30 percent to 50 percent. Third,

use of the optional gross income

methods of apportionment would

constitute a binding election to use such

methods in subsequent years. The

election would not be revocable without

the prior consent of the Commissioner.

The three changes were proposed in

part on the basis of an economic study

performed by the Treasury Department

pursuant to Rev. Proc. 92–56 (1992–2

C.B. 409), ‘‘The Relationship Between

U.S. Research and Development and

Foreign Income,’’ which was published

by the Treasury Department

simultaneously with the proposed

regulations.

Written comments responding to the

notice were received, and a public

hearing was held on September 8, 1995.

Regarding the determination of

product categories under § 1.861–

8(e)(3)(i)(B) of the proposed regulations,

commenters suggested that the rule

requiring a taxpayer to determine

relevant product categories by reference

to the three-digit classification of the

Standard Industrial Classification

Manual should be modified to allow

determinations by reference to the fivedigit classifications of the Manual. This

suggestion was not adopted, because

such a rule would too narrowly restrict

the necessarily broad scope of the

deduction. The IRS continues to believe

that research and experimentation is an

inherently speculative activity, that

findings may contribute unexpected

benefits, and that gross income derived

from successful research and

experimentation must bear the cost of

unsuccessful research and

experimentation.

Commenters suggested that the

regulations permit taxpayers to

determine product categories by

reference to two- or three-digit

categories at the annual election of the

taxpayer. This suggestion was not

adopted. The regulations provide that a

taxpayer may determine product

categories by reference to two- or threedigit categories. A taxpayer may

aggregate, disaggregate or change a

previously selected SIC code category if

the taxpayer establishes to the

satisfaction of the Commissioner that,

due to changes in the relevant facts, a

change in product category is

appropriate. This rule provides a simple

and workable format for balancing the

need for consistency with the desire for

flexibility.

Referring to current § 1.861–8(g)

Example 6 (which has been

redesignated § 1.861–17(h) Example 4),

commenters suggested that the

regulations allow the use of the

Wholesale Trade SIC code category with

respect to sales from any other category.

The current § 1.861–8(g) Example 6 was

not correct on this point and does not

override the rule stated parenthetically

in the list of two digit SIC code

categories in present § 1.861–

8(e)(3)(i)(A) that wholesale trade may

not be combined with other product

categories. The final regulations include

this rule along with Example 6

corrected to conform to the rule.

Regarding the exclusive place of

performance apportionment rule under

§ 1.861–8(e)(3)(ii)(A) of the proposed

regulations, commenters suggested

adding a rule providing that if the ratio

of foreign research and experimental

expenditures in a three digit SIC code

category of all foreign affiliates of a

United States consolidated group over

foreign affiliate sales in that SIC code

category exceed fifty percent of the ratio

of United States consolidated group

research and experimental expenditures

in that SIC code category over United

States consolidated group sales in that

SIC code category, then the United

States consolidated group research and

experimental expenditures should be

exclusively apportioned to United

States source gross income. This

suggestion has not been adopted.

Although a foreign affiliate may incur

substantial research and experimental

expenditures in a given product

category, the foreign affiliate may still

benefit from the research and

experimental expenditures of the United

States consolidated group. See PerkinElmer Corporation v. Commissioner,

103 T.C. 464 (1994).

Regarding the optional gross income

methods of apportionment under

§ 1.861–8(e)(3)(iii) of the proposed

regulations, commenters suggested that
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66503

the final regulations include a fifty

percent exclusive place of performance

apportionment under the optional gross

income methods to be parallel with

§ 1.861–8(e)(3)(ii)(A). This suggestion

has been adopted in part. Section

(b)(1)(ii) of the final regulations includes

a twenty-five percent exclusive place of

performance apportionment under the

optional gross income methods. This

twenty-five percent exclusive

apportionment ensures that taxpayers

electing to use one of the optional gross

income methods also obtain results

comparable to those obtained by

taxpayers electing to use the sales

method, i.e., an overall allocation that is

twenty-five percent lower on average

than the allocation to foreign source

income resulting from the current

regulations. The Treasury Department

study does not support a greater

exclusive apportionment.

Commenters suggested that the

proposed regulations should be

modified to reduce the floor on the

amount of research and experimental

expenditures that must be apportioned

to foreign source income under the

optional gross income methods from

fifty percent to thirty percent of the

amount that would have been

apportioned under the sales method.

This suggestion has not been adopted.

The adoption of this suggested rule in

addition to the twenty-five percent

exclusive apportionment rule is not

supported by the Treasury Department

study.

Commenters suggested the

elimination of the binding election to

use the optional gross income methods

under § 1.861–8(e)(3)(iii)(C) of the

proposed regulations. Commenters also

suggested that the binding election rule

should be modified to provide for a

change of method without the prior

consent of the Commissioner after five

years’ use of one method. This

suggestion, which recognizes the need

for consistency while reducing the

administrative burden on taxpayers, has

been adopted.

Commenters suggested that the

effective date election under § 1.861–

8(e)(3)(vi) of the proposed regulations

permit election by fiscal year taxpayers

whose taxable years begin after August

1, 1994, but before January 1, 1995. This

suggestion has been adopted.

Finally, these provisions, which were

previously published as § 1.861–8(e)(3),

have been renumbered and will now be

published as § 1.861–17. This change

has been made solely for the purpose of

achieving greater clarity in formatting

and is not intended to result in any

additional substantive changes.

Special Analyses

It has been determined that these final

regulations are 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 final regulations has

been submitted to the Chief Counsel for

Advocacy of the Small Business

Administration for comment on its

impact on small business.

Drafting Information

The principal author of these

regulations is Carl Cooper, Office of the

Associate Chief Counsel (International).

However, other personnel from IRS and

Treasury participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

continues to read as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.861–8 is amended

by:

1. Revising paragraph (e)(3) to read as

set forth below.

2. Removing and reserving paragraph

(g), Examples 3 through 16 and 23.

§ 1.861–8 Computation of taxable income

from sources within the United States and

from other sources and activities.

* * * * *

(e) * * *

(3) Research and experimental

expenditures. For rules regarding the

allocation and apportionment of

research and experimental

expenditures, see § 1.861–17.

* * * * *

Par. 3. Section 1.861–17 is added to

read as follows:

§ 1.861–17 Allocation and apportionment

of research and experimental expenditures.

(a) Allocation—(1) In general. The

methods of allocation and

apportionment of research and

experimental expenditures set forth in

this section recognize that research and

experimentation is an inherently

speculative activity, that findings may

contribute unexpected benefits, and that

the gross income derived from

successful research and experimentation

must bear the cost of unsuccessful

research and experimentation.

Expenditures for research and

experimentation that a taxpayer deducts

under section 174 ordinarily shall be

considered deductions that are

definitely related to all income

reasonably connected with the relevant

broad product category (or categories) of

the taxpayer and therefore allocable to

all items of gross income as a class

(including income from sales, royalties,

and dividends) related to such product

category (or categories). For purposes of

this allocation, the product category (or

categories) that a taxpayer may be

considered to have shall be determined

in accordance with the provisions of

paragraph (a)(2) of this section.

(2) Product categories—(i) Allocation

based on product categories. Ordinarily,

a taxpayer’s research and experimental

expenditures may be divided between

the relevant product categories. Where

research and experimentation is

conducted with respect to more than

one product category, the taxpayer may

aggregate the categories for purposes of

allocation and apportionment; however,

the taxpayer may not subdivide the

categories. Where research and

experimentation is not clearly identified

with any product category (or

categories), it will be considered

conducted with respect to all the

taxpayer’s product categories.

(ii) Use of three digit standard

industrial classification codes. A

taxpayer shall determine the relevant

product categories by reference to the

three digit classification of the Standard

Industrial Classification Manual (SIC

code). A copy may be purchased from

the Superintendent of Documents,

United States Government Printing

Office, Washington, DC 20402. The

individual products included within

each category are enumerated in

Executive Office of the President, Office

of Management and Budget, Standard

Industrial Classification Manual, 1987

(or later edition, as available).

(iii) Consistency. Once a taxpayer

selects a product category for the first

taxable year for which this section is

effective with respect to the taxpayer, it

must continue to use that product

category in following years, unless the

taxpayer establishes to the satisfaction

of the Commissioner that, due to

changes in the relevant facts, a change

in the product category is appropriate.

For this purpose, a change in the
66504 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

taxpayer’s selection of a product

category shall include a change from a

three digit SIC code category to a two

digit SIC code category, a change from

a two digit SIC code category to a three

digit SIC code category, or any other

aggregation, disaggregation or change of

a previously selected SIC code category.

(iv) Wholesale trade category. The

two digit SIC code category ‘‘Wholesale

trade’’ is not applicable with respect to

sales by the taxpayer of goods and

services from any other of the taxpayer’s

product categories and is not applicable

with respect to a domestic international

sales corporation (DISC) or foreign sales

corporation (FSC) for which the

taxpayer is a related supplier of goods

and services from any of the taxpayer’s

product categories.

(v) Retail trade category. The two

digit SIC code category ‘‘Retail trade’’ is

not applicable with respect to sales by

the taxpayer of goods and services from

any other of the taxpayer’s product

categories, except wholesale trade, and

is not applicable with respect to a DISC

or FSC for which the taxpayer is a

related supplier of goods and services

from any other of the taxpayer’s product

categories, except wholesale trade.

(3) Affiliated Groups—(i) In general.

Except as provided in paragraph

(a)(3)(ii) of this section, the allocation

and apportionment required by this

section shall be determined as if all

members of the affiliated group (as

defined in § 1.861–14T(d)) were a single

corporation. See § 1.861–14T.

(ii) Possessions corporations. (A) For

purposes of the allocation and

apportionment required by this section,

sales and gross income from products

produced in whole or in part in a

possession by an electing corporation

(within the meaning of section

936(h)(5)(E)), and dividends from an

electing corporation, shall not be taken

into account, except that this paragraph

(a)(3)(ii) shall not apply to sales of (and

gross income and dividends attributable

to sales of) products with respect to

which an election under section

936(h)(5)(F) is not in effect.

(B) The research and experimental

expenditures taken into account for

purposes of this section shall be

reduced by the amount of such

expenditures included in computing the

cost-sharing amount (determined under

section 936(h)(5)(C)(i)).

(4) Legally mandated research and

experimentation. Where research and

experimentation is undertaken solely to

meet legal requirements imposed by a

political entity with respect to

improvement or marketing of specific

products or processes, and the results

cannot reasonably be expected to

generate amounts of gross income

(beyond de minimis amounts) outside a

single geographic source, the deduction

for such research and experimentation

shall be considered definitely related

and therefore allocable only to the

grouping (or groupings) of gross income

within that geographic source as a class

(and apportioned, if necessary, between

such groupings as set forth in

paragraphs (c) and (d) of this section).

For example, where a taxpayer performs

tests on a product in response to a

requirement imposed by the U.S. Food

and Drug Administration, and the test

results cannot reasonably be expected to

generate amounts of gross income

(beyond de minimis amounts) outside

the United States, the costs of testing

shall be allocated solely to gross income

from sources within the United States.

(b) Exclusive apportionment—(1) In

general. An exclusive apportionment

shall be made under this paragraph (b),

where an apportionment based upon

geographic sources of income of a

deduction for research and

experimentation is necessary (after

applying the exception in paragraph

(a)(4) of this section).

(i) Exclusive apportionment under the

sales method. If the taxpayer apportions

on the sales method under paragraph (c)

of this section, an amount equal to fifty

percent of such deduction for research

and experimentation shall be

apportioned exclusively to the statutory

grouping of gross income or the residual

grouping of gross income, as the case

may be, arising from the geographic

source where the research and

experimental activities which account

for more than fifty percent of the

amount of such deduction were

performed.

(ii) Exclusive apportionment under

the optional gross income methods. If

the taxpayer apportions on the optional

gross income methods under paragraph

(d) of this section, an amount equal to

twenty-five percent of such deduction

for research and experimentation shall

be apportioned exclusively to the

statutory grouping or the residual

grouping of gross income, as the case

may be, arising from the geographic

source where the research and

experimental activities which account

for more than fifty percent of the

amount of such deduction were

performed.

(iii) Exception. If the applicable fifty

percent geographic source test of the

preceding paragraph (b)(1)(i) or (ii) is

not met, then no part of the deduction

shall be apportioned under this

paragraph (b)(1).

(2) Facts and circumstances

supporting an increased exclusive

apportionment—(i) In general. The

exclusive apportionment provided for in

paragraph (b)(1) of this section reflects

the view that research and

experimentation is often most valuable

in the country where it is performed, for

two reasons. First, research and

experimentation often benefits a broad

product category, consisting of many

individual products, all of which may

be sold in the nearest market but only

some of which may be sold in foreign

markets. Second, research and

experimentation often is utilized in the

nearest market before it is used in other

markets, and in such cases, has a lower

value per unit of sales when used in

foreign markets. The taxpayer may

establish to the satisfaction of the

Commissioner that, in its case, one or

both of the conditions mentioned in the

preceding sentences warrant a

significantly greater exclusive allocation

percentage than allowed by paragraph

(b)(1) of this section because the

research and experimentation is

reasonably expected to have very

limited or long delayed application

outside the geographic source where it

was performed. Past experience with

research and experimentation may be

considered in determining reasonable

expectations.

(ii) Not all products sold in foreign

markets. For purposes of establishing

that only some products within the

product category (or categories) are sold

in foreign markets, the taxpayer shall

compare the commercial production of

individual products in domestic and

foreign markets made by itself, by

uncontrolled parties (as defined under

paragraph (c)(2)(i) of this section) of

products involving intangible property

which was licensed or sold by the

taxpayer, and by those controlled

corporations (as defined under

paragraph (c)(3)(ii) of this section) that

can reasonably be expected to benefit

directly or indirectly from any of the

taxpayer’s research expense connected

with the product category (or

categories). The individual products

compared for this purpose shall be

limited, for nonmanufactured

categories, solely to those enumerated in

Executive Office of the President, Office

of Management and Budget Standard

Industrial Classification Manual, 1987

(or later edition, as available), and, for

manufactured categories, solely to those

enumerated at a 7-digit level in the U.S.

Bureau of the Census, Census of

Manufacturers: 1992, Numerical List of

Manufactured Products, 1993, (or later

edition, as available). Copies of both of

these documents may be purchased

from the Superintendent of Documents,
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66505

United States Government Printing

Office, Washington, DC 20402.

(iii) Delayed application of research

findings abroad. For purposes of

establishing the delayed application of

research findings abroad, the taxpayer

shall compare the commercial

introduction of its own particular

products and processes (not limited by

those listed in the Standard Industrial

Classification Manual or the Numerical

List of Manufactured Products) in the

United States and foreign markets, made

by itself, by uncontrolled parties (as

defined under paragraph (c)(2)(i) of this

section) of products involving intangible

property that was licensed or sold by

the taxpayer, and by those controlled

corporations (as defined under

paragraph (c)(3)(i) of this section) that

can reasonably be expected to benefit,

directly or indirectly, from the

taxpayer’s research expense. For

purposes of evaluating the delay in the

application of research findings in

foreign markets, the taxpayer shall use

a safe haven discount rate of 10 percent

per year of delay unless he is able to

establish to the satisfaction of the

Commissioner, by reference to the cost

of money and the number of years

during which economic benefit can be

directly attributable to the results of the

taxpayer’s research, that another

discount rate is more appropriate.

(c) Sales method—(1) In general. The

amount equal to the remaining portion

of such deduction for research and

experimentation, not apportioned under

paragraph (a)(4) or (b)(1)(i) of this

section, shall be apportioned between

the statutory grouping (or among the

statutory groupings) within the class of

gross income and the residual grouping

within such class in the same

proportions that the amount of sales

from the product category (or categories)

that resulted in such gross income

within the statutory grouping (or

statutory groupings) and in the residual

grouping bear, respectively, to the total

amount of sales from the product

category (or categories).

(i) Apportionment in excess of gross

income. Amounts apportioned under

this section may exceed the amount of

gross income related to the product

category within the statutory grouping.

In such case, the excess shall be applied

against other gross income within the

statutory grouping. See § 1.861–8(d)(1)

for instances where the apportionment

leads to an excess of deductions over

gross income within the statutory

grouping.

(ii) Leased property. For purposes of

this paragraph (c), amounts received

from the lease of equipment during a

taxable year shall be regarded as sales

receipts for such taxable year.

(2) Sales of uncontrolled parties. For

purposes of the apportionment under

paragraph (c)(1) of this section, the sales

from the product category (or categories)

by each party uncontrolled by the

taxpayer, of particular products

involving intangible property that was

licensed or sold by the taxpayer to such

uncontrolled party shall be taken fully

into account both for determining the

taxpayer’s apportionment and for

determining the apportionment of any

other member of a controlled group of

corporations to which the taxpayer

belongs if the uncontrolled party can

reasonably be expected to benefit

directly or indirectly (through any

member of the controlled group of

corporations to which the taxpayer

belongs) from the research expense

connected with the product category (or

categories) of such other member. An

uncontrolled party can reasonably be

expected to benefit from the research

expense of a member of a controlled

group of corporations to which the

taxpayer belongs if such member can

reasonably be expected to license, sell,

or transfer intangible property to that

uncontrolled party or transfer secret

processes to that uncontrolled party,

directly or indirectly through a member

of the controlled group of corporations

to which the taxpayer belongs. Past

experience with research and

experimentation shall be considered in

determining reasonable expectations.

(i) Definition of uncontrolled party.

For purposes of this paragraph (c)(2) the

term uncontrolled party means a party

that is not a person with a relationship

to the taxpayer specified in section

267(b), or is not a member of a

controlled group of corporations to

which the taxpayer belongs (within the

meaning of section 993(a)(3) or

927(d)(4)).

(ii) Licensed products. In the case of

licensed products, if the amount of sales

of such products is unknown (for

example, where the licensed product is

a component of a large machine), a

reasonable estimate based on the

principles of section 482 should be

made.

(iii) Sales of intangible property. In

the case of sales of intangible property,

regardless of whether the consideration

received in exchange for the intangible

is a fixed amount or is contingent on the

productivity, use, or disposition of the

intangible, if the amount of sales of

products utilizing the intangible

property is unknown, a reasonable

estimate of sales shall be made

annually. If necessary, appropriate

economic analyses shall be used to

estimate sales.

(3) Sales of controlled parties. For

purposes of the apportionment under

paragraph (c)(1) of this section, the sales

from the product category (or categories)

of the taxpayer shall be taken fully into

account and the sales from the product

category (or categories) of a corporation

controlled by the taxpayer shall be taken

into account to the extent provided in

this paragraph (c)(3) for determining the

taxpayer’s apportionment, if such

corporation can reasonably be expected

to benefit directly or indirectly (through

another member of the controlled group

of corporations to which the taxpayer

belongs) from the taxpayer’s research

expense connected with the product

category (or categories). A corporation

controlled by the taxpayer can

reasonably be expected to benefit from

the taxpayer’s research expense if the

taxpayer can be expected to license, sell,

or transfer intangible property to that

corporation or transfer secret processes

to that corporation, either directly or

indirectly through a member of the

controlled group of corporations to

which the taxpayer belongs. Past

experience with research and

experimentation shall be considered in

determining reasonable expectations.

(i) Definition of a corporation

controlled by the taxpayer. For purposes

of this paragraph (c)(3), the term a

corporation controlled by the taxpayer

means any corporation that has a

relationship to the taxpayer specified in

section 267(b) or is a member of a

controlled group of corporations to

which the taxpayer belongs (within the

meaning of section 993(a)(3) or

927(d)(4).

(ii) Sales to be taken into account.

The sales from the product category (or

categories) of a corporation controlled

by the taxpayer taken into account shall

be equal to the amount of sales that bear

the same proportion to the total sales of

the controlled corporation as the total

value of all classes of the stock of such

corporation owned directly or indirectly

by the taxpayer, within the meaning of

section 1563, bears to the total value of

all classes of stock of such corporation.

(iii) Sales not to be taken into account

more than once. Sales from the product

category (or categories) between or

among such controlled corporations or

the taxpayer shall not be taken into

account more than once; in such a

situation, the amount sold by the selling

corporation to the buying corporation

shall be subtracted from the sales of the

buying corporation.

(iv) Effect of cost-sharing

arrangements. If the corporation

controlled by the taxpayer has entered
66506 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

into a bona fide cost-sharing

arrangement, in accordance with the

provisions of § 1.482–7, with the

taxpayer for the purpose of developing

intangible property, then that

corporation shall not reasonably be

expected to benefit from the taxpayer’s

share of the research expense.

(d) Gross income methods—(1)(i) In

general. In lieu of applying the sales

method of paragraph (c) of this section,

the remaining amount of the deduction

for research and experimentation, not

apportioned under paragraph (a)(4) or

(b)(1)(ii) of this section, shall be

apportioned as prescribed in paragraphs

(d)(2) and (3) of this section, between

the statutory grouping (or among the

statutory groupings) of gross income and

the residual grouping of gross income.

(ii) Optional methods to be applied to

all research and experimental

expenditures. These optional methods

must be applied to the taxpayer’s entire

deduction for research and experimental

expense remaining after applying the

exception in paragraph (a)(4) of this

section, and may not be applied on a

product category basis. Thus, after the

allocation of the taxpayer’s entire

deduction for research and experimental

expense under paragraph (a)(2) of this

section (by attribution to SIC code

categories), the taxpayer must then

apportion as necessary the entire

deduction as allocated by separate

amounts to various product categories,

using only the sales method under

paragraph (c) of this section or only the

optional gross income methods under

this paragraph (d). The taxpayer may

not use the sales method for a portion

of the deduction and optional gross

income methods for the remainder of

the deduction separately allocated.

(2) Option one. The taxpayer may

apportion its research and experimental

expenditures ratably on the basis of

gross income between the statutory

grouping (or among the statutory

groupings) of gross income and the

residual grouping of gross income in the

same proportions that the amount of

gross income in the statutory grouping

(or groupings) and the amount of gross

income in the residual grouping bear,

respectively, to the total amount of gross

income, if the conditions described in

paragraph (d)(2)(i) and (ii) of this

section are both met.

(i) The amount of research and

experimental expense ratably

apportioned to the statutory grouping

(or groupings in the aggregate) is not

less than fifty percent of the amount that

would have been so apportioned if the

taxpayer had used the method described

in paragraph (c) of this section; and

(ii) The amount of research and

experimental expense ratably

apportioned to the residual grouping is

not less than fifty percent of the amount

that would have been so apportioned if

the taxpayer had used the method

described in paragraph (c) of this

section.

(3) Option two. If, when the amount

of research and experimental expense is

apportioned ratably on the basis of gross

income, either of the conditions

described in paragraph (d)(2)(i) or (ii) of

this section is not met, the taxpayer may

either—

(i) Where the condition of paragraph

(d)(2)(i) of this section is not met,

apportion fifty percent of the amount of

research and experimental expense that

would have been apportioned to the

statutory grouping (or groupings in the

aggregate) under paragraph (c) of this

section to such statutory grouping (or to

such statutory groupings in the

aggregate and then among such

groupings on the basis of gross income

within each grouping), and apportion

the balance of the amount of research

and experimental expenses to the

residual grouping; or

(ii) Where the condition of paragraph

(d)(2)(ii) of this section is not met,

apportion fifty percent of the amount of

research and experimental expense that

would have been apportioned to the

residual grouping under paragraph (c) of

this section to such residual grouping,

and apportion the balance of the amount

of research and experimental expenses

to the statutory grouping (or to the

statutory groupings in the aggregate and

then among such groupings ratably on

the basis of gross income within each

grouping).

(e) Binding election—(1) In general. A

taxpayer may choose to use either the

sales method under paragraph (c) of this

section or the optional gross income

methods under paragraph (d) of this

section for its original return for its first

taxable year to which this section

applies. The taxpayer’s use of either the

sales method or the optional gross

income methods for its return filed for

its first taxable year to which this

section applies shall constitute a

binding election to use the method

chosen for that year and for four taxable

years thereafter.

(2) Change of method. The taxpayer’s

election of a method may not be revoked

during the period referred to in

paragraph (e)(1) of this section without

the prior consent of the Commissioner.

After the expiration of that period, the

taxpayer may change methods without

the prior consent of the Commissioner.

However, the taxpayer’s use of the new

method shall constitute a binding

election to use the new method for its

return filed for the first year for which

the taxpayer uses the new method and

for four taxable years thereafter. The

taxpayer’s election of the new method

may not be revoked during that period

without the prior consent of the

Commissioner.

(i) Short taxable years. For purposes

of this paragraph (e), the term taxable

year includes a taxable year of less than

twelve months.

(ii) Affiliated groups. In the case of an

affiliated group, the period referred to in

paragraph (e)(1) of this section shall

commence as of the latest taxable year

in which any member of the group has

changed methods.

(f) Special rules for partnerships—(1)

Research and experimental

expenditures. For purposes of applying

this section, if research and

experimental expenditures are incurred

by a partnership in which the taxpayer

is a partner, the taxpayer’s research and

experimental expenditures shall include

the taxpayer’s distributive share of the

partnership’s research and experimental

expenditures.

(2) Purpose and location of

expenditures. In applying the exception

for expenditures undertaken to meet

legal requirements under paragraph

(a)(4) of this section and the exclusive

apportionment for the sales method and

the optional gross income methods

under paragraph (b) of this section, a

partner’s distributive share of research

and experimental expenditures incurred

by a partnership shall be treated as

incurred by the partner for the same

purpose and in the same location as

incurred by the partnership.

(3) Apportionment under the sales

method. In applying the remaining

apportionment for the sales method

under paragraph (c) of this section, a

taxpayer’s sales from a product category

shall include the taxpayer’s share of any

sales from the product category of any

partnership in which the taxpayer is a

partner. For purposes of the preceding

sentence, a taxpayer’s share of sales

shall be proportionate to the taxpayer’s

distributive share of the partnership’s

gross income in the product category.

(g) Effective date. This section applies

to taxable years beginning after

December 31, 1995. However, a taxpayer

may at his or her option, apply this

section in its entirety to all taxable years

beginning after August 1, 1994.

(h) Examples. The following examples

illustrate the application of this section:

Example 1—(i) Facts. X, a domestic

corporation, is a manufacturer and

distributor of small gasoline engines for lawn

mowers. Gasoline engines are a product

within the category, Engines and Turbines
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66507

(SIC Industry Group 351). Y, a wholly owned

foreign subsidiary of X, also manufactures

and sells these engines abroad. During 1996,

X incurred expenditures of $60,000 on

research and experimentation, which it

deducts as a current expense, to invent and

patent a new and improved gasoline engine.

All of the research and experimentation was

performed in the United States. In 1996, the

domestic sales by X of the new engine total

$500,000 and foreign sales by Y total

$300,000. X provides technology for the

manufacture of engines to Y via a license that

requires the payment of an arm’s length

royalty. In 1996, X’s gross income is

$160,000, of which $140,000 is U.S. source

income from domestic sales of gasoline

engines and $10,000 is foreign source

royalties from Y, and $10,000 is U.S. source

interest income.

(ii) Allocation. The research and

experimental expenditures were incurred in

connection with small gasoline engines and

they are definitely related to the items of

gross income to which the research gives rise,

namely gross income from the sale of small

gasoline engines in the United States and

royalties received from subsidiary Y, a

foreign manufacturer of gasoline engines.

Accordingly, the expenses are allocable to

this class of gross income. The U.S. source

interest income is not within this class of

gross income and, therefore, is not taken into

account.

(iii) Apportionment. (A) For purposes of

applying the foreign tax credit limitation, the

statutory grouping is general limitation gross

income from sources without the United

States and the residual grouping is gross

income from sources within the United

States. Since the related class of gross income

derived from the use of engine technology

consists of both gross income from sources

without the United States (royalties from Y)

and gross income from sources within the

United States (gross income from engine

sales), X’s deduction of $60,000 for its

research and experimental expenditure must

be apportioned between the statutory and

residual grouping before the foreign tax

credit limitation may be determined. Because

more than 50 percent of X’s research and

experimental activity was performed in the

United States, 50 percent of that deduction

can be apportioned exclusively to the

residual grouping of gross income, gross

income from sources within the United

States. The remaining 50 percent of the

deduction can then be apportioned between

the residual and statutory groupings on the

basis of sales of small gasoline engines by X

and Y. Alternatively, X’s deduction for

research and experimentation can be

apportioned under the optional gross income

method. The apportionment for 1996 is as

follows:

(1) Tentative Apportionment on the Basis of

Sales

(i) Research and experimental

expense to be apportioned between residual and statutory

groupings of gross income: ...... $60,000

(ii) Less: Exclusive apportionment of research and experimental expense to the residual

grouping of gross income

($60,000×50 percent): .............. $30,000

(iii) Research and experimental

expense to be apportioned between residual and statutory

groupings of gross income on

the basis of sales: ..................... $30,000

(iv) Apportionment of research

and experimental expense to

the residual grouping of gross

income ($30,000×$500,000/

($500,000+$300,000)): .............. $18,750

(v) Apportionment of research

and experimental expense to

the statutory grouping of gross

income ($30,000×$300,000/

($500,000+$300,000)): .............. $11,250

(vi) Total apportioned deduction

for research and experimentation: ........................................ $60,000

(vii) Amount apportioned to the

residual grouping

($30,000+$18,750): ................... $48,750

(viii) Amount apportioned to the

statutory grouping: ................... $11,250

(2) Tentative Apportionment on the Basis of

Gross Income.

(i) Exclusive apportionment of

research and experimental expense to the residual grouping

of gross income ($60,000×25

percent): .................................... $15,000

(ii) Research and experimental

expense apportioned to

sources within the United

States (residual grouping)

($45,000×$140,000/

($140,000+$10,000)): ................ $42,000

(iii) Research and experimental

expense apportioned to

sources within country Y (statutory grouping)

($45,000×$10,000/

($140,000+$10,000)): ................ $3,000

(iv) Amount apportioned to the

residual grouping: .................... $57,000

(v) Amount apportioned to the

statutory grouping: ................... $3,000

(B) The total research and experimental

expense apportioned to the statutory

grouping ($3,000) under the gross income

method is approximately 26 percent of the

amount apportioned to the statutory grouping

under the sales method. Thus, X may use

option two of the gross income method

(paragraph (d)(3) of this section) and

apportion to the statutory grouping fifty

percent (50%) of the $11,250 apportioned to

that grouping under the sales method. Thus,

X apportions $5,625 of research and

experimental expense to the statutory

grouping. X’s use of the optional gross

income methods will constitute a binding

election to use the optional gross income

methods for 1996 and four taxable years

thereafter.

Example 2—(i) Facts. Assume the same

facts as in Example 1 except that X also

spends $30,000 in 1996 for research on steam

turbines, all of which is performed in the

United States, and X has steam turbine sales

in the United States of $400,000. X’s foreign

subsidiary Y neither manufactures nor sells

steam turbines. The steam turbine research is

in addition to the $60,000 in research which

X does on gasoline engines for lawnmowers.

X thus has a deduction of $90,000 for its

research activity. X’s gross income is

$200,000, of which $140,000 is U.S. source

income from domestic sales of gasoline

engines, $50,000 is U.S. source income from

domestic sales of steam turbines, and $10,000

is foreign source royalties from Y.

(ii) Allocation. X’s research expenses

generate income from sales of small gasoline

engines and steam turbines. Both of these

products are in the same three digit SIC code

category, Engines and Turbines (SIC Industry

Group 351). Therefore, the deduction is

definitely related to this product category

and allocable to all items of income

attributable to it. These items of X’s income

are gross income from the sale of small

gasoline engines and steam turbines in the

United States and royalties from foreign

subsidiary Y, a foreign manufacturer and

seller of small gasoline engines.

(iii) Apportionment. (A) For purposes of

applying the foreign tax credit limitation, the

statutory grouping is general limitation gross

income from sources outside the United

States and the residual grouping is gross

income from sources within the United

States. X’s deduction of $90,000 must be

apportioned between the statutory and

residual groupings. Because more than 50

percent of X’s research and experimental

activity was performed in the United States,

50 percent of that deduction can be

apportioned exclusively to the residual

grouping, gross income from sources within

the United States. The remaining 50 percent

of the deduction can then be apportioned

between the residual and statutory groupings

on the basis of total sales of small gasoline

engines and steam turbines by X and Y.

Alternatively, X’s deduction for research and

experimentation can be apportioned under

the optional gross income methods. The

apportionment for 1996 is as follows:

(1) Tentative Apportionment on the Basis of

Sales

(i) Research and experimental expense to be apportioned between residual and statutory groupings of gross income: ................... $90,000

(ii) Less: Exclusive apportionment of the research and experimental expense to the residual grouping of gross income

($90,000×50 percent): .............................................................................................................................................................................. $45,000

(iii) Research and experimental expense to be apportioned between the residual and statutory groupings of gross income on the

basis of sales: ........................................................................................................................................................................................... $45,000

(iv) Apportionment of research and experimental expense to the residual grouping of gross income

($45,000×($500,000+$400,000)/($500,000+$400,000+$300,000)): ....................................................................................................... $33,750
66508 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

(v) Apportionment of research and experimental expense to the statutory grouping of gross income ($45,000×$300,000/

($500,000+$400,000+$300,000)): ............................................................................................................................................................ $11,250

(vi) Total apportioned deduction for research and experimentation: ..................................................................................................... $90,000

(vii) Amount apportioned to the residual grouping ($45,000+$33,750): ................................................................................................ $78,750

(viii) Amount apportioned to the statutory grouping: .............................................................................................................................. $11,250

(2) Tentative Apportionment on the Basis of Gross Income

(i) Exclusive apportionment of research and experimental expense to the residual grouping of gross income ($90,000×25 percent): ........................................................................................................................................................................................................ $22,500

(ii) Research and experimental expense apportioned to sources within the United States (residual grouping) ($67,500×$190,000/

($140,000+$50,000+$10,000)): ................................................................................................................................................................ $64,125

(iii) Research and experimental expense apportioned to sources within country Y (statutory grouping) ($67,500×$10,000/

($140,000+$50,000+$10,000)): ................................................................................................................................................................ $3,375

(iv) Amount apportioned to the residual grouping: ................................................................................................................................. $86,625

(v) Amount apportioned to the statutory grouping: ................................................................................................................................. $3,375

(B) The total research and experimental

expense apportioned to the statutory

grouping ($3,375) under the gross income

method is 30 percent of the amount

apportioned to the statutory grouping under

the sales method. Thus, X may use option

two of the gross income method (paragraph

(d)(3) of this section) and apportion to the

statutory grouping fifty percent (50%) of the

$11,250 apportioned to that grouping under

the sales method. Thus, X apportions $5,625

of research and experimental expense to the

statutory grouping. X’s use of the optional

gross income methods will constitute a

binding election to use the optional gross

income methods for 1996 and four taxable

years thereafter.

Example 3—(i) Facts. Assume the same

facts as in Example 1 except that in 1997 X

continues its sales of the new engines, with

sales of $600,000 in the United States and

$400,000 abroad by subsidiary Y. X also

acquires a 60 percent (by value) ownership

interest in foreign corporation Z and a 100

percent ownership interest in foreign

corporation C. X transfers its engine

technology to Z for a royalty equal to 5

percent of sales, and X enters into an arm’s

length cost-sharing arrangement with C to

share the funding of all of X’s research

activity. In 1997, corporation Z has sales in

country Z equal to $1,000,000. X incurs

expense of $80,000 on research and

experimentation in 1997, and in addition, X

performs $15,000 of research on gasoline

engines which was funded by the costsharing arrangement with C. All of Z’s sales

are from the product category, Engines and

Turbines (SIC Industry Group 351). X

performs all of its research in the United

States and $20,000 of its expenditure of

$80,000 is made solely to meet pollution

standards mandated by law. X establishes, to

the satisfaction of the Commissioner, that the

expenditure in response to pollution

standards is not expected to generate gross

income (beyond de minimis amounts)

outside the United States.

(ii) Allocation. The $20,000 of research

expense which X incurred in connection

with pollution standards is definitely related

and thus allocable to the residual grouping,

gross income from sources within the United

States. The remaining $60,000 in research

and experimental expenditure incurred by X

is definitely related to all gasoline engines

and is therefore allocable to the class of gross

income to which the engines give rise, gross

income from sales of gasoline engines in the

United States, royalties from country Y, and

royalties from country Z. No part of the

$60,000 research expense is allocable to

dividends from country C, because

corporation C has already paid, through its

cost-sharing arrangement, for research

activity performed by X which may benefit

C.

(iii) Apportionment. For purposes of

applying the foreign tax credit limitation, the

statutory grouping is general limitation gross

income from sources without the United

States, and the residual grouping is gross

income from sources within the United

States. X’s deduction of $60,000 for its

research and experimental expenditure must

be apportioned between these groupings.

Because more than 50 percent of the research

and experimentation was performed in the

United States, 50 percent of the $60,000

deduction can be apportioned exclusively to

the residual grouping. The remaining 50

percent of the deduction can then be

apportioned between the residual and the

statutory grouping on the basis of sales of

gasoline engines by X, Y, and Z. (If X utilized

the optional gross income methods in 1996,

then its use of such methods constituted a

binding election to use the optional gross

income methods in 1996 and for four taxable

years thereafter. If X utilized the sales

method in 1996, then its use of such method

constituted a binding election to use the sales

method in 1996 and for four taxable years

thereafter.) The optional gross income

methods are not illustrated in this Example

3 (see instead Examples 1 and 2). Since X has

only a 60 percent ownership interest in

corporation Z, only 60 percent of Z’s sales

(60% of $1,000,000, or $600,000) are

included for purposes of apportionment. The

allocation and apportionment for 1997 is as

follows:

(A) X’s total research expense: .................................................................................................................................................................. $80,000

(B) Less: Legally mandated research directly allocated to the residual grouping of gross income: ..................................................... $20,000

(C) Tentative apportionment on the basis of sales.

(1) Research and experimental expense to be apportioned between residual and statutory groupings of gross income: .................. $60,000

(2) Less: Exclusive apportionment of research and experimental expense to the residual grouping of gross income ($60,000×50

percent): ................................................................................................................................................................................................... $30,000

(3) Research and experimental expense to be apportioned between the residual and the statutory groupings on the basis of

sales: ......................................................................................................................................................................................................... $30,000

(4) Apportionment of research and experimental expense to gross income from sources within the United States (residual

grouping) ($30,000×$600,000/($600,000+$400,000+$600,000)): .......................................................................................................... $11,250

(5) Apportionment of research and experimental expense to general limitation gross income from countries Y and Z (statutory

grouping) ($30,000×$400,000+$600,000/($600,000+$400,000+$600,000)): ......................................................................................... $18,750

(6) Total apportioned deduction for research and experimentation ($30,000+$30,000): ...................................................................... $60,000

(7) Amount apportioned to the residual grouping ($30,000+$11,250): .................................................................................................. $41,250

(8) Amount apportioned to the statutory grouping of gross income from sources within countries Y and Z: .................................... $18,750

Example 4—Research and

Experimentation—(i) Facts. X, a domestic

corporation, manufactures and sells forklift

trucks and other types of materials handling

equipment in the United States. The

manufacture and sale of forklift trucks and

other materials handling equipment belongs

to the product category, Construction,

Mining, and Materials Handling Machinery

and Equipment (SIC Industry Group 353). X

also sells its forklift trucks to a wholesaling

subsidiary located in foreign country Y (but

title passes in the United States), and X

manufactures forklift trucks in foreign

country Z. The wholesaling of forklift trucks

to country Y also belongs to X’s product

category Transportation equipment and,

therefore, may not belong to the product
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66509

category, Wholesale trade (SIC Major Group

50 and 51). In 1997, X sold $7,000,000 of

forklift trucks to purchasers in the United

States, $3,000,000 of forklift trucks to the

wholesaling subsidiary in Y, and transferred

forklift truck components with an FOB

export value of $2,000,000 to its branch in Z.

The branch’s sales of finished forklift trucks

were $5,000,000. In response to legally

mandated emission control requirements, X’s

United States research department has been

engaged in a research project to improve the

performance and quality of engine exhaust

systems used on its products in the United

States. It incurs expenses of $100,000 for this

purpose in 1997. In the past, X has

customarily adapted the product

improvements developed originally for the

domestic market to its forklift trucks

manufactured abroad. During the taxable year

1997, development of an improved engine

exhaust system is completed and X begins

installing the new system during the latter

part of the taxable year in products

manufactured and sold in the United States.

X continues to manufacture and sell forklift

trucks in foreign countries without the

improved engine exhaust systems.

(ii) Allocation. X’s deduction for its

research expense is definitely related to the

income to which it gives rise, namely income

from the manufacture and sale of forklift

trucks within the United States and in

country Z. Although the research is

undertaken in response to a legal mandate, it

can reasonably be expected to generate gross

income from the manufacture and sale of

trucks by the branch in Z. Therefore, the

deduction is not allocable solely to income

from X’s domestic sales of forklift trucks. It

is allocable to income from such sales and

income from the sales of X’s branch in Z.

(iii) Apportionment. For the method of

apportionment on the basis of either sales or

gross income, see Example 3. However, in

determining the amount of research

apportioned to income from foreign and

domestic sources, the net sales of the branch

in Z are $3,000,000 ($5,000,000 less

$2,000,000) and the sales within the United

States are $12,000,000 ($7,000,000 plus

$3,000,000 plus $2,000,000). See § 1.861–

17(c)(3)(iii).

Example 5—(i) Facts. X, a domestic

corporation, is a drug company that

manufactures a wide variety of

pharmaceutical products for sale in the

United States. Pharmaceutical products

belong to the product category, Drugs (SIC

Industry Group 283). X exports its

pharmaceutical products through a foreign

sales corporation (FSC). X’s wholly owned

foreign subsidiary Y also manufactures

pharmaceutical products. In 1997, X has

domestic sales of pharmaceutical products of

$10,000,000, the FSC has sales of

pharmaceutical products of $3,000,000, and

Y has sales of pharmaceutical products of

$5,000,000. In that same year, 1997, X incurs

expense of $200,000 on research to test a

product in response to requirements imposed

by the United States Food and Drug

Administration (FDA). X is able to show that,

even though country Y imposes certain

testing requirements on pharmaceutical

products, the research performed in the

United States is not accepted by country Y

for purposes of its own licensing

requirements, and the research has minimal

use abroad. X is further able to show that FSC

sells goods to countries that do not accept or

do not require research performed in the

United States for purposes of their own

licensing standards.

(ii) Allocation. Since X’s research expense

of $200,000 is undertaken to meet the

requirements of the United States Food and

Drug Administration, and since it is

reasonable to expect that the expenditure

will not generate gross income (beyond de

minimis amounts) outside the United States,

the deduction is definitely related and thus

allocable to the residual grouping.

(iii) Apportionment. No apportionment is

necessary since the entire expense is

allocated to the residual grouping, gross

income from sales within the United States.

Example 6—(i) Facts. X, a domestic

corporation, is engaged in continuous

research and experimentation to improve the

quality of the products that it manufactures

and sells, which are floodlights, flashlights,

fuse boxes, and solderless connectors. X

incurs and deducts $100,000 of expenditure

for research and experimentation in 1997 that

was performed exclusively in the United

States. As a result of this research activity, X

acquires patents that it uses in its own

manufacturing activity. X licenses its

floodlight patent to Y and Z, uncontrolled

foreign corporations, for use in their own

territories, countries Y and Z, respectively.

Corporation Y pays X an arm’s length royalty

of $3,000 plus $0.20 for each floodlight sold.

Sales of floodlights by Y for the taxable year

are $135,000 (at $4.50 per unit) or 30,000

units, and the royalty is $9,000 ($3,000 +

$0.20 x 30,000). Y has sales of other products

of $500,000. Z pays X an arm’s length royalty

of $3,000 plus $0.30 for each unit sold. Z

manufactures 30,000 floodlights in the

taxable year, and the royalty is $12,000

($3,000 + $0.30 x 30,000). The dollar value

of Z’s floodlight sales is not known and

cannot be reasonably estimated because, in

this case, the floodlights are not sold

separately by Z but are instead used as a

component in Z’s manufacture of lighting

equipment for theaters. The sales of all Z’s

products, including the lighting equipment

for theaters, are $1,000,000. Y and Z each sell

the floodlights exclusively within their

respective countries. X’s sales of floodlights

for the taxable year are $500,000 and its sales

of its other products, flashlights, fuse boxes,

and solderless connectors, are $400,000. X

has gross income of $500,000, consisting of

gross income from domestic sources from

sales of floodlights, flashlights, fuse boxes,

and solderless connectors of $479,000, and

royalty income of $9,000 and $12,000 from

foreign corporations Y and Z respectively. X

utilized the optional gross income methods

of apportionment for its return filed for its

first taxable year to which this section

applies.

(ii) Allocation. X’s research and

experimental expenses are definitely related

to all of the products that it produces, which

are floodlights, flashlights, fuse boxes, and

solderless connectors. All of these products

are in the same three digit SIC Code category,

Electric Lighting and Wiring Equipment (SIC

Industry Group 364). Thus, X’s research and

experimental expenses are allocable to all

items of income attributable to this product

category, domestic sales income and royalty

income from the foreign countries in which

corporations Y and Z operate.

(iii) Apportionment. (A) The statutory

grouping of gross income is general

limitation income from sources without the

United States. The residual grouping is gross

income from sources within the United

States. X’s deduction of $100,000 for its

research expenditures must be apportioned

between the groupings. For apportionment

on the basis of sales in accordance with

paragraph (c) of this section, X is entitled to

an exclusive apportionment of 50 percent of

its research and experimental expense to the

residual grouping, gross income from sources

within the United States, since more than 50

percent of the research activity was

performed in the United States. The

remaining 50 percent of the deduction can

then be apportioned between the residual

and statutory groupings on the basis of sales.

Since Y and Z are unrelated licensees of X,

only their sales of the licensed product,

floodlights, are included for purposes of

apportionment. Floodlight sales of Z are

unknown, but are estimated at ten times

royalties from Z, or $120,000. All of X’s sales

from the entire product category are included

for purposes of apportionment on the basis

of sales. Alternatively, X may apportion its

deduction on the basis of gross income, in

accordance with paragraph (d) of this section.

The apportionment is as follows:

(1) Tentative Apportionment on the Basis of Sales

(i) Research and experimental expense to be apportioned between statutory and residual groupings of gross income: ................... $100,000

(ii) Less: Exclusive apportionment of research and experimental expense to the residual groupings of gross income

($100,000×50 percent): ............................................................................................................................................................................ $50,000

(iii) Research and experimental expense to be apportioned between the statutory and residual groupings of gross income on the

basis of sales: ........................................................................................................................................................................................... $50,000

(iv) Apportionment of research and experimental expense to the residual groupings of gross income ($50,000×$900,000/

($900,000+$135,000+$120,000)): ............................................................................................................................................................ $38,961

(v) Apportionment of research and experimental expense to the statutory grouping, royalty income from countries Y and Z

($50,000×$135,000+$120,000/($900,000+$135,000+$120,000)): .......................................................................................................... $11,039
66510 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

(vi) Total apportioned deduction for research and experimentation: ..................................................................................................... $100,000

(vii) Amount apportioned to the residual grouping ($50,000+$38,961): ................................................................................................ $88,961

(viii) Amount apportioned to the statutory grouping of sources within countries Y and Z: ................................................................ $11,039

(2) Tentative Apportionment on Gross Income Basis

(i) Exclusive apportionment of research and experimental expense to the residual grouping of gross income ($100,000×25 percent): ........................................................................................................................................................................................................ $25,000

(ii) Apportionment of research and experimental expense to the residual grouping of gross income ($75,000×$479,000/

$500,000): ................................................................................................................................................................................................ $71,850

(iii) Apportionment of research and experimental expense to the statutory grouping of gross income ($75,000×$9,000+$12,000/

$500,000): ................................................................................................................................................................................................ $3,150

(iv) Amount apportioned to the residual grouping: ................................................................................................................................. $96,850

(v) Amount apportioned to the statutory grouping of general limitation income from sources without the United States: .............. $3,150

(B) Since X has elected to use the optional gross income methods of apportionment and its apportionment on the basis of gross

income to the statutory grouping, $3,150, is less than 50 percent of its apportionment on the basis of sales to the statutory grouping,

$11,039, it must use Option two of paragraph (d)(3) of this section and apportion $5,520 (50 percent of $11,039) to the statutory

grouping.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: December 13, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 95–30901 Filed 12–21–95; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF ENERGY

48 CFR Part 970

RIN 1991–AA63

Acquisition Regulation; Technology

Transfer Activities of Department of

Energy (DOE) Management and

Operating Contractors

AGENCY: Department of Energy.

ACTION: Final rule.

SUMMARY: The Department of Energy

(DOE) amends the Department of Energy

Acquisiton Regulation (DEAR) to codify

DOE’s implementation of its technology

transfer mission for DOE laboratories

(including weapon production facilities)

operated by management and operating

contractors.

EFFECTIVE DATE: January 22, 1996.

FOR FURTHER INFORMATION CONTACT:

Howard K. Mitchell, Policy Analyst,

Office of Policy (HR–51), Office of the

Deputy Assistant Secretary for

Procurement and Assistance

Management, Washington, D.C., 20585,

(202) 586–8190.

SUPPLEMENTARY INFORMATION:

I. Background

II. Disposition of comments

III. Procedural Requirements

A. Regulatory Review Under Executive

Order 12866

B. Review Under Executive Order 12612

C. Review Under Executive Order 12778

D. Review Under the Regulatory Flexibility

Act

E. Review Under the Paperwork Reduction

Act

F. Review Under the National

Environmental Policy Act (NEPA)

I. Background

The proposed rule was published on

May 22, 1995, at 60 FR 27069 (1995). It

was intended to amend the Department

of Energy Acquisition Regulation

(DEAR) to codify DOE’s implementation

of its technology transfer mission for

DOE laboratories and weapon

production facilities operated by

management and operating contractors.

This mission was established by The

National Competitiveness Technology

Transfer Act of 1989, as amended by

Sections 3134 and 3160 of the National

Defense Authorization Act for Fiscal

Year 1994.

II. Disposition of Comments

DOE received formal comments from

only one entity. This commenter is a

current Departmental non-profit

Management and Operating Laboratory

contractor. The commenter noted the

need for inclusion in the proposed

definition of bailment the term,

Laboratory Tangible Research Product.

This term would encompass tangible

material results of research which (i) are

provided to permit replication,

reproduction, evaluation or

confirmation of the research effort, or to

evaluate its potential commercial utility,

(ii) are not materials generally

commercially available, and (iii) were

made under the contract by Laboratory

employees or through the use of

Laboratory research facilities. The

definition of bailment has been

modified to incorporate this new term.

The commenter also expressed concern

that the current definition of allowable

costs only encompassed costs ‘‘through

an ORTA’’, with the implication that the

activities and costs associated with

autonomous Laboratory organizations

such as finance, procurement, legal and

other offices involved in technology

transfer would be excluded. DOE agrees

that such Laboratory organizations may

be ‘‘appropriate organizational elements

consistent with the requirements for an

Office of Research and Technology

Applications’’ and that the costs

associated with supporting technology

transfer at these Laboratory

organizations would be allowable

subject to other provisions of the M&O

contract. One of the organizational

examples cited by the commenter,

however, falls under the definition of a

home or corporate office general and

administrative (G&A) expense. DEAR

970.3102–1 indicates that, in its fee

allowance, DOE provides appropriate

compensation for home office G&A

expense. DOE policy also recognizes

that the circumstances and the need for

such home office involvement vary

considerably from site to site. Therefore,

home office G&A (including technology

transfer related expenses) would

normally be considered in the

individual negotiation of the fee for the

contract. When the fee amount is

believed to be insufficient to cover the

extent of such offsite involvement,

however, DEAR 970.3102–1 also

permits separate treatment of such a

home office expense. Therefore, no

change in the language of the rule is

believed necessary.

The commenter further suggested

adding language under Conflicts of

Interest to reflect that other persons

working at the Laboratory participating

in Laboratory research or technology