Source: https://www.federalregister.gov/documents/2013/08/27/2013-20786/use-of-differential-income-stream-as-an-application-of-the-income-method-and-as-a-consideration-in
Timestamp: 2017-08-22 12:32:44
Document Index: 263305684

Matched Legal Cases: ['§\u20091', '§\u20091', '§\u20091', '§\u20091', '§\u20091', '§\u20091']

Federal Register :: Use of Differential Income Stream as an Application of the Income Method and as a Consideration in Assessing the Best Method
78 FR 52854
52854-52856 (3 pages)
1545-BK71
2013-20786
IRS-2011-0050
https://www.federalregister.gov/d/2013-20786 https://www.federalregister.gov/d/2013-20786
Applicability Dates: For dates of applicability, see § 1.482-7(l).
The Treasury Department and the IRS were aware that some taxpayers were taking unreasonable positions in applying the income method by using relatively low licensing discount rates, and relatively high cost sharing discount rates, without sufficiently considering the appropriate interrelationship of the discount rates and financial projections. This practice gave rise to material distortions and the potential for PCT Payments not in accordance with the arm's length standard. To address these problems, the temporary and proposed regulations provided additional guidance on evaluating the results of an application of the income method (§ 1.482-7T(g)(2)(v)(B)(2) (Implied discount rates) and (g)(4)(vi)(F)(2) (Use of differential income stream as a consideration in assessing the best method)), and Start Printed Page 52855provided a new specified application of the income method for directly determining the arm's length charge for PCT Payments (§ 1.482-7(g)(4)(v) (Application of income method using differential income stream)).
Comments noted that § 1.482-7T(g)(4)(vi)(F)(2) explicitly provides that the implied discount rate may be used to evaluate the reliability of the corresponding actual discount rates associated with the licensing and cost sharing alternatives, but no similar explicit provision is contained in § 1.482-7(g)(4)(v) regarding the use of actual discount rates to evaluate the reliability of the corresponding implied discount rate. Thus, the comments suggested that such an explicit provision be adopted. The Treasury Department and the IRS agree that, depending on facts and circumstances, separately derived discount rates pursuant to a general application of the income method may yield a more reliable measure of an arm's length result than a proffered discount rate pursuant to a differential income stream application of the income method in a particular case. In such a case, however, the best method rule already would require a determination of PCT Payments under the method, and the application of such method, that, under the facts and circumstances, provides the most reliable measure of an arm's length result. See, for example, §§ 1.482-1(c)(1) and 1.482-7(g)(4)(vi)(A). Accordingly, the suggested change was not adopted.
(v) Application of income method using differential income stream. In some cases, the present value of an arm's length PCT Payment may be determined as the present value, discounted at the appropriate rate, of the PCT Payor's reasonably anticipated stream of additional positive or negative income over the duration of the CSA Activity that would result (before PCT Payments) from undertaking the cost sharing alternative rather than the licensing alternative (differential income stream). See Example 9 of paragraph (g)(4)(viii) of this section.
(2) Use of differential income stream as a consideration in assessing the best method. An analysis under the income method that uses a different discount rate for the cost sharing alternative than for the licensing alternative will be more reliable the greater the extent to which the implied discount rate for the projected present value of the differential income stream is consistent with reliable direct evidence of the appropriate discount rate applicable for activities reasonably anticipated to generate an income stream with a similar risk profile to the differential income stream. Such differential income stream is defined as the stream of the reasonably anticipated residuals of the PCT Payor's licensing payments to be made under the licensing alternative, minus the PCT Payor's cost contributions to be made under the cost sharing alternative. See, for example, Example 8 of this paragraph (g)(4)(viii).
(i) The facts are the same as in Example 1, except that the taxpayer determines that the appropriate discount rate for the cost sharing alternative is 20%. In addition, the taxpayer determines that the appropriate discount rate for the licensing alternative is 10%. Accordingly, the taxpayer determines that the appropriate present value of the PCT Payment is $146 million.
(ii) Based on the best method analysis described in Example 2, the Commissioner determines that the taxpayer's calculation of the present value of the PCT Payments is outside of the interquartile range (as shown in the sixth column of Example 2), and thus warrants an adjustment. Furthermore, in evaluating the taxpayer's analysis, the Commissioner undertakes an analysis based on the difference in the financial projections between the cost sharing and licensing alternatives (as shown in column 11 of Example 1). This column shows the anticipated differential income stream of additional positive or negative income for FS over the duration of the CSA Activity that would result from undertaking the cost sharing alternative (before any PCT Payments) rather than the licensing alternative. This anticipated differential income stream thus reflects the anticipated incremental undiscounted profits to FS from the incremental activity of undertaking the risk of developing the cost shared intangibles and enjoying the value of its divisional interests. Taxpayer's analysis logically implies that the present value of this stream must be $146 million, since only then would FS have the same anticipated value in both the cost sharing and licensing alternatives. A present value of $146 million implies that the discount rate applicable to this stream is Start Printed Page 5285634.4%. Based on a reliable calculation of discount rates applicable to the anticipated income streams of uncontrolled companies whose resources, capabilities, and rights consist primarily of software applications intangibles and research and development teams similar to USP's platform contributions to the CSA, and which income streams, accordingly, may be reasonably anticipated to reflect a similar risk profile to the differential income stream, the Commissioner concludes that an appropriate discount rate for the anticipated income stream associated with USP's platform contributions (that is, the additional positive or negative income over the duration of the CSA Activity that would result, before PCT Payments, from switching from the licensing alternative to the cost sharing alternative) is 16%, which is significantly less than 34.4%. This conclusion further suggests that Taxpayer's analysis is unreliable. See paragraphs (g)(2)(v)(B)(2) and (g)(4)(vi)(F)(1) and (2) of this section.
The facts are the same as in Example 1, except that additional data on discount rates are available that were not available in Example 1. The Commissioner determines the arm's length charge for the PCT Payment by discounting at an appropriate rate the differential income stream associated with the rights contributed by USP in the PCT (that is, the stream of income in column (11) of Example 1). Based on an analysis of a set of public companies whose resources, capabilities, and rights consist primarily of resources, capabilities, and rights similar to those contributed by USP in the PCT, the Commissioner determines that 15% to 17% is an appropriate range of discount rates to use to assess the value of the differential income stream associated with the rights contributed by USP in the PCT. The Commissioner determines that applying a discount rate of 17% to the differential income stream associated with the rights contributed by USP in the PCT yields a present value of $446 million, while applying a discount rate of 15% to the differential income stream associated with the rights contributed by USP in the PCT yields a present value of $510 million. Because the taxpayer's result, $464 million, is within the interquartile range determined by the Commissioner, no adjustments are warranted. See paragraphs (g)(2)(v)(B)(2), (g)(4)(v), and (g)(4)(vi)(F)(1) of this section.
[FR Doc. 2013-20786 Filed 8-26-13; 8:45 am]