[Federal Register Volume 61, Number 93 (Monday, May 13, 1996)]
[Rules and Regulations]
[Pages 21955-21957]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11781]



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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.

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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 Sec. 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 Sec. 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 
Sec. 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

[[Page 21956]]

from the use of covered intangibles. In addition, Sec. 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, Sec. 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 Sec. 1.482-7(j)(2) will satisfy the principal document requirement 
of Sec. 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 
Secs. 1.482-7 (c) and (j) to read as follows:


Sec. 1.482-0  Outline of regulations under 482.

* * * * *

Sec. 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 text of paragraph (j)(2) following the 
heading as paragraph (j)(2)(i) 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:


Sec. 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 Sec. 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

[[Page 21957]]

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 Sec. 1.6662-6(d)(2)(iii)(B) with respect to 
a qualified cost sharing arrangement.
* * * * *
    Approved: May 2, 1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.

Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 96-11781 Filed 5-9-96; 8:45 am]
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