Internal Revenue Bulletin 2012-12 (PDF rendition): IRS Announcements

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

Bulletin No. 201
2-12
March 19, 2012
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
T.D. 9568, page 499.
Final regulations under section 482 of the Code provide guid-
ance on the determination of and compensation for all eco-
nomic contributions by all controlled participants in connection
with a cost sharing arrangement (CSA) in accordance with the
arm’s length standard. The regulations address issues that
have arisen in administering the cost sharing regulations.
T.D. 9573, page 498.
Final regulations update the regulations under section 104 of
the Code to reflect statutory amendments limiting the section
104(a)(2) exclusion to damages for personal physical injuries
or physical sickness and to delete the “tort or tort-type rights”
test.
EXEMPT ORGANIZATIONS
T.D. 9574, page 559.
REG–135071–11, page 561.
Temporary and proposed regulations under section 501 of the
Code authorize the IRS to prescribe the procedures by which
certain entities may apply to the IRS for recognition of exemp-
tion from Federal income tax. The regulations affect qualified
nonprofit health insurance issuers, participating in the Con-
sumer Operated and Oriented Plan program established by the
Centers for Medicare and Medicaid Services, that seek exemp-
tion from federal income tax as an organization described in
section 501(c)(29) of the Code.
Announcement 2012–12, page 562.
Announcement 2010–19, 2010–14 I.R.B. 529 relating to a pro-
cedure to obtain a ruling regarding an organization’s status as
being described in section 509(a)(3), is declared obsolete be-
cause its special procedures have been replaced by the pro-
cedures contained in Revenue Procedure 2012–10, 2012–2
I.R.B. 273. Announcement 2010–19 obsoleted.
Finding Lists begin on page ii.

The IRS Mission
Provide Americ
a’s taxpayers top-quality service by helping
them understa
nd and meet their tax responsibilities and en-
force the law wi
th integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B, Leg-
islation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Secre-
tary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
The c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
March 19, 20122012–12 I.R.B.

Part I. Rulings
and Decisions Under the Internal Revenue Code
of 1986
Section 104.—Compensa-
tion for Injuries or Sickness
26 CFR 1.104–1: Compensation for injuries or sick-
ness.
T.D. 9573
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Damages Received on
Account of Personal Physical
Injuries or Physical Sickness
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final
regulations relating to the exclusion from
gross income for amounts received on ac-
count of personal physical injuries or phys-
ical sickness. The final regulations reflect
amendments under the Small Business Job
Protection Act of 1996. The final regula-
tions affect taxpayers receiving damages
on account of personal physical injuries
or physical sickness and taxpayers paying
these damages.
DATES:Effective Date:These regulations
are effective on January 23, 2012.
Applicability Date:For date of applica-
bility, see §1.104–1(c)(3).
FOR FURTHER INFORMATION
CONTACT: Sheldon Iskow, (202)
622–4920 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regula-
tions that amend the Income Tax Regu-
lations (26 CFR part 1) to reflect amend-
ments made to section 104(a)(2) of the
Internal Revenue Code (Code) by sec-
tion 1605(a) and (b) of the Small Busi-
ness Job Protection Act of 1996, Public
Law 104–188, 110 Stat. 1838 (the 1996
Act). On September 15, 2009, a notice of
proposed rulemaking (REG–127270–06,
2009–42 I.R.B. 534) was published in the
Federal Register(74 FR 47152). Writ-
ten comments responding to the notice of
proposed rulemaking were received. The
comments are available for public inspec-
tion atwww.regulations.govor on request.
A public hearing was requested and held
on February 23, 2010. After consideration
of all the comments, the proposed regu-
lations are adopted without substantive
change by this Treasury decision. The
comments are discussed in the preamble.
Summary of Comments
The proposed regulations deleted the
requirement that to qualify for exclusion
from gross income, damages received
from a legal suit, action, or settlement
agreement must be based upon “tort or
tort type rights.” The proposed regula-
tions provided, instead, that the section
104(a)(2) exclusion may apply to damages
recovered for a personal physical injury or
physical sickness under a statute that does
not provide for a broad range of remedies,
and that the injury need not be defined as
atort.
A commentator suggested that elimi-
nating the tort type rights test would cre-
ate confusion about what constitutes a per-
sonal injury. The commentator suggested
that the regulations should retain the tort
type rights test but clarify that meeting the
test does not depend on the nature of the
remedies or the state law characterization
of the cause of action.
The final regulations do not adopt this
comment. Before the 1996 amendment,
the section 104(a)(2) exclusion was not
limited to damages for physical injuries
or sickness. The tort-type rights test was
intended to distinguish damages for per-
sonal injuries from, for example, damages
for breach of contract. Since that time,
however,Commissioner v. Schleier,515
U.S. 323 (1995), has interpreted the statu-
tory “on account of” test to exclude only
damages directly linked to “personal” in-
juries or sickness. Furthermore, under the
1996 Act, only damages for personal phys-
ical injuries or physical sickness are ex-
cludable. These legislative and judicial
developments have eliminated the need to
base the section 104(a)(2) exclusion on tort
cause of action and remedy concepts.
A commentator requested that the fi-
nal regulations address whether a claimant
has constructive receipt or the current eco-
nomic benefit of a damage award that is set
aside for the claimant’s benefit in a trust or
fund, such as a qualified settlement fund
described in §1.468B–1. Other commen-
tators asked that the final regulations de-
fine certain personal injuries as physical
injuries and describe the circumstances in
which emotional distress is attributable to
physical injuries.
The final regulations do not adopt these
comments because they are beyond the
scope of the proposed regulations, which
did not propose rules on the issues raised
by the comments. However, these com-
ments will be considered if guidance is
published on these topics in the future.
Effective/Applicability Date
These regulations apply to dam-
ages paid pursuant to a written bind-
ing agreement, court decree, or media-
tion award entered into or issued after
September 13, 1995, and received after
January 23, 2012. This September 13,
1995, effective date derives from an
exception set forth in section 1605(d)(2) of
the 1996 Act to the statutory effective date
of the amendments to section 104(a)(2).
In addition, taxpayers may apply these
regulations to amounts paid pursuant to a
written binding agreement, court decree,
or mediation award entered into or issued
after September 13, 1995, and received af-
ter August 20, 1996, and if otherwise eli-
gible may file a claim for refund for a tax-
able year for which the period of limita-
tion on credit or refund under section 6511
has not expired. To qualify for a refund
of tax on damages paid after August 20,
1996, under a written binding agreement,
court decree, or mediation award entered
into or issued after September 13, 1995, a
taxpayer must meet the requirements of the
1996 Act, including the requirement that
excludable damages must be received on
account of personal physical injuries.
2012–12 I.R.B.498March 19, 2012

Special Analyses
This Treasury decision is not a signif-
icant regulatory action as defined in Ex-
ecutive Order 12866, as supplemented by
Executive Order 13563. Therefore, a reg-
ulatory assessment is not required. Sec-
tion 553(b) of the Administrative Proce-
dure Act (5 U.S.C. chapter 5) does not ap-
ply to these regulations, and because the
regulations do not impose a collection of
information on small entities, the Regu-
latory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking that pre-
ceded these final regulations was submit-
ted to the Chief Counsel for Advocacy
of the Small BusinessAdministration for
comment on its impact on small business.
Drafting Information
The principal author of these regula-
tions is Sheldon Iskow of the Office of
Associate Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In §1.104–1, paragraph (c) is
revised to read as follows:
§1.104–1 Compensation for injuries or
sickness.
*****
(c)Damages received on account
of personal physical injuries or physi-
cal sickness—(1)In general. Section
104(a)(2) excludes from gross income
the amount of any damages (other than
punitive damages) received (whether by
suit or agreement and whether as lump
sums or as periodic payments) on account
of personal physical injuries or physical
sickness. Emotional distress is not consid-
ered a physical injury or physical sickness.
However, damages for emotional distress
attributable to a physical injury or physical
sickness are excluded from income under
section 104(a)(2). Section 104(a)(2) also
excludes damages not in excess of the
amount paid for medical care (described in
section 213(d)(1)(A) or (B)) for emotional
distress. For purposes of this paragraph
(c), the termdamagesmeans an amount
received (other than workers’ compensa-
tion) through prosecution of a legal suit or
action, or through a settlement agreement
entered into in lieu of prosecution.
(2)Cause of action and remedies.The
section 104(a)(2) exclusion may apply to
damages recovered for a personal physical
injury or physical sickness under a statute,
even if that statute does not provide for a
broad range of remedies. The injury need
not be defined as a tort under state or com-
mon law.
(3)Effective/applicability date.This
paragraph (c) applies to damages paid
pursuant to a written binding agreement,
court decree, or mediation award en-
tered into or issued after September 13,
1995, and received after January 23, 2012.
Taxpayers also may apply these final reg-
ulations to damages paid pursuant to a
written binding agreement, court decree,
or mediation award entered into or issued
after September 13, 1995, and received
after August 20, 1996. If applying these
final regulations to damages received
after August 20, 1996, results in an
overpayment of tax, the taxpayer may file
a claim for refund before the period of
limitations under section 6511 expires. To
qualify for a refund of tax on damages
paid after August 20, 1996, under a
written binding agreement, court decree,
or mediation award entered into or issued
after September 13, 1995, a taxpayer must
meet the requirements of section 1605
of the Small Business Job Protection Act
of 1996, Public Law 104–188 (110 Stat.
1838).
*****
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
Approved December 6, 2011.
Emily S. McMahon,
Assistant Secretary of
the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on January 20,
2012, 8:45 a.m., and published in the issue of the Federal
Register for January 23, 2012, 77 F.R. 3106)
Section 482.—Allocation
of Income and Deduction
Among Taxpayers
26 CFR 1.482–1: Allocation of income and deduc-
tions among taxpayers.
T.D. 9568
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1, 301, and 602
Section 482: Methods to
Determine Taxable Income
in Connection With a Cost
Sharing Arrangement
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains fi-
nal regulations regarding methods to de-
termine taxable income in connection with
a cost sharing arrangement under section
482 of the Internal Revenue Code (Code).
The final regulationsaddress issues that
have arisen in administering the current
cost sharing regulations. The final regu-
lations affect domestic and foreign entities
that enter into cost sharing arrangements
described in the final regulations.
DATES:Effective Date:These regulations
are effective on December 16, 2011.
Applicability Date:For dates of
applicability, see §§1.482–1(j)(6)(i),
1.482–2(f), 1.482–4(h), 1.482–7(l),
1.482–8(c),1.482–9(n)(3),and
301.7701–1(f).
FOR FURTHER INFORMATION
CONTACT: Joseph L. Tobin, (202)
435–5265 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in these final regulations has
March 19, 20124992012–12 I.R.B.

been reviewed by the Office of Man-
agement and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545–1364. The collections of
information in these final regulations are
in §1.482–7(b)(2) and (k). Responses to
the collections of information are required
by the IRS to monitor compliance of
controlled taxpayers with the provisions
applicable to cost sharing arrangements.
An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless it displays
a valid control number assigned by the Of-
fice of Management and Budget.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by section 6103 of the Code.
Background
A notice of proposed rulemaking and
notice of public hearing regarding ad-
ditional guidance to improve compli-
ance with, and administration of, the
rules in connection with a cost sharing
arrangement (CSA) were published in
theFederal Register(70 FR 51116)
(REG–144615–02) on August 29, 2005
(2005 proposed regulations). A correction
to the notice of proposed rulemaking and
notice of public hearing was published in
theFederal Register(70 FR 56611) on
September 28, 2005. A public hearing
was held on December 16, 2005.
The Treasury Department and the IRS
received numerous comments on a wide
range of issues addressed in the 2005 pro-
posed regulations. In response to these
comments, temporary and proposed regu-
lations were published in theFederal Reg-
ister(74 FR 340–01 and 74 FR 236–01)
(REG–144615–02) on January 5, 2009
(2008 temporary regulations). Corrections
to the 2008 temporary regulations were
published in theFederal Registeron Feb-
ruary 27, 2009 (74 FR 8863–01), March 5,
2009 (74 FR 9570–01, 74 FR 9570–02,
and 74 FR 9577–01), and March 19, 2009
(74 FR 11644–01). A public hearing was
held on April 21, 2009.
The Treasury Department and the IRS
received comments on a range of issues
addressed in the 2008 temporary regula-
tions. These final regulations make sev-
eral changes to the 2008 temporary regu-
lations in response to these comments. In
addition, a number of editorial clarifica-
tions have been made. These regulations
adopt the effective date and transition rules
under the 2008 temporary regulations so
that they are generally applicable for all
CSAs, with transition rules for certain pre-
existing arrangements in existence prior to
January 5, 2009.
Explanation of Provisions
A. Overview – Economic Contributions
and Their Arm’s Length Compensation in
aCSA
These final regulations provide guid-
ance on the determination of and compen-
sation for all economic contributions by all
controlled participants in connection with
a CSA in accordance with the arm’s length
standard.
The arm’s length analysis under sec-
tion 482 begins with the factual and
functional analysis of the actual transac-
tion or transactions among the controlled
taxpayers. In a CSA, the controlled par-
ticipants make economic contributions
of two types, namely, mutual commit-
ments to prospectively share intangible
development costs in proportion to their
reasonably anticipated benefits from ex-
ploitation of the cost shared intangibles
(cost contributions) and to provide any ex-
isting resources, capabilities, or rights that
are reasonably anticipated to contribute
to developing cost shared intangibles
(platform contributions). CSAs may also
involve economic contributions by the
controlled participants of other existing
resources, capabilities, or rights related to
the exploitation of cost shared intangibles
(operating contributions). The concepts
of platform and operating contributions
are intended to encompass any existing
inputs that are reasonably anticipated to
facilitate developing or exploiting cost
shared intangibles at any time, including
resources, capabilities, or rights, such as
expertise in decision-making concerning
research and product development, man-
ufacturing or marketing intangibles or
services, and management oversight and
direction. Other prospective economic
contributions consist of costs incurred to
develop or acquire resources, capabilities,
and rights that facilitate the exploitation
of cost shared intangibles (operating cost
contributions). These regulations provide
guidance for determining the arm’s length
charge for all such contributions to clearly
reflect the incomes of the controlled par-
ticipants.
The valuation guidance in the regula-
tions applies to determine the most reliable
measure of arm’s length results for these
economic contributions over the duration
of the activity of developing and exploit-
ing cost shared intangibles (CSA Activ-
ity). The combined effect of multiple con-
tributions, potentially including controlled
transactions outside of the CSA (for ex-
ample, make-or-sell licenses, or intangible
transfers governed by section 367(d)), may
need to be evaluated on an aggregate ba-
sis, where that approach provides the most
reliable measure of an arm’s length result.
So, for example, if a taxpayer transfers in-
tangibles in a transaction governed by sec-
tion 367(d) in connection with contribu-
tions related to those same intangibles in
connection with a CSA, then the pricing of
the intangibles under section 367(d) may
need to be evaluated along with the pricing
of all contributions in connection with the
CSA on an aggregate basis, where that ap-
proach provides the most reliable measure
of an arm’s length result. Under the prin-
ciples of the investor model, the relative
reliability of the analysis will depend on
the degree of consistency of the valuation
with the expectation that each controlled
participant’s net investment attributable to
cost contributions, platform contributions,
operating contributions, and operating cost
contributions, is reasonably anticipated to
earn a rate of return (which might be re-
flected in a discount rate used in apply-
ing a method) appropriate to the riskiness
of the controlled participant’s CSA Activ-
ity over the entire period of the CSA Ac-
tivity. The duration of the CSA Activity
may, or may not, correspond to the conven-
tional concept of useful life with respect to
any of the underlying economic contribu-
tions; it represents the period over which
the controlled participants reasonably an-
ticipate returns from the CSA Activity.
For purposes of determining the best
method of measuring the arm’s length re-
sults of a CSA, and any related controlled
transactions, these regulations adopt the
guidance included inthe 2008 temporary
2012–12 I.R.B.500March 19, 2012

regulations on assessing the potential ap-
plicability of the comparable uncontrolled
transaction (CUT) method. The arm’s
length standard seeks to determine the
results that would obtain had uncontrolled
taxpayers engaged in the same transaction
under the same circumstances. It is im-
material whether the arrangement among
uncontrolled taxpayers is denominated
as a “cost sharing arrangement,” so long
as the arrangement involves the same
circumstances (or similar circumstances,
assuming that reliable adjustments can
be made to account for any differences).
Thus, long-term licenses or research and
development services contracts may pro-
vide CUTs, provided and to the extent they
involve the same or similar scope and con-
tractual terms, uncertainty of outcomes,
profit potential, allocation of intangible
development and exploitation risks, in-
cluding allocation of the risks of existing
contributions and the risks of developing
future contributions, consistent with the
actual allocation of risks under the CSA
and through relatedcontrolled transac-
tions.
A CSA may benefit from, and con-
tribute to, a controlled group’s unique
competitive advantages. Therefore, there
may be no uncontrolled transactions that
reliably reflect the same contributions by
the parties, over a similar period of com-
mitment, and with the same risk profile
and profit potential. The arm’s length stan-
dard requires application of the method
that most reliably reflects the results that
would have been realized had uncontrolled
taxpayers engaged in the same transaction.
Where comparable uncontrolled transac-
tions are unavailable,these regulations,
like other regulations under section 482,
allow for reference to the results the con-
trolled taxpayers could have realized by
choosing a realistic alternative. These reg-
ulations adopt a specified income method
included in the 2008 temporary regula-
tions that represents an application of
the realistic alternatives principle. These
regulations adopt the 2008 temporary
regulations’ provision of a licensing al-
ternative to the CSA that closely aligns
with the economics of the CSA, but takes
account of the licensor’s commitment to
bear the entire risk of the intangible devel-
opment that would otherwise have been
shared. The realistic alternatives analysis
effectively constructs a comparable un-
controlled transaction that, depending on
the facts and circumstances, may more
reliably reflect the economics of the ac-
tual contributions to the CSA than can be
derived from third party transactions. For
cases where more than one controlled par-
ticipant makes significant contributions
to residual profits (including platform or
operating contributions), these regulations
adopt the guidance included in the 2008
temporary regulationson a specified resid-
ual profit split method (RPSM), which is
also an application of the realistic alterna-
tives principle.
These regulations also adopt guidance
on the application of two other specified
methods included in the 2008 tempo-
rary regulations — the acquisition price
method and the market capitalization
method. The guidance regarding unspec-
ified methods adopted from the 2008
temporary regulations reemphasizes that
any such method should take into account
the general principle that uncontrolled tax-
payers evaluate the terms of a transaction
by considering the realistic alternatives to
that transaction, and enter into a particular
transaction only if none of the alternatives
is clearly preferable to it.
These regulations resolve issues that
have been raised under the 1995 regula-
tions. No inference is intended regarding
the appropriate resolution of those issues
under the 1995 regulations. These regula-
tions do not turn on whether a given trans-
action in connection with a CSA involves
intangible property within the meaning of
section 936(h)(3)(B), or whether such item
has been transferred, licensed, or retained.
Rather, if a controlled participant devotes,
in whole or part, any existing resource,
capability, or right to intangible develop-
ment for the benefit of another controlled
participant, whether by transfer or license
to the other controlled participant, or by
leveraging such resource, capability, or
right within the context of the CSA, then
the regulations require an arm’s length
charge for such platform contribution, in
addition to the funding of intangible de-
velopment costs.
For example, the regulations require an
arm’s length charge for one controlled par-
ticipant’s platform contribution commit-
ment of a particular research team’s expe-
rience and expertise to intangible devel-
opment under a CSA, in addition to the
controlled participants’ sharing of the on-
going intangible development costs of the
salaries of such researchers. To limit the
arm’s length charge in these circumstances
to sharing the ongoing salary costs would
ignore the value of having the particular
research team already in place to under-
take the intangible development with the
benefit of its particular knowhow. See
§1.482–7(c)(5),Example 2.Asanother
example, the contribution of core entrepre-
neurial functions such as product selection,
market positioning, research strategy, and
risk determinations and management re-
quires an arm’s length charge under these
regulations. To omit charges for these or
any other significant economic contribu-
tions one controlled taxpayer makes for
another’s benefit would fail to clearly re-
flect the incomes of such controlled tax-
payers.
A unifying underpinning of the sec-
tion 482 regulations is that controlled
transactions reflecting similar economics,
regardless of the type of transaction (such
as transfer of intangibles or provision of
services), should be valued in accordance
with similar principles and methods. See,
for example, §1.482–1(b)(2)(iii). In con-
junction with finalizing §1.482–7, parallel
rules are also finalized in §§1.482–4(g)
and 1.482–9(m)(3). Under these provi-
sions, the principles and methods for valu-
ing platform and operating contributions
under a CSA may also apply for purposes
of determining the best method, which
may be an unspecified method, for valuing
similar contributions in connection with
controlled transfers of intangibles or pro-
visions of services.
B. Platform contributions, make-or-sell
rights excluded – §1.482–7(c)(4)
A comment requested clarification of
the treatment of an item –e.g.,apro-
gram or tool to facilitate research (research
tools) – used under a CSA to further the
development of intangibles targeted by the
CSA, as within, or outside, the defini-
tion of make-or-sell rights. The Treasury
Department and the IRS intend research
tools to be treated as platform contribu-
tions, and not as excluded make-or-sell
rights. Accordingly, §1.482–7(c)(4)(i) has
been modified and a new example added
to illustrate this concept.
March 19, 20125012012–12 I.R.B.

C. Intangible Development Activity and
Costs – §1.482–7(d)(3)
The Treasury Department and the IRS
requested comments in Notice 2005–99,
2005–2 C.B. 1214, regarding the valua-
tion of stock options and other stock-based
compensation. Several comments were re-
ceived. The Treasury Department and the
IRS continue to consider the matters de-
scribed in Notice 2005–99, and intend to
address these issues in a subsequent regu-
lations project.
D. Reasonably Anticipated Benefit Shares
– §1.482–7(e)(1)(i)
Several comments requested clarifica-
tion concerning how and when to update
reasonably anticipated benefit (RAB)
shares, and whether such updates may
be made retroactively or only prospec-
tively. In response to these comments, the
Treasury Department and the IRS added
several sentences to §1.482–7(e)(1)(i) to
clarify that RAB shares determined for
a particular purpose should not be fur-
ther updated for that purpose based on
information not available at the time that
determination needed to be made. For
example, RAB shares determined in order
to determine intangible development cost
shares for a particular taxable year should
not be recomputed based on information
not available during that particular tax-
able year, and RAB shares determined for
the purpose of using a particular trans-
fer pricing method to evaluate the arm’s
length amount charged in a PCT should
not be recomputed based on information
not available on the date of that PCT.
An example is added to illustrate this
clarification. See §1.482–7(e)(1)(iii),
Example 2. For readability, a portion
of the text of §1.482–7T(e)(1)(i) was
redesignated as §1.482–7(e)(1)(ii), and
§1.482–7T(e)(1)(ii) was redesignated
as §1.482–7(e)(1)(iii). The Treasury
Department and the IRS also observe
in these clarifications that nothing in
§1.482–7(e)(1) limits the Commissioner’s
use of subsequently available information
for purposes of its allocation determina-
tions in accordance with the provisions of
§1.482–7(i) (Allocations by the Commis-
sioner in connection with a CSA).
E. Transfer Pricing Methods– §1.482–7(g)
1. Supplemental Guidance on Methods
Applicable to PCTs – §1.482–7(g)(1)
One method for determining the arm’s
length charge for a contribution is to
calculate the total present value of the
stream of future economic benefits one
can expect in connection with such contri-
bution. In a CSA, the stream of anticipated
economic benefits to be discounted will
reflect the economic benefits expected to
arise from cost shared intangibles to be
developed under the CSA. Consequently,
the arm’s length charge for a PCT can
appropriately be determined by taking
into account the economic benefits antici-
pated to be produced in the future by cost
shared intangibles developed under the
CSA. Accordingly, a sentence has been
added to paragraph (g)(1) to clarify that
each method used for evaluating the arm’s
length amount charged in a PCT must
yield results consistent with measuring the
value of a platform contribution by refer-
ence to the future income anticipated to
be generated by the resulting cost shared
intangibles.
2. Best Method Analysis Considerations
and the Income Method – §1.482–7(g)(2)
and (4).
a. Discounting operating income –
§1.482–7(g)(2)(v)
The preamble to the 2008 temporary
regulations solicited comments on whether
and how the cost sharing rules could reli-
ably be administered on the basis of cash
flows instead of operating income, and
whether such a basis is consistent with the
second sentence of section 482. No com-
ments were received that addressed this re-
quest, though some comments did object
to the use of operating income, rather than
cash flows, in the cost sharing rules.
The Treasury Department and the IRS
believe that, while the use of cash flow pro-
jections is permitted under the regulations,
detailed guidance on the specific applica-
tions of the methods should be based on
discounting operating income rather than
cash flows for a number of practical and
administrative reasons and, accordingly,
no changes were adopted to address this is-
sue.
b. Financial projections and discount
rates – §1.482–7(g)(2)(v) and (vi)
Under the temporary regulations, the
specific applications of the income method
discussed in §1.482–7(g)(4) require a
number of input parameters, including
financial projections and the associated
discount rate under the licensing alter-
native, and financial projections and the
associated discount rate under the cost
sharing alternative. These regulations
modify the 2008 temporary regulations in
several respects to clarify the interaction
of these input parameters in applying the
income method.
i. Financial projections for the licensing
and cost sharing alternatives are
interrelated
These regulations provide that, under
the specific applications of the income
method, the financial projections associ-
ated with the licensing and cost sharing
alternatives are the same except for the
licensing payments to be made under the
licensing alternative, and the cost contri-
butions and PCT Payments to be made
under the cost sharing alternative. Thus,
for example, if the PCT Payor anticipates
sales associated with the cost shared intan-
gibles to third parties of $100 in the cost
sharing alternative, then it must anticipate
sales associated with the licensed intangi-
ble to third parties of this same $100 under
the licensing alternative. Similarly, if the
PCT Payor’s anticipated selling costs as-
sociated with those sales are $60 in the cost
sharing alternative, then its anticipated
selling costs are the same $60 in the licens-
ing alternative. The financial projections
associated with the licensing alternative
to the CSA are closely associated with the
financial projections associated with the
cost sharing alternative, differing only in
the treatment of licensing payments, cost
contributions, and PCT Payments. As a
result, the income method, as in the case
of the more traditional discounted cash
flow methods, builds off of the (single)
probability-weighted financial projections
associated with the CSA Activity.
ii. Discount rates for the licensing and
cost sharing alternatives are interrelated
The Treasury Department and the IRS
received several comments requesting fur-
2012–12 I.R.B.502March 19, 2012

ther guidance on the relationship between
the discount rate that is appropriate for dis-
counting the operating income associated
with the cost sharing alternative and the
discount rate that is appropriate for dis-
counting the operating income associated
with the licensing alternative. In response
to these comments, and as a corollary to
the interrelationship of the financial pro-
jections for the licensing and cost shar-
ing alternatives discussed in the preceding
paragraph, these regulations provide fur-
ther guidance on the discount rates appro-
priate for these two alternatives. Specifi-
cally, the difference, if any, in market-cor-
related risks between the licensing and cost
sharing alternatives is due solely to the dif-
ferent effects on risks of the PCT Payor
making licensing payments under the li-
censing alternative, and the PCT Payor
making cost contributions and PCT Pay-
ments under the cost sharing alternative.
That is, the difference in risk between the
two scenarios solely reflects (1) the incre-
mental risk, if any, associated with the cost
contributions taken on by the PCT Payor in
developing the cost shared intangible un-
der the cost sharing alternative, and (2) the
difference in risk, if any, associated with
the particular payment forms of the licens-
ing payments and the PCT Payments, in
light of the fact that the licensing payments
in the licensing alternative are partially re-
placed by cost contributions and partially
replaced by PCT Payments in the cost shar-
ing alternative, each with its own payment
form.
c.Valuationundertakenonapre-taxbasis
– §1.482–7(g)(2)(x)
Several comments requested that the
final regulations clarify the term “tax rate”
for purposes of determining amounts on a
pre-tax basis. In response, that term has
been clarified in §1.482–7(j)(1) to mean
the reasonably anticipated effective tax
rate with respect to the pre-tax income to
which the rate of tax is being applied. For
example, under the income method, this
rate would be the reasonably anticipated
effective tax rate of the PCT Payor or PCT
Payee under the cost sharing alternative or
licensing alternative, as appropriate. See
§1.482–7(g)(4)(i)(G).
Several comments also requested clar-
ification on the guidance concerning the
determination of pre-tax PCT Payments
under the income method. While PCT
Payments must be determined on a pre-
tax basis, in general, the financial pro-
jections and discount rates used to apply
the income method are post-tax measures.
Comments suggested that this discrepancy
makes such a determination difficult and
raises concerns about valuation principles
to derive a pre-tax PCT Payment based on
post-tax data.
The Treasury Department and the IRS
believe that the requirement that PCT Pay-
ments be determined on a pre-tax basis
is fundamental to the determination of an
arm’s length result, and, while no changes
were made to the regulations in this regard,
examples were added to illustrate this
concept. Under the income method, the
operative rule in all cases is to derive the
pre-taxPCT Payments that set thepost-tax
present value of the cost sharing alterna-
tive equal to the post-tax present value of
the licensing alternative. The operative
rule can be satisfied in a number of ways.
For example, annual pre-tax PCT Pay-
ments can be directly determined such that,
when incorporated into the PCT Payor’s
financial projections (which should reflect
the deductibility of the pre-tax PCT Pay-
ments), the post-tax net present values of
the licensing and cost sharing alternatives
are equated. See §1.482–7(g)(4)(viii),Ex-
ample 4. Alternatively, the present value
of post-tax PCT Payments can be directly
determined by subtracting the present
value of the post-tax income associated
with the licensing alternative from the
present value of the post-tax income as-
sociated with the cost sharing alternative
(exclusive of the PCT Payment). This
difference, which reflects the post-tax
present value of the PCT Payment, must
begrosseduptoderivethepre-taxPCT
Payment. See §1.482–7(g)(4)(viii),Ex-
ample 5. Another alternative, in certain
situations (for example, when financial
projections are based on income, rather
than cash flows, and when a controlled
participant’s tax rate is not materially af-
fected by whether it enters into the cost
sharing or licensing alternative), is for the
present value of pre-tax PCT Payments to
be directly determined by subtracting the
present value of the pre-tax income asso-
ciated with the licensing alternative from
the present value of the pre-tax income
associated with the cost sharing alterna-
tive (exclusive of the PCT Payment), both
discounted atpost-taxdiscount rates. That
is, under certain conditions the pre-tax
PCT Payments that equate the pre-tax
present values of the two alternatives will
also equate the post-tax present values of
the two alternatives (which satisfies the
operative rule). This last method does
not reflect a violation of valuation theory,
but merely a method that applies under
certain conditions to derive the pre-tax
PCT Payment more directly, rather than
deriving the post-tax PCT Payment un-
der the operative rule and grossing it up.
Discounting pre-tax income with post-tax
discount rates conceptually provides a
measure of pre-tax income. Discount-
ing pre-tax income with pre-tax discount
rates, on the other hand, conceptually pro-
vides a measure of post-tax income. See
§1.482–7(g)(4)(viii),Example 6.Thespe-
cific applications of the income method
described in paragraphs (g)(4)(ii) through
(iv) and the examples set forth in para-
graph (g)(4)(viii) of these final regulations
assume that such circumstances apply,
but the regulations do not exclude other
applications.
3. Acquisition Price and Market
Capitalization Methods – §1.482–7(g)(5)
and (6)
The acquisition price method as spec-
ified in §1.482–7(g)(5) typically may be
considered for determining PCT Payments
with respect to platform contributions as
a result of asset or stock acquisitions.
Comments were received that, with some
acquisitions, there may be benefits to the
controlled group whose scope extends
beyond the development of cost shared
intangibles. The Treasury Department and
the IRS agree that these facts and circum-
stances should be taken into account in
the appropriate application of the acqui-
sition price method and any other meth-
ods for purposes of determining the best
method, but believe that this is adequately
addressed by other provisions of the sec-
tion 482 regulations. See, for example,
§§1.482–1(c) (Best method rule) and (d)
(Comparability), and 1.482–7(g)(2)(iv)
(Aggregation of transactions).
Several comments requested that the
final regulations provide more guidance
on what types of tax adjustments may
be needed with respect to PCT Payments
determined under the acquisition price
March 19, 20125032012–12 I.R.B.

or market capitalization method. The
Treasury Department and the IRS believe
that the determination as to whether to
make such adjustments should be based on
facts and circumstances of each case and
thus are best addressed under the general
comparability guidance in Treas. Reg.
§1.482–1(d) (Comparability). Therefore,
the specific references to tax adjustments
under those methods were removed.
4. Residual Profit Split Method –
§1.482–7(g)(7)
The residual profit split method un-
der §1.482–7(g)(7) allocates a PCT
Payor’s nonroutine residual divisional
profit or loss according to the con-
trolled participants’ relative nonrou-
tine contributions. The calculation of
nonroutine residual divisional profit or
loss includes a subtraction of market
returns for routine contributions. See
§1.482–7(g)(7)(iii)(B). These regulations
clarify that market returns for operating
cost contributions are included in, and
market returns for cost contributions are
excluded from, that subtraction. Mar-
ket returns are not assigned to cost con-
tributions because, under this method,
resources, capabilities, and rights that
benefit the development of cost shared
intangibles (and thus make such devel-
opment more valuable than its cost) are
compensated as platform contributions.
F. Form of Payment – §1.482–7(h)
1. Consistency of Form of Payment with
Arm’s Length Charge
Under the section 482 regulations, con-
trolled taxpayers have flexibility to choose
a form of payment with respect to an arm’s
length charge, provided that the form of
payment may be reasonably expected to
yield a value consistent with such arm’s
length charge determined as of the date
of the PCT. Thus, a taxpayer must not
only determine an arm’s length charge cor-
rectly under §1.482–7(g) but also desig-
nate a form of payment that is consistent
with that arm’s length charge determined
as of the date of the PCT. This dual con-
cept of the flexibility in selecting the form
of payment as well as the obligation to pre-
serve the arm’s length charge through de-
termining the form of payment as of the
date of the PCT is clarified by a new sen-
tence added to §1.482–7(h)(2)(i).
2. Services Markup Form of Payment
Several comments suggested that the fi-
nal regulations should expressly permit the
use of methods in §1.482–9, particularly
the cost of services plus method, for valu-
ing and determining the form of payment
of PCT Payments for services provided as,
for example, by a research team. As noted
in the preceding paragraph, these regula-
tions clarify the flexibility taxpayers enjoy
to adopt a form of payment consistent
with the arm’s length charge determined
for a PCT. In theory, therefore, the arm’s
length charge for a platform contribu-
tion of services of a research team might
be converted into a cost-of-services-plus
form of payment, provided that, among
other conditions, the method and form of
payment treating the platform value of
such research team separately from the
arm’s length charge for any other platform
contributions provide the most reliable
measures of the arm’s length charges. The
experience of the IRS, however, is that the
arm’s length charges for platform contri-
butions of the services of a research team
along with other platform contributions
(e.g., of a base technology) are most often
most reliably determined in the aggregate.
G. Periodic Adjustments – §1.482–7(i)
1. Determination of Periodic Adjustments
– §1.482–7(i)(6)(v) and (vi)
a. In general – §1.482–7(i)(6)(i)
The temporary regulations provided
detailed guidance for the calculation of
periodic adjustments in situations where
there is a single adjustment with respect to
a single controlled participant. The Trea-
sury Department and the IRS intended that
the principles of that detailed guidance
should also be applied in cases involving
multiple periodic adjustments (whether
with respect to one or multiple controlled
participants, or with respect to one or mul-
tiple PCT Payments) and, accordingly,
§1.482–7T(i)(6)(i) provided that the Com-
missioner may make periodic adjustments
with respect toallPCT Payments between
all PCT Payors and PCT Payees for the
Adjustment Year and all subsequent years
for the duration of the CSA Activity. In re-
sponse to these comments, a new example
in §1.482–7(i)(6)(vii) illustrates the ap-
plication of §1.482–7(i)(6)(i) when more
than one periodic adjustment is required.
b. Adjusted RPSM – §1.482–7(i)(6)(v)(B)
One comment suggested that the re-
quirement that an adjusted RPSM be used
for determining periodic adjustments is in-
consistent with the arm’s length standard
because the arm’s length standard requires
that the best method rule be applied in
all circumstances, and the adjusted RPSM
will not be the best method in every cir-
cumstance. The Treasury Department and
the IRS believe that this is sufficiently
addressedbythe2008temporaryregula-
tions, which provide for periodic adjust-
ments to be administered consistent with
the arm’s length standard. Specifically,
§1.482–7(i)(6)(i) provides that, in deter-
mining whether to make periodic adjust-
ments, the Commissioner may consider
whether the outcome as adjusted more re-
liably reflects an arm’s length result under
all the relevant facts and circumstances.
c. Exceptions to periodic adjustments –
§1.482–7(i)(6)(vi)
Several comments suggested that the
definition of “divisional profits or losses”
is too broad and includes too much value
in the concept of the actually experienced
return ratio (AERR), thereby making the
numerator in the Periodic Trigger too
large relative to the denominator, and thus
too easily triggered. In response to this
comment, the exception to periodic ad-
justments in §1.482–7T(i)(6)(vi)(A)(3)is
expanded to take into account the PCT
Payor’s routine platform contributions.
The language is further clarified to pro-
vide that, in addition to the exclusion of
certain profits or losses, the PCT Payor’s
divisional profits or losses are calculated
by taking into account the expenses on
account of operatingcost contributions
and routine platform contributions.
d. Contractual CWI provisions –
§1.482–7(h)(2)(iii)(C), Examples 3
through 7
The IRS has encountered a number
of contracts that contain price terms for
2012–12 I.R.B.504March 19, 2012

transactions that are subject to section 482,
including buy-ins and PCTs, that provide
for contingent terms based on subsequent
actual income experience. Some such
terms specify a charge for the transaction
and then further provide for adjustments
to that charge based generally on the ac-
tual income results. Certain of these terms
are specifically tied to the mechanics
of the CWI regulations (for example, a
price adjustment is required if the income
is less than 80 percent or greater than
120 percent of the price charged). See
§§1.482–4(f)(2)(ii)(B)(6) and (C)(4)and
1.482–7T(i)(6)(i) and (ii).
Controlled participants have flexibility
in agreeing to contingent payment terms
and, thus, in allocating upside or down-
side risk among the parties. In so doing,
the parties can tie their prices to the in-
come actually earned with respect to the
subject of the buy-in or PCT. Such price
terms must be determined on an upfront
basis and must be coordinated and consis-
tent with the arm’s length charge. The IRS
has experience, however, with taxpayers
failing to provide for arm’s length com-
pensation for the allocation of risk, as well
as failing to provide price terms that are
sufficiently clear so as to constitute an up-
front allocation of risk that has economic
substance. Accordingly, several examples
have been added to §1.482–7(h)(2)(iii)(C)
to illustrate the treatment of certain types
of contingent price terms under these regu-
lations, and apply the principles set forth in
§§1.482–7(h)(2)(iii)(B) and (k)(1)(iv) and
1.482–1(d)(3)(ii)(B)(1) and (iii)(B).
2. Advance Pricing Agreement
As stated in the Preamble to the 2008
temporary regulations, the Treasury De-
partment and the IRS are considering issu-
ing a revenue procedure providing an ex-
ception to periodic adjustments, similar to
exceptions provided in §1.482–7(i)(6)(vi),
in the context of an advance pricing agree-
ment (APA) entered into pursuant to Rev.
Proc. 2006–9, 2006–1 C.B. 278. Ac-
cordingly, no periodic adjustments would
bemadeinanyyearbasedonaTrigger
PCT that is a covered transaction under the
APA. See §601.601(d)(2)(ii)(b).
H. Administrative Requirements –
§1.482–7(k)
1. CSA Statements, mailing to Ogden
Campus – §1.482–7(k)(4)(iii)
A number of comments requested that
the regulations provideaspecificaddress
for mailing CSA Statements to the Ogden
Campus. In response to these comments,
a specific mailing address for CSA State-
ments has been added to the regulations.
2. Advance Pricing Agreements
One comment requested that taxpayers
with CSAs covered by APAs be relieved
from the administrative requirements in
§1.482–7(k)(2) through (4). The Trea-
sury Department and the IRS are consider-
ing guidance addressing this issue, and so-
licit further comments concerning the ex-
tent to which compliance with the APA
procedures should be deemed to satisfy
any of the administrative requirements un-
der §1.482–7(k)(2) through (4). These
comments should address the impact of
any such change on the ability of the IRS
to properly examine CSA-related transac-
tions.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations. It is hereby
certified that the collections of information
in these regulations will not have a sig-
nificant economic impact on a substantial
number of small entities. This certifica-
tion is based on the fact that this rule ap-
plies to U.S. businesses and foreign affil-
iates that enter into cost sharing arrange-
ments. Few small entities are expected to
enter into cost sharing agreements, as de-
fined by these regulations. Accordingly, a
Regulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 6) is not required. Pursuant to section
7805(f) of the Code, these regulations were
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
(CCASBA) for comment on their impact
on small businesses. CCASBA did not
have any comments.
Drafting Information
The principal author of these regula-
tions is Joseph L. Tobin of the Office of
Associate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.
*****
Amendment to the Regulations
Accordingly, 26 CFR parts 1, 301, and
602 are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.482–7 also issued under
26 U.S.C. 482. * * *
Par 2. Section 1.367(a)–1 is amended
by revising paragraph (d)(3) to read as fol-
lows:
§1.367(a)–1 Transfers to foreign
corporations subject to section 367(a):
In general.
*****
(d) * * *
(3)Transfer. For purposes of section
367 and regulations thereunder, the term
“transfer” means any transaction that con-
stitutes a transfer for purposes of section
332, 351, 354, 355, 356, or 361, as ap-
plicable. A person’s entering into a cost
sharing arrangement under §1.482–7 or ac-
quiring rights to intangible property under
such an arrangement shall not be consid-
ered a transfer of property described in sec-
tion 367(a)(1). See §1.6038B–1T(b)(4) for
thedateonwhichthetransferisconsidered
to be made.
*****
Par. 3. Section 1.367(a)–1T is amended
by revising paragraph (d)(3) to read as fol-
lows:
§1.367(a)–1T Transfers to foreign
corporations subject to section 367(a): In
general (temporary).
*****
March 19, 20125052012–12 I.R.B.

(d) * * *
(3) [Reserved]. For further guidance,
see §1.367(a)–1(d)(3).
*****
Par. 4. Section 1.482–0 is amended as
follows:
1. The entries for §1.482–1(b)(2)(i) and
(iii) are revised.
2. The entries for §1.482–2(e) and (f)
are revised.
3. The entries for §1.482–4(f)(3)(i)(B),
(g) and (h) are revised.
4. The entry for §1.482–7 is revised.
5. The entries for §1.482–9(m)(3) and
(n) are revised.
The additions and revisions read as fol-
lows:
§1.482–0 Outline of regulations under
section 482.
*****
§1.482–1 Allocation of income and
deductions among taxpayers.
*****
(b) * * *
(2)* * *
(i) Methods.
*****
(iii) Coordination of methods applica-
ble to certain intangible development ar-
rangements.
*****
§1.482–2 Determination of taxable
income in specific situations.
*****
(e) Cost sharing arrangement.
(f) Effective/applicability Date.
(1) In general.
(2) Election to apply paragraph (b) to
earlier taxable years.
*****
§1.482–4 Methods to determine taxable
income in connection with a transfer of
intangible property.
*****
(f) * * *
(3) * * *
(i) * * *
(B) Cost sharing arrangements.
*****
(g) Coordination with rules governing
cost sharing arrangements.
(h) Effective/applicability date.
(1) In general.
(2) Election to apply regulation to ear-
lier taxable years.
*****
§1.482–7 Methods to determine taxable
income in connection with a cost sharing
arrangement.
(a) In general.
(1) RAB share method for cost sharing
transactions (CSTs).
(2) Methods for platform contribution
transactions (PCTs).
(3) Methods for other controlled trans-
actions.
(i) Contribution to a CSA by a con-
trolled taxpayer that is not a controlled par-
ticipant.
(ii) Transfer of interest in a cost shared
intangible.
(iii) Other controlled transactions in
connection with a CSA.
(iv) Controlled transactions in the ab-
sence of a CSA.
(4) Coordination with the arm’s length
standard.
(b) Cost sharing arrangement.
(1) Substantive requirements.
(i) CSTs.
(ii) PCTs.
(iii) Divisional interests.
(iv) Examples.
(2) Administrative requirements.
(3)DateofaPCT.
(4) Divisional interests.
(i) In general.
(ii) Territorial based divisional inter-
ests.
(iii) Field of use based divisional inter-
ests.
(iv) Other divisional bases.
(v) Examples.
(5) Treatment of certain arrangements
as CSAs.
(i) Situation in which Commissioner
must treat arrangement as a CSA.
(ii) Situation in which Commissioner
may treat arrangement as a CSA.
(iii) Examples.
(6) Entity classification of CSAs.
(c) Platform contributions.
(1) In general.
(2) Terms of platform contributions.
(i) Presumed to be exclusive.
(ii) Rebuttal of Exclusivity.
(iii) Proration of PCT Payments to the
extent allocable to other business activi-
ties.
(A) In general.
(B) Determining the proration of PCT
Payments.
(3) Categorization of the PCT.
(4) Certain make-or-sell rights ex-
cluded.
(i) In general.
(ii) Examples.
(5) Examples.
(d) Intangible development costs.
(1) Determining whether costs are
IDCs.
(i) Definition and scope of the IDA.
(ii) Reasonably anticipated cost shared
intangible.
(iii) Costs included in IDCs.
(iv) Examples.
(2)Allocationofcosts.
(3) Stock-based compensation.
(i) In general.
(ii) Identification of stock-based com-
pensation with the IDA.
(iii) Measurement and timing of stock-
based compensation IDC.
(A) In general.
(1) Transfers to which section 421 ap-
plies.
(2) Deductions of foreign controlled
participants.
(3) Modification of stock option.
(4
) Expiration or termination of CSA.
(B) Election with respect to options on
publicly traded stock.
(1) In general.
(2) Publicly traded stock.
(3) Generally accepted accounting prin-
ciples.
(4) Time and manner of making the
election.
(C) Consistency.
(4) IDC share.
(5) Examples.
(e) Reasonably anticipated benefits
share.
(1) Definition.
(i) In general.
(ii) Reliability.
(iii) Examples.
(2) Measure of benefits.
(i) In general.
(ii) Indirect bases for measuring antici-
pated benefits.
(A) Units used, produced, or sold.
(B) Sales.
2012–12 I.R.B.506March 19, 2012

(C) Operating profit.
(D) Other bases for measuring antici-
pated benefits.
(E) Examples.
(iii) Projections used to estimate bene-
fits.
(A) In general.
(B) Examples.
(f) Changes in participation under a
CSA.
(1) In general.
(2) Controlled transfer of interests.
(3) Capability variation.
(4) Arm’s length consideration for a
change in participation.
(5) Examples.
(g) Supplemental guidance on methods
applicable to PCTs.
(1) In general.
(2) Best method analysis applicable for
evaluation of a PCT pursuant to a CSA.
(i) In general.
(ii) Consistency with upfront contrac-
tual terms and risk allocation – the investor
model.
(A) In general.
(B) Example.
(iii) Consistency of evaluation with re-
alistic alternatives.
(A) In general.
(B) Examples.
(iv) Aggregation of transactions.
(v) Discount rate.
(A) In general.
(B) Considerations in best method anal-
ysis of discount rate.
(1) Discount rate variation between re-
alistic alternatives.
(2)[Reserved].
(3) Discount rate variation between
forms of payment.
(4) Post-tax rate.
(C) Example.
(vi) Financial projections.
(vii) Accounting principles.
(A) In general.
(B) Examples.
(viii) Valuations of subsequent PCTs.
(A) Date of subsequent PCT.
(B) Best method analysis for subse-
quent PCT.
(ix) Arm’s length range.
(A) In general.
(B) Methods based on two or more in-
put parameters.
(C) Variable input parameters.
(D) Determination of arm’s length PCT
Payment.
(1) No variable input parameters.
(2) One variable input parameter.
(3) More than one variable input param-
eter.
(E) Adjustments.
(x) Valuation undertaken on a pre-tax
basis.
(3) Comparable uncontrolled transac-
tion method.
(4) Income method.
(i) In general.
(A) Equating cost sharing and licensing
alternatives.
(B) Cost sharing alternative.
(C) Licensing alternative.
(D) Only one controlled participant
with nonroutine platform contributions.
(E) Income method payment forms.
(F) Discount rates appropriate to cost
sharing and licensing alternatives.
(G) The effect of taxation on determin-
ing the arm’s length amount.
(ii) Evaluation of PCT Payor’s cost
sharing alternative.
(iii) Evaluation of PCT Payor’s licens-
ing alternative.
(A) Evaluation based on CUT.
(B) Evaluation based on CPM.
(iv) Lump sum payment form.
(v) [Reserved].
(vi) Best method analysis considera-
tions.
(A) Coordination with §1.482–1(c).
(B) Assumptions Concerning Tax
Rates.
(C) Coordination with §1.482–4(c)(2).
(D) Coordination with §1.482–5(c).
(E) Certain Circumstances Concerning
PCT Payor.
(F) Discount rates.
(1) Reflection of similar risk profiles
of cost sharing alternative and licensing
alternative.
(2) [Reserved].
(vii) Routine platform and operating
contributions.
(viii) Examples.
(5) Acquisition Price Method.
(i) In general.
(ii) Determination of arm’s length
charge.
(iii) Adjusted acquisition price.
(iv) Best method analysis considera-
tions.
(v) Example.
(6) Market capitalization method.
(i) In general.
(ii) Determination of arm’s length
charge.
(iii) Average market capitalization.
(iv) Adjusted average market capital-
ization.
(v) Best method analysis considera-
tions.
(vi) Examples.
(7) Residual profit split method.
(i) In general.
(ii) Appropriate share of profits and
losses.
(iii) Profit split.
(A) In general.
(B) Determine nonroutine residual divi-
sional profit or loss.
(C) Allocate nonroutine residual divi-
sional profit or loss.
(1) In general.
(
2) Relative value determination.
(3) Determination of PCT Payments.
(4) Routine platform and operating con-
tributions.
(iv) Best method analysis considera-
tions.
(A) In general.
(B) Comparability.
(C) Data and assumptions.
(D) Other factors affecting reliability.
(v) Examples.
(8) Unspecified methods.
(h)Formofpaymentrules.
(1) CST Payments.
(2) PCT Payments.
(i) In general.
(ii) No PCT Payor stock.
(iii) Specified form of payment.
(A) In general.
(B) Contingent payments.
(C) Examples.
(iv) Conversion from fixed to contin-
gent form of payment.
(3) Coordination of best method rule
and form of payment.
(i) Allocations by the Commissioner in
connection with a CSA.
(1) In general.
(2) CST allocations.
(i) In general.
(ii) Adjustments to improve the relia-
bility of projections used to estimate RAB
shares.
(A) Unreliable projections.
(B) Foreign-to-foreign adjustments.
(C) Correlative adjustments to PCTs.
(D) Examples.
(iii) Timing of CST allocations.
(3) PCT allocations.
March 19, 20125072012–12 I.R.B.

(4) Allocations regarding changes in
participation under a CSA.
(5) Allocations when CSTs are consis-
tently and materially disproportionate to
RAB shares.
(6) Periodic adjustments.
(i) In general.
(ii) PRRR.
(iii) AERR.
(A) In general.
(B) PVTP.
(C) PVI.
(iv) ADR.
(A) In general.
(B) Publicly traded companies.
(C) Publicly traded.
(D) PCT Payor WACC.
(E) Generally accepted accounting
principles.
(v) Determination of periodic adjust-
ments.
(A) In general.
(B)AdjustedRPSMasofDetermina-
tion Date.
(vi) Exceptions to periodic adjustments.
(A) Controlled participants establish
periodic adjustment not warranted.
(1) Transactions involving the same
platform contribution as in the Trigger
PCT.
(2) Results not reasonably anticipated.
(3) Reduced AERR does not cause Pe-
riodic Trigger.
(4) Increased AERR does not cause Pe-
riodic Trigger.
(B) Circumstances in which Periodic
Trigger deemed not to occur.
(1) 10-year period.
(2) 5-year period.
(vii) Examples.
(j) Definitions and special rules.
(1) Definitions.
(i) In general.
(ii) Examples.
(2) Special rules.
(i) Consolidated group.
(ii) Trade or business.
(iii) Partnership.
(3) Character.
(i) CST Payments.
(ii) PCT Payments.
(iii) Examples.
(k) CSA administrative requirements.
(1) CSA contractual requirements.
(i) In general.
(ii) Contractual provisions.
(iii) Meaning of contemporaneous.
(A) In general.
(B) Example.
(iv) Interpretation of contractual provi-
sions.
(A) In general.
(B) Examples.
(2) CSA documentation requirements.
(i) In general.
(ii) Additional CSA documentation re-
quirements.
(iii) Coordination rules and production
of documents.
(A) Coordination with penalty regula-
tions.
(B) Production of documentation.
(3) CSA accounting requirements.
(i) In general.
(ii) Reliance on financial accounting.
(4) CSA reporting requirements.
(i) CSA Statement.
(ii) Content of CSA Statement.
(iii) Time for filing CSA Statement.
(A) 90-day rule.
(B) Annual return requirement.
(1) In general.
(2) Special filing rule for annual return
requirement.
(iv) Examples.
(l) Effective/applicability date.
(m) Transition rule.
(1) In general.
(2) Transitional modification of appli-
cable provisions.
(3) Special rule for certain periodic ad-
justments.
*****
§1.482–9 Methods to determine taxable
income in connection with a controlled
services transaction.
*****
(m) * * *
(3) Coordination with rules governing
cost sharing arrangements.
*****
(n) Effective/applicability dates.
§1.482–0T [Removed]
Par. 5. Section 1.482–0T is removed.
Par. 6. Section 1.482–1 is amended by:
1. Revising paragraph (b)(2)(i) and the
last sentence in paragraph (c)(1).
2. Adding a new paragraph (b)(2)(iii).
3. Adding a new sentence to the end of
paragraph (j)(6)(i).
The additions and revisions read as fol-
lows:
§1.482–1 Allocation of income and
deductions among taxpayers.
*****
(b) * * *
(2)Arm’s length methods—(i)Meth-
ods. Sections 1.482–2 through 1.482–7
and 1.482–9 provide specific methods
to be used to evaluate whether transac-
tions between or among members of the
controlled group satisfy the arm’s length
standard, and if they do not, to deter-
mine the arm’s length result. This section
provides general principles applicable in
determining arm’s length results of such
controlled transactions, but do not pro-
vide methods, for which reference must
be made to those other sections in accor-
dance with paragraphs (b)(2)(ii) and (iii)
of this section. Section 1.482–7 provides
the specific methods to be used to eval-
uate whether a cost sharing arrangement
as defined in §1.482–7 produces results
consistent with an arm’s length result.
*****
(iii)Coordination of methods appli-
cable to certain intangible development
arrangements. Section 1.482–7 provides
the specific methods to be used to deter-
mine arm’s length results of controlled
transactions in connection with a cost shar-
ing arrangement as defined in §1.482–7.
Sections 1.482–4 and 1.482–9, as appro-
priate, provide the specific methods to be
used to determine arm’s length results of
arrangements, including partnerships, for
sharing the costs and risks of developing
intangibles, other than a cost sharing ar-
rangement covered by §1.482–7. See also
§§1.482–4(g) (Coordination with rules
governing cost sharing arrangements) and
1.482–9(m)(3) (Coordination with rules
governing cost sharing arrangements).
*****
(c) * * *
(1) * * * See §1.482–7 for the applica-
ble methods in the case of a cost sharing
arrangement.
*****
(j) * * *
(6) * * *
(i) * * * The provision of paragraph
(b)(2)(iii) of this section is generally appli-
cable on January 5, 2009.
*****
2012–12 I.R.B.508March 19, 2012

§1.482–1T [Removed]
Par. 7. Section 1.482–1T is removed.
Par. 8. Section 1.482–2 is amended by
revising paragraphs (e) and (f) to read as
follows:
§1.482–2 Determination of taxable
income in specific situations.
*****
(e)Cost sharing arrangement.For
rules governing allocations under section
482 to reflect an arm’s length considera-
tion for controlled transactions involving
a cost sharing arrangement, see §1.482–7.
(f)Effective/applicability date—(1)In
general. The provision of paragraph (b) of
this section is generally applicable for tax-
able years beginning after December 31,
2006. The provision of paragraph (e) of
this section is generally applicable on Jan-
uary 5, 2009.
(2)Election to apply paragraph (b)
to earlier taxable years.Apersonmay
elect to apply the provisions of paragraph
(b) of this section to earlier taxable years
in accordance with the rules set forth in
§1.482–9(n)(2).
§1.482–2T [Removed]
Par. 9. Section 1.482–2T is removed.
Par. 10. Section 1.482–4 is amended as
follows
1. Paragraphs (f)(3)(i)(B), (g) and (h)
are revised.
2. Paragraph (f)(7) is removed.
The revisions read as follows:
§1.482–4 Methods to determine taxable
income in connection with a transfer of
intangible property.
*****
(f) * * *
(3) * * *
(i) * * *
(B)Cost sharing arrangements.The
rules in this paragraph (f)(3) regarding
ownership with respect to cost shared in-
tangibles and cost sharing arrangements
will apply only as provided in §1.482–7.
*****
(g)Coordination with rules govern-
ing cost sharing arrangements. Section
1.482–7 provides the specific methods to
be used to determine arm’s length results
of controlled transactions in connection
with a cost sharing arrangement. This sec-
tion provides the specific methods to be
used to determine arm’s length results of
a transfer of intangible property, including
in an arrangement for sharing the costs
and risks of developing intangibles other
than a cost sharing arrangement covered
by §1.482–7. In the case of such an ar-
rangement, consideration of the principles,
methods, comparability, and reliability
considerations set forth in §1.482–7 is
relevant in determining the best method,
including an unspecified method, under
this section, as appropriately adjusted in
light of the differences in the facts and
circumstances betweensuch arrangement
and a cost sharing arrangement.
(h)Effective/applicability date—(1)In
general. Except as provided in the suc-
ceeding sentence, the provisions of para-
graphs (f)(3) and (4) of this section are
generally applicable for taxable years be-
ginning after December 31, 2006. The pro-
visions of paragraphs (f)(3)(i)(B) and (g)
of this section are generally applicable on
January 5, 2009.
(2)Election to apply regulation to ear-
lier taxable years. A person may elect to
apply the provisions of paragraphs (f)(3)
and (4) of this section to earlier taxable
years in accordance with the rules set forth
in §1.482–9(n)(2).
§1.482–4T [Removed].
Par. 11. Section 1.482–4T is removed.
Par. 12. Section 1.482–5 is amended
by revising the last sentence of paragraph
(c)(2)(iv) to read as follows:
§1.482–5 Comparable profits method.
*****
(c) * * *
(2) * * *
(iv)***Asanotherexample,itmaybe
appropriate to adjust the operating profit
of a party to account for material differ-
ences in the utilization of or accounting for
stock-based compensation (as defined by
§1.482–7(d)(3)(i)) among the tested party
and comparable parties.
*****
Par. 13. Section 1.482–7 is added to
read as follows:
§1.482–7 Methods to determine taxable
income in connection with a cost sharing
arrangement.
(a)In general. The arm’s length
amount charged in a controlled transaction
reasonably anticipated to contribute to
developing intangibles pursuant to a cost
sharing arrangement (CSA), as described
in paragraph (b) of this section, must be
determined under a method described in
this section. Each method must be ap-
plied in accordance with the provisions of
§1.482–1, except as those provisions are
modified in this section.
(1)RAB share method for cost shar-
ing transactions (CSTs). See paragraph
(b)(1)(i) of this section regarding the re-
quirement that controlled participants, as
defined in section (j)(1)(i) of this section,
share intangible development costs (IDCs)
in proportion to their shares of reason-
ably anticipated benefits (RAB shares)
by entering into cost sharing transactions
(CSTs).
(2)Methods for platform contribution
transactions (PCTs). The arm’s length
amount charged in a platform contribu-
tion transaction (PCT) described in para-
graph (b)(1)(ii) of this section must be de-
termined under the method or methods ap-
plicable under the other section or sections
of the section 482 regulations, as supple-
mented by paragraph (g) of this section.
See §1.482–1(b)(2)(ii) (Selection of cate-
gory of method applicable to transaction),
§1.482–1(b)(2)(iii) (Coordination of meth-
ods applicable to certain intangible devel-
opment arrangements), and paragraph (g)
of this section (Supplemental guidance on
methods applicable to PCTs).
(3)Methods for other controlled trans-
actions—(i)Contribution to a CSA by a
controlled taxpayer that is not a controlled
participant. If a controlled taxpayer that
is not a controlled participant contributes
to developing a cost shared intangible, as
defined in section (j)(1)(i) of this section,
it must receive consideration from the
controlled participants under the rules of
§1.482–4(f)(4) (Contribution to the value
of an intangible owned by another). Such
consideration will be treated as an intan-
gible development cost for purposes of
paragraph (d) of this section.
(ii)Transfer of interest in a cost shared
intangible. If at any time (during the term,
or upon or after the termination, of a CSA)
March 19, 20125092012–12 I.R.B.

a controlled participant transfers an inter-
est in a cost shared intangible to another
controlled taxpayer, the controlled partici-
pant must receive an arm’s length amount
of consideration from the transferee under
the rules of §§1.482–4 through 1.482–6 as
supplemented by paragraph (f)(4) of this
section regarding arm’s length considera-
tion for a change in participation. For this
purpose, a capability variation described in
paragraph (f)(3) of this section is consid-
ered to be a controlled transfer of interests
in cost shared intangibles.
(iii)Other controlled transactions
in connection with a CSA. Controlled
transactions between controlled partici-
pants that are not PCTs or CSTs and are
not described in paragraph (a)(3)(ii) of
this section (for example, provision of a
cross operating contribution, as defined
in paragraph (j)(1)(i) of this section, or
make-or-sell rights, as defined in para-
graph (c)(4) of this section) require arm’s
length consideration under the rules of
§§1.482–1 through 1.482–6, and 1.482–9
as supplemented by paragraph (g)(2)(iv)
of this section.
(iv)Controlled transactions in the ab-
sence of a CSA. If a controlled transac-
tion is reasonably anticipated to contribute
to developing intangibles pursuant to an
arrangement that is not a CSA described
in paragraph (b)(1) or (5) of this section,
whether the results of any such controlled
transaction are consistent with an arm’s
length result must be determined under the
applicable rules of the other sections of
the regulations under section 482. For
example, an arrangement for developing
intangibles in which one controlled tax-
payer’s costs of developing the intangi-
bles significantly exceeds its share of rea-
sonably anticipated benefits from exploit-
ing the developed intangibles would not in
substance be a CSA, as described in para-
graphs (b)(1)(i) through (iii) of this sec-
tion or paragraph (b)(5)(i) of this section.
In such a case, unless the rules of this
section are applicable by reason of para-
graph (b)(5) of this section, the arrange-
ment must be analyzed under other appli-
cable sections of regulations under section
482 to determine whether it achieves arm’s
length results, and if not, to determine any
allocations by the Commissioner that are
consistent with such other regulations un-
der section 482. See §1.482–1(b)(2)(ii)
(Selection of category of method applica-
ble to transaction) and (iii) (Coordination
of methods applicable to certain intangible
development arrangements).
(4)Coordination with the arm’s length
standard. A CSA produces results that
are consistent with an arm’s length result
within the meaning of §1.482–1(b)(1) if,
and only if, each controlled participant’s
IDC share (as determined under paragraph
(d)(4) of this section) equals its RAB
share, each controlled participant com-
pensates its RAB share of the value of all
platform contributions by other controlled
participants, and all other requirements of
this section are satisfied.
(b)Cost sharing arrangement.Acost
sharing arrangement is an arrangement
by which controlled participants share the
costs and risks of developing cost shared
intangibles in proportion to their RAB
shares. An arrangement is a CSA if and
only if the requirements of paragraphs
(b)(1) through (4) of this section are met.
(1)Substantive requirements–(i)CSTs.
All controlled participants must commit to,
and in fact, engage in cost sharing transac-
tions. In CSTs, the controlled participants
make payments to each other (CST Pay-
ments) as appropriate, so that in each tax-
able year each controlled participant’s IDC
share is in proportion to its respective RAB
share.
(ii)PCTs. All controlled participants
must commit to, and in fact, engage in
platform contributions transactions to the
extent that there are platform contributions
pursuant to paragraph (c) of this section.
In a PCT, each other controlled participant
(PCT Payor) is obligated to, and must in
fact, make arm’s length payments (PCT
Payments) to each controlled participant
(PCT Payee) that provides a platform con-
tribution. For guidance on determining
such arm’s length obligation, see para-
graph (g) of this section.
(iii)Divisional interests.Each
controlled participant must receive a
non-overlapping interest in the cost shared
intangibles without further obligation to
compensate another controlled participant
for such interest.
(iv)Examples. The following examples
illustrate the principles of this paragraph
(b)(1):
Example 1. Company A and Company B, who
are members of the same controlled group, execute
an agreement to jointly develop Vaccine X and own
the exclusive rights to commercially exploit Vaccine
X in their respective territories, which together com-
prise the whole world. The agreement provides that
they will share some, but not all, of the costs for
developing Vaccine X in proportion to RAB share.
Such agreement is nota CSA because Company A
and Company B have not agreed to share all of the
IDCs in proportion to their respective RAB shares.
Example 2. Company A and Company B agree
to share all the costs of developing Vaccine X. The
agreement also provides for employing certain re-
sources and capabilities of Company A in this pro-
gram including a skilled research team and certain
research facilities, and provides for Company B to
make payments to Company A in this respect. How-
ever, the agreement expressly provides that the pro-
gram will not employ, and so Company B is expressly
relieved of the payments in regard to, certain software
developed by Company A as a medical research tool
to model certain cellular processes expected to be im-
plicated in the operation of Vaccine X even though
such software would reasonably be anticipated to be
relevant to developing Vaccine X and, thus, would be
a platform contribution. See paragraph (c) of this sec-
tion. Such agreement is not a CSA because Company
A and Company B have not engaged in a necessary
PCT for purposes of developing Vaccine X.
Example 3. Companies C and D, who are mem-
bers of the same controlled group, enter into a CSA.
In the first year of the CSA, C and D conduct the in-
tangible development activity, as described in para-
graph (d)(1) of this section. The total IDCs in re-
gard to such activity are $3,000,000 of which C and
D pay $2,000,000 and $1,000,000, respectively, di-
rectly to third parties. As between C and D, how-
ever, their CSA specifies that they will share all IDCs
in accordance with their RAB shares (as described
in paragraph (e)(1) of this section), which are 60%
for C and 40% for D. It follows that C should bear
$1,800,000 of the total IDCs (60% of total IDCs of
$3,000,000) and D should bear $1,200,000 of the total
IDCs (40% of total IDCs of $3,000,000). D makes a
CST payment to C of $200,000, that is, the amount by
which D’s share of IDCs in accordance with its RAB
share exceeds the amount of IDCs initially borne by
D ($1,200,000 – $1,000,000), and which also equals
the amount by which the total IDCs initially borne by
C exceeds its share of IDCS in accordance with its
RAB share ($2,000,000 - $1,800,000). As a result of
D’s CST payment to C, the IDC shares of C and D are
in proportion to their respective RAB shares.
(2)Administrative requirements.The
CSA must meet the requirements of para-
graph (k) of this section.
(3)Date of a PCT. The controlled par-
ticipants must enter into a PCT as of the
earliest date on or after the CSA is entered
into on which a platform contribution is
reasonably anticipated to contribute to de-
veloping cost shared intangibles.
(4)Divisional interests—(i)In general.
Pursuant to paragraph (b)(1)(iii) of this
section, each controlled participant must
receive a non-overlapping interest in the
cost shared intangibles without further
obligation to compensate another con-
trolled participant for such interest. Each
2012–12 I.R.B.510March 19, 2012

controlled participant must be entitled to
the perpetual and exclusive right to the
profits from transactions of any member
of the controlled group that includes the
controlled participant with uncontrolled
taxpayers to the extent that such profits
are attributable to such interest in the cost
shared intangibles.
(ii)Territorial based divisional inter-
ests. The CSA may divide all interests
in cost shared intangibles on a territorial
basis as follows. The entire world must be
divided into two or more non-overlapping
geographic territories. Each controlled
participant must receive at least one such
territory, and in the aggregate all the par-
ticipants must receive all such territories.
Each controlled participant will be as-
signed the perpetual and exclusive right to
exploit the cost shared intangibles through
the use, consumption, or disposition of
property or services in its territories. Thus,
compensation will be required if other
members of the controlled group exploit
the cost shared intangibles in such terri-
tory.
(iii)Field of use based divisional inter-
ests. The CSA may divide all interests in
cost shared intangibles on the basis of all
uses (whether or not known at the time of
the division) to which cost shared intangi-
bles are to be put as follows. All antici-
pated uses of cost shared intangibles must
be identified. Each controlled participant
must be assigned at least one such antici-
pated use, and in the aggregate all the par-
ticipants must be assigned all such antic-
ipated uses. Each controlled participant
will be assigned the perpetual and exclu-
sive right to exploit the cost shared intan-
gibles through the use or uses assigned to it
and one controlled participant must be as-
signed the exclusive and perpetual right to
exploit cost shared intangibles through any
unanticipated uses.
(iv)Other divisional bases.(A)Inthe
event that the CSA does not divide inter-
ests in the cost shared intangibles on the
basis of exclusive territories or fields of
use as described in paragraphs (b)(4)(ii)
and (iii) of this section, the CSA may
adopt some other basis on which to divide
all interests in the cost shared intangibles
among the controlled participants, pro-
vided that each of the following criteria is
met:
(1) The basis clearly and unambigu-
ously divides all interests in cost shared
intangibles among the controlled partici-
pants.
(2) The consistent use of such basis
for the division of all interests in the cost
shared intangibles can be dependably ver-
ified from the records maintained by the
controlled participants.
(3) The rights of the controlled partici-
pants to exploit cost shared intangibles are
non-overlapping, exclusive, and perpetual.
(4) The resulting benefits associated
with each controlled participant’s interest
in cost shared intangibles are predictable
with reasonable reliability.
(B) See paragraph (f)(3) of this sec-
tion for rules regarding the requirement
of arm’s length consideration for changes
in participation in CSAs involving divi-
sions of interest described in this para-
graph (b)(4)(iv).
(v)Examples. The following examples
illustrate the principles of this paragraph
(b)(4):
Example 1. Companies P and S, both members
of the same controlled group, enter into a CSA to de-
velop product Z. Under the CSA, P receives the in-
terest in product Z in the United States and S receives
the interest in product Z in the rest of the world, as
described in paragraph (b)(4)(ii) of this section. Both
P and S have plants for manufacturing product Z lo-
cated in their respective geographic territories. How-
ever, for commercial reasons, product Z is neverthe-
less manufactured by P in the United States for sale to
customers in certain locations just outside the United
States in close proximity to P’s U.S. manufacturing
plant. Because S owns the territorial rights outside
the United States, P must compensate S to ensure that
S realizes all the cost sharedintangible profits from
P’s sales of product Z in S’s territory. The pricing
of such compensation must also ensure that P real-
izes an appropriate return for its manufacturing ef-
forts. Benefits projected with respect to such sales
will be included for purposes of estimating S’s, but
not P’s, RAB share.
Example 2. The facts are the same as inExam-
ple 1except that P and S agree to divide their inter-
est in product Z based on site of manufacturing. P
will have exclusive and perpetual rights in product
Z manufactured in facilities owned by P. S will have
exclusive and perpetual rights to product Z manufac-
tured in facilities owned by S. P and S agree that nei-
ther will license manufacturingrightsinproductZto
any related or unrelated party. Both P and S maintain
books and records that allow production at all sites
to be verified. Both own facilities that will manu-
facture product Z and the relative capacities of these
sites are known. All facilities are currently operating
at near capacity and are expected to continue to oper-
ate at near capacity when product Z enters production
so that it will not be feasible to shift production be-
tween P’s and S’s facilities. P and S have no plans
to build new facilities and the lead time required to
plan and build a manufacturing facility precludes the
possibility that P or S will build a new facility during
the period for which sales of Product Z are expected.
Based on these facts, this basis for the division of in-
terests in Product Z is a division described in para-
graph (b)(4)(iv) of this section. The basis for the di-
vision of interest is unambiguous and clearly defined
and its use can be dependably verified. P and S both
have non-overlapping, exclusive and perpetual rights
in Product Z. The division of interest results in the
participant’s relative benefits being predictable with
reasonable reliability.
Example 3.ThefactsarethesameasinExample
2except that P’s and S’s manufacturing facilities are
not expected to operate at full capacity when product
Z enters production. Production of Product Z can be
shifted at any time between sites owned by P and sites
owned by S, although neither P nor S intends to shift
production as a result of the agreement. The division
of interests in Product Z between P and S based on
manufacturing site is not a division described in para-
graph (b)(4)(iv) of this section because their relative
shares of benefits are not predictable with reasonable
reliability. The fact that neither P nor S intends to
shift production is irrelevant.
(5)Treatment of certain arrangements
as CSAs—(i)Situation in which Commis-
sioner must treat arrangement as a CSA.
The Commissioner must apply the rules of
this section to an arrangement among con-
trolled taxpayers if the administrative re-
quirements of paragraph (b)(2) of this sec-
tion are met with respect to such arrange-
ment and the controlled taxpayers reason-
ably concluded that such arrangement was
a CSA meeting the requirements of para-
graphs (b)(1), (3), and (4) of this section.
(ii)SituationinwhichCommissioner
may treat arrangement as a CSA.Forar-
rangements among controlled taxpayers
not described in paragraph (b)(5)(i) of this
section, the Commissioner may apply the
provisions of this section if the Commis-
sioner concludes that the administrative
requirements of paragraph (b)(2) of this
section are met, and, notwithstanding
technical failure to meet the substantive
requirements of paragraph (b)(1), (3), or
(4) of this section, the rules of this section
will provide the most reliable measure of
an arm’s length result. See §1.482–1(c)(1)
(the best method rule). For purposes of
applying this paragraph (b)(5)(ii), any
such arrangement shall be interpreted by
reference to paragraph (k)(1)(iv) of this
section.
(iii)Examples. The following examples
illustrate the principles of this paragraph
(b)(5). In the examples, assume that Com-
panies P and S are both members of the
same controlled group.
Example 1. (i) P owns the patent on a formula for
a capsulated pain reliever, P-Cap. P reasonably antic-
ipates, pending further research and experimentation,
that the P-Cap formula could form the platform for a
March 19, 20125112012–12 I.R.B.

formula for P-Ves, an effervescent version of P-Cap.
P also owns proprietary software that it reasonably
anticipates to be critical to the research efforts. P and
S execute a contract that purports to be a CSA by
which they agree to proportionally share the costs and
risks of developing a formula for P-Ves. The agree-
ment reflects the various contractual requirements de-
scribed in paragraph (k)(1) of this section and P and
S comply with the documentation, accounting, and
reporting requirements of paragraphs (k)(2) through
(4) of this section. Both the patent rights for P-Cap
and the software are reasonably anticipated to con-
tribute to the development of P-Ves and therefore are
platform contributions for which compensation is due
from S as part of PCTs. Though P and S enter into and
implement a PCT for the P-Cap patent rights that sat-
isfies the arm’s length standard, they fail to enter into
a PCT for the software.
(ii) In this case, P and S have substantially com-
plied with the contractual requirements of paragraph
(k)(1) of this section and the documentation, account-
ing, and reporting requirements of paragraphs (k)(2)
through (4) of this section and therefore have met the
administrative requirements of paragraph (b)(2) of
this section. However, because they did not enter into
a PCT, as required under paragraphs (b)(1)(ii) and
(b)(3) of this section, for the software that was rea-
sonably anticipated to contribute to the development
of P-Ves (see paragraph (c) of this section), they can-
not reasonably conclude that their arrangement was a
CSA. Accordingly, the Commissioner is not required
under paragraph (b)(5)(i) of this section to apply the
rules of this section to their arrangement.
(iii) Nevertheless, the arrangement between P and
S closely resembles a CSA. If the Commissioner con-
cludes that the rules of this section provide the most
reliable measure of an arm’s length result for such ar-
rangement, then pursuant to paragraph (b)(5)(ii) of
this section, the Commissioner may apply the rules
of this section and treat P and S as entering into a
PCT for the software in accordance with the require-
ments of paragraph (b)(1)(ii) of this section, and make
any appropriate allocations under paragraph (i) of this
section. Alternatively, the Commissioner may con-
clude that the rules of this section do not provide the
most reliable measure of an arm’s length result. In
such case, the arrangement would be analyzed under
the methods under other sections of the 482 regula-
tions to determine whether the arrangement reaches
an arm’s length result.
Example 2. The facts are the same as inExample
1except that P and S do enter into and implement a
PCT for the software as required under this paragraph
(b). The Commissioner determines that the PCT Pay-
ments for the software were not arm’s length; never-
theless, under the facts and circumstances at the time
they entered into the CSA and PCTs, P and S rea-
sonably concluded their arrangement to be a CSA.
Because P and S have met the requirements of para-
graph (b)(2) of this section and reasonably concluded
their arrangement is a CSA, pursuant to paragraph
(b)(5)(i) of this section, the Commissioner must ap-
ply the rules of this section to their arrangement. Ac-
cordingly, the Commissioner treats the arrangement
as a CSA and makes adjustments to the PCT Pay-
ments as appropriate under this section to achieve an
arm’s length result for the PCT for the software.
Example 3. (i)ThefactsarethesameasinEx-
ample 1except that P and S do enter into a PCT for
the software as required under this paragraph (b). The
agreement entered into by P and S provides for a fixed
consideration of $50 million per year for four years,
payable at the end of each year. This agreement sat-
isfies the arm’s length standard. However, S actually
pays P consideration at the end of each year in the
form of four annual royalties equal to two percent of
sales. While such royalties at the time of the PCT
were expected to be $50 million per year, actual sales
during the first year were less than anticipated and the
first royalty payment was only $25 million.
(ii) In this case, P and S failed to implement the
terms of their agreement. Under these circumstances,
P and S could not reasonably conclude that their
arrangement was a CSA, as described in paragraph
(b)(1) of this section. Accordingly, the Commis-
sioner is not required under paragraph (b)(5)(i) of
this section to apply the rules of this section to their
arrangement.
(iii) Nevertheless, the arrangement between P
and S closely resembles a CSA. If the Commissioner
concludes that that the rules of this section provide
the most reliable measure of an arm’s length result
for such arrangement, then pursuant to paragraph
(b)(5)(ii) of this section, the Commissioner may
apply the rules of this section and make any appro-
priate allocations under paragraph (i) of this section.
Alternatively, the Commissioner may conclude that
the rules of this section do not provide the most
reliable measure of an arm’s length result. In such
case, the arrangement would be analyzed under the
methods under other sections of the 482 regulations
to determine whether the arrangement reaches an
arm’s length result.
Example 4. (i) The facts are the same as inExam-
ple 1except that P does not own proprietary software
and P and S use a method for determining the arm’s
length amount of the PCT Payment for the P-Cap
patent rights different from the method used inEx-
ample 1.
(ii) P and S determine that the arm’s length
amount of the PCT Payments for the P-Cap patent
is $10 million. However, the Commissioner deter-
mines the best method for determining the arm’s
length amount of the PCT Payments for the P-Cap
patent rights and under such method the arm’s length
amount is $100 million. To determine this $10 mil-
lion present value, P and S assumed a useful life of
eight years for the platform contribution, because
the P-Cap patent rights will expire after eight years.
However, the P-Cap patent rights are expected to
lead to benefits attributable to exploitation of the cost
shared intangibles extending many years beyond the
expiration of the P-Cap patent, because use of the
P-CappatentrightswillletPandSbringP-Vesto
market before the competition, and because P and
S expect to apply for additional patents covering
P-Ves, which would bar competitors from selling that
product for many future years. The assumption by
P and S of a useful life for the platform contribution
that is less than the anticipated period of exploitation
of the cost shared intangibles is contrary to paragraph
(g)(2)(ii) of this section, and reduces the reliability
ofthemethodusedbyPandS.
(iii) The method used by P and S employs a de-
clining royalty. The royalty starts at 8% of sales,
based on an application of the CUT method in which
the purported CUTs all involve licenses to manufac-
ture and sell the current generation of P-Cap, and de-
clines to 0% over eight years, declining by 1% each
year. Such make-or-sell rights are fundamentally dif-
ferent from use of the P-Cap patent rights to gener-
ate a new product. This difference raises the issue of
whether the make-or-sell rights are sufficiently com-
parable to the rights that are the subject of the PCT
Payment. See §1.482–4(c). While a royalty rate for
make-or-sell rights can form the basis for a reliable
determination of an arm’s length PCT Payment in the
CUT-based implementation of the income method
described in paragraph (g)(4) of this section, under
that method such royalty rate does not decline to zero.
Therefore, the use of a declining royalty rate based on
an initial rate for make-or-sell rights further reduces
the reliability of the method used by P and S.
(iv) Sales of the next-generation product are not
anticipated until after sevenyears, at which point the
royalty rate will have declined to 1%. The tempo-
ral mismatch between the period of the royalty rate
decline and the period of exploitation raises further
concerns about the method’s reliability.
(v) For the reasons given in paragraphs (ii)
through (iv) of thisExample 4, the method used by P
and S is so unreliable and so contrary to provisions
of this section that P and S could not reasonably
conclude that they had contracted to make arm’s
length PCT Payments as required by paragraphs
(b)(1)(ii) and (b)(3) of this section, and thus could
not reasonably conclude that their arrangement was a
CSA. Accordingly, the Commissioner is not required
under paragraph (b)(5)(i) of this section to apply the
rules of this section to their arrangement.
(vi) Nevertheless, the arrangement between P
and S closely resembles a CSA. If the Commissioner
concludes that that the rules of this section provide
the most reliable measure of an arm’s length result
for such arrangement, then pursuant to paragraph
(b)(5)(ii) of this section, the Commissioner may ap-
ply the rules of this section and make any appropriate
allocations under paragraph (i) of this section. Al-
ternatively, the Commissioner may conclude that the
rules of this section do not provide the most reliable
measure of an arm’s length result. In such case, the
arrangement would be analyzed under the methods
under other section 482 regulations to determine
whether the arrangement reaches an arm’s length
result.
(6)Entity classification of CSAs.See
§301.7701–1(c) of this chapter for the clas-
sification of CSAs for purposes of the In-
ternal Revenue Code.
(c)Platform contributions–(1)In gen-
eral. A platform contribution is any re-
source, capability, or right that a controlled
participant has developed, maintained, or
acquired externally to the intangible devel-
opment activity (whether prior to or dur-
ing the course of the CSA) that is rea-
sonably anticipated to contribute to devel-
oping cost shared intangibles. The deter-
mination whether a resource, capability,
or right is reasonably anticipated to con-
tribute to developing cost shared intangi-
bles is ongoing and based on the best avail-
able information. Therefore, a resource,
2012–12 I.R.B.512March 19, 2012

capability, or right reasonably determined
not to be a platform contribution as of an
earlier point in time, may be reasonably de-
termined to be a platform contribution at
a later point in time. The PCT obligation
regarding a resource or capability or right
once determined to be a platform contribu-
tion does not terminate merely because it
may later be determined that such resource
or capability or right has not contributed,
and no longer is reasonably anticipated to
contribute, to developing cost shared in-
tangibles. Notwithstanding the other pro-
visions of this paragraph (c), platform con-
tributions do not include rights in land or
depreciable tangible property, and do not
include rights in other resources acquired
by IDCs. See paragraph (d)(1) of this sec-
tion.
(2)Terms of platform contribu-
tions—(i)Presumed to be exclusive.For
purposes of a PCT, the PCT Payee’s provi-
sion of a platform contribution is presumed
to be exclusive. Thus, it is presumed that
the platform resource, capability, or right
is not reasonably anticipated to be com-
mitted to any business activities other than
the CSA Activity, as defined in paragraph
(j)(1)(i) of this section, whether carried
out by the controlled participants, other
controlled taxpayers,or uncontrolled tax-
payers.
(ii)Rebuttal of exclusivity.Thecon-
trolled participants may rebut the pre-
sumption set forth in paragraph (c)(2)(i)
of this section to the satisfaction of the
Commissioner. For example, if the plat-
form resource is a research tool, then the
controlled participants could rebut the
presumption by establishing to the satis-
faction of the Commissioner that, as of
the date of the PCT, the tool is reasonably
anticipated not only to contribute to the
CSA Activity but also to be licensed to an
uncontrolled taxpayer. In such case, the
PCT Payments may need to be prorated as
described in paragraph (c)(2)(iii) of this
section.
(iii)Proration of PCT Payments to
the extent allocable to other business ac-
tivities—(A)In general. Some transfer
pricing methods employed to determine
the arm’s length amount of the PCT Pay-
ments do so by considering the overall
value of the platform contributions as op-
posed to, for example, the value of the
anticipated use of theplatform contribu-
tions in the CSA Activity. Such a transfer
pricing method is consistent with the pre-
sumption that the platform contribution
is exclusive (that is, that the resources,
capabilities or rightsthat are the subject
of a platform contribution are reasonably
anticipated to contribute only to the CSA
Activity). See paragraph (c)(2)(i) (Terms
of platform contributions – Presumed to
be exclusive) of this section. The PCT
Payments determined under such transfer
pricingmethodmayhavetobeprorated
if the controlled participants can rebut the
presumption that the platform contribu-
tion is exclusive to the satisfaction of the
Commissioner as provided in paragraph
(c)(2)(ii) of this section. In the case of a
platform contributionthat also contributes
to lines of business of a PCT Payor that
are not reasonably anticipated to involve
exploitation of the cost shared intangibles,
the need for explicit proration may in some
cases be avoided through aggregation of
transactions. See paragraph (g)(2)(iv) of
this section (Aggregation of transactions).
(B)Determining the proration of PCT
Payments. Proration will be done on a
reasonable basis in proportion to the rel-
ative economic value, as of the date of
the PCT, reasonably anticipated to be de-
rived from the platform contribution by the
CSA Activity as compared to the value
reasonably anticipated to be derived from
the platform contribution by other busi-
ness activities. In the case of an aggre-
gate valuation done under the principles
of paragraph (g)(2)(iv) of this section that
addresses payment for resources, capabil-
ities, or rights used for business activities
other than the CSA Activity (for example,
the right to exploit an existing intangible
without further development), the prora-
tion of the aggregate payments may have
to reflect the economic value attributable
to such resources, capabilities, or rights
as well. For purposes of the best method
rule under §1.482–1(c), the reliability of
the analysis under a method that requires
proration pursuant to this paragraph is re-
duced relative to the reliability of an anal-
ysis under a method that does not require
proration.
(3)Categorization of the PCT. For pur-
poses of §1.482–1(b)(2)(ii) and paragraph
(a)(2) of this section, a PCT must be identi-
fied by the controlled participants as a par-
ticulartypeoftransaction(forexample,a
license for royalty payments). See para-
graph (k)(2)(ii)(H) of this section. Such
designation must be consistent with the ac-
tual conduct of the controlled participants.
If the conduct is consistent with different,
economically equivalent types of transac-
tions, then the controlled participants may
designate the PCT as being any of such
types of transactions. If the controlled
participants fail to make such designation
in their documentation, the Commissioner
may make a designation consistent with
the principles of paragraph (k)(1)(iv) of
this section.
(4)Certain make-or-sell rights ex-
cluded—(i)In general. Any right to
exploit an existing resource, capability, or
right without further development of such
item, such as the right to make, replicate,
license, or sell existing products, does
not constitute a platform contribution to
aCSA(andthearm’slengthcompensa-
tion for such rights (make-or-sell rights)
does not satisfy the compensation obli-
gation under a PCT) unless exploitation
without further development of such item
is reasonably anticipated to contribute to
developing or further developing a cost
shared intangible.
(ii)Examples. The following examples
illustrate the principles of this paragraph
(c)(4):
Example 1. P and S, which are members of the
same controlled group, execute a CSA. Under the
CSA, P and S will bear their RAB shares of IDCs
for developing the second generation of ABC, a com-
puter software program. Prior to that arrangement,
P had incurred substantial costs and risks to develop
ABC. Concurrent with entering into the arrangement,
P (as the licensor) executes a license with S (as the li-
censee) by which S may make and sell copies of the
existing ABC. Such make-or-sell rights do not consti-
tute a platform contribution to the CSA. The rules of
§§1.482–1 and 1.482–4 through 1.482–6 must be ap-
plied to determine the arm’s length consideration in
connection with the make-or-sell licensing arrange-
ment. In certain circumstances, this determination
of the arm’s length consideration may be done on
an aggregate basis with the evaluation of compensa-
tion obligations pursuant to the PCTs entered into by
P and S in connection with the CSA. See paragraph
(g)(2)(iv) of this section.
Example 2. (i) P, a software company, has devel-
oped and currently exploits software program ABC.
P and S enter into a CSA to develop future genera-
tions of ABC. The ABC source code is the platform
on which future generations of ABC will be built and
is therefore a platform contribution of P for which
compensation is due from S pursuant to a PCT. Con-
current with entering into the CSA, P licenses to S the
make-or-sell rights for the current version of ABC.
P has entered into similar licenses with uncontrolled
parties calling for sales-based royalty payments at a
rate of 20%. The current version of ABC has an ex-
pected product life of three years. P and S enter into
March 19, 20125132012–12 I.R.B.

a contingent payment agreement to cover both the
PCT Payments due from S for P’s platform contri-
bution and payments due from S for the make-or-sell
license. Based on the uncontrolled make-or-sell li-
censes, P and S agree on a sales-based royalty rate of
20% in Year 1 that declines on a straight line basis to
0% over the 3 year product life of ABC.
(ii) The make-or-sell rights for the current version
of ABC are not platform contributions, though para-
graph (g)(2)(iv) of this section provides for the possi-
bility that the most reliable determination of an arm’s
length charge for the platform contribution and the
make-or-sell license may be one that values the two
transactions in the aggregate. A contingent payment
schedule based on the uncontrolled make-or-sell li-
censes may provide an arm’s length charge for the
separate make-or-sell license between P and S, pro-
vided the royalty rates in the uncontrolled licenses
similarly decline, but as a measure of the aggregate
PCT and licensing payments it does not account for
the arm’s length value of P’s platform contributions
which include the rights in the source code and future
development rights in ABC.
Example 3. S is a controlled participant that owns
Patent Q, which protects S’s use of a research tool that
is helpful in developing and testing new pharmaceuti-
cal compounds. The research tool, which is not itself
such a compound, is used in the CSA Activity to de-
velop such compounds. However, the CSA Activity
is not anticipated to result in the further development
of the research tool or in patents based on Patent Q.
Although the right to use Patent Q is not anticipated
to result in the further development of Patent Q or
the technology that it protects, that right constitutes
a platform contribution (as opposed to make-or-sell
rights) because it is anticipated to contribute to the re-
search activity to develop cost shared intangibles re-
lating to pharmaceutical compounds covered by the
CSA.
(5)Examples. The following examples
illustrate the principles of this paragraph
(c). In each example, Companies P and S
are members of the same controlled group,
and execute a CSA providing that each
will have the exclusive right to exploit cost
shared intangibles in its own territory. See
paragraph (b)(4)(ii) of this section (Terri-
torial based divisional interests).
Example 1. Company P has developed and cur-
rently markets version 1.0 of a new software appli-
cation XYZ. Company P and Company S execute a
CSA under which they will share the IDCs for de-
veloping future versions of XYZ. Version 1.0 is rea-
sonably anticipated to contribute to the development
of future versions of XYZ and therefore Company
P’s rights in version 1.0 constitute a platform contri-
bution from Company P that must be compensated
by Company S pursuant to a PCT. Pursuant to para-
graph (c)(3) of this section, the controlled partici-
pants designate the platform contribution as a transfer
of intangibles that would otherwise be governed by
§1.482–4, if entered into by controlled parties. Ac-
cordingly, pursuant to paragraph (a)(2) of this sec-
tion, the applicable method for determining the arm’s
length value of the compensation obligation under the
PCT between Company P and Company S will be
governed by §1.482–4 as supplemented by paragraph
(g) of this section. Absent a showing to the contrary
by P and S, the platform contribution in this case is
presumed to be the exclusive provision of the bene-
fit of all rights in version 1.0, other than the rights
described in paragraph (c)(4) of this section (Certain
make-or-sell rights excluded). This includes the right
to use version 1.0 for purposes of research and the
exclusive right in S’s territory to exploit any future
products that incorporated the technology of version
1.0, and would cover a term extending as long as the
controlled participants were to exploit future versions
of XYZ or any other product based on the version 1.0
platform. The compensation obligation of Company
S pursuant to the PCT will reflect the full value of
the platform contribution, as limited by Company S’s
RAB share.
Example 2. Company P and Company S execute
a CSA under which they will share the IDCs for de-
veloping Vaccine Z. Company P will commit to the
project its research team that has successfully devel-
oped a number of other vaccines. The expertise and
existing integration of the research team is a unique
resource or capability of Company P which is reason-
ably anticipated to contribute to the development of
Vaccine Z. Therefore, P’s provision of the capabilities
of the research team constitute a platform contribu-
tion for which compensation is due from Company S
as part of a PCT. Pursuant to paragraph (c)(3) of this
section, the controlled parties designate the platform
contribution as a provision of services that would oth-
erwise be governed by §1.482–9(a) if entered into
by controlled parties. Accordingly, pursuant to para-
graph (a)(2) of this section, the applicable method for
determining the arm’s length value of the compensa-
tion obligation under the PCT between Company P
and Company S will be governed by §1.482–9(a) as
supplemented by paragraph (g) of this section. Ab-
sent a showing to the contrary by P and S, the plat-
formcontributioninthiscaseispresumedtobethe
exclusive provision of the benefits by Company P of
its research team to the development of Vaccine Z.
Because the IDCs include the ongoing compensation
of the researchers, the compensation obligation un-
der the PCT is only for the value of the commitment
of the research team by Company P to the CSA’s de-
velopment efforts net of such researcher compensa-
tion. The value of the compensation obligation of
Company S for the PCT will reflect the full value of
the provision of services, as limited by Company S’s
RAB share.
(d)Intangible development costs—(1)
Determining whether costs are IDCs.
Costs included in IDCs are determined by
reference to the scope of the intangible
development activity (IDA).
(i)Definition and scope of the IDA.For
purposes of this section, the IDA means
the activity under the CSA of developing
or attempting to develop reasonably antici-
pated cost shared intangibles. The scope of
the IDA includes all of the controlled par-
ticipants’ activities that could reasonably
be anticipated to contribute to developing
the reasonably anticipated cost shared in-
tangibles. The IDA cannot be described
merely by a list of particular resources,
capabilities, or rights that will be used in
the CSA, because such a list would not
identify reasonably anticipated cost shared
intangibles. Also, the scope of the IDA
may change as the nature or identity of the
reasonably anticipated cost shared intan-
gibles changes or the nature of the activ-
ities necessary for their development be-
come clearer. For example, the relevance
of certain ongoing work to developing rea-
sonably anticipated cost shared intangibles
or the need for additional work may only
become clear over time.
(ii)Reasonably anticipated cost shared
intangible. For purposes of this section,
reasonably anticipated cost shared in-
tangiblemeans any intangible, within
the meaning of §1.482–4(b), that, at the
applicable point in time, the controlled
participants intend to develop under the
CSA. Reasonably anticipated cost shared
intangibles may change over the course
of the CSA. The controlled participants
may at any time change the reasonably
anticipated cost shared intangibles but
must document any such change pursuant
to paragraph (k)(2)(ii)(A)(1)ofthissec-
tion. Removal of reasonably anticipated
cost shared intangibles does not affect the
controlled participants’ interests in cost
shared intangibles already developed un-
der the CSA. In addition, the reasonably
anticipated cost shared intangibles auto-
matically expand to include the intended
result of any further development of a
cost shared intangible already developed
under the CSA, or applications of such
an intangible. However, the controlled
participants may override this automatic
expansion in a particular case if they
separately remove specified further devel-
opment of such intangible (or specified
applications of such intangible) from the
IDA, and document such separate removal
pursuant to paragraph (k)(2)(ii)(A)(3)of
this section.
(iii)Costs included in IDCs.Forpur-
poses of this section,IDCsmean all costs,
incashorinkind(including stock-based
compensation, as described in paragraph
(d)(3) of this section), but excluding ac-
quisition costs for land or depreciable
property, in the ordinary course of busi-
ness after the formation of a CSA that,
based on analysis of the facts and circum-
stances, are directly identified with, or are
reasonably allocable to, the IDA. Thus,
IDCs include costs incurred in attempting
2012–12 I.R.B.514March 19, 2012

to develop reasonably anticipated cost
shared intangibles regardless of whether
such costs ultimately lead to development
of those intangibles, other intangibles de-
veloped unexpectedly, or no intangibles.
IDCs shall also include the arm’s length
rental charge for the use of any land or
depreciable tangible property (as deter-
mined under §1.482–2(c) (Use of tangible
property)) directly identified with, or rea-
sonably allocable to, the IDA. Reference
to generally accepted accounting princi-
ples or Federal income tax accounting
rules may provide a useful starting point
but will not be conclusive regarding inclu-
sion of costs in IDCs. IDCs do not include
interest expense, foreign income taxes
(as defined in §1.901–2(a)), or domestic
income taxes.
(iv)Examples. The following examples
illustrate the principles of this paragraph
(d)(1):
Example 1. A contract that purports to be a CSA
provides that the IDA to which the agreement applies
consists of all research and development activity con-
ducted at laboratories A, B, and C but not at other fa-
cilities maintained by the controlled participants. The
contract does not describe the reasonably anticipated
cost shared intangibles with respect to which research
and development is to be undertaken. The contract
fails to meet the requirements set forth in paragraph
(k)(1)(ii)(B) of this section because it fails to ade-
quately describe the scope of the IDA to be under-
taken.
Example 2. A contract that purports to be a CSA
provides that the IDA towhich the agreement ap-
plies consists of all research and development activ-
ity conducted by any of the controlled participants
with the goal of developing a cure for a particular dis-
ease. Such a cure is thus a reasonably anticipated cost
shared intangible. The contract also contains a provi-
sion that the IDA will exclude any activity that builds
on the results of the controlled participants’ prior re-
search concerning Enzyme X even though such ac-
tivity could reasonably be anticipated to contribute
to developing such cure. The contract fails to meet
the requirement set forth in paragraph (d)(1)(i) of this
section that the scope of the IDA include all of the
controlled participants’ activities that could reason-
ably be anticipated to contribute to developing rea-
sonably anticipated cost shared intangibles.
(2)Allocation of costs. If a particular
cost is directly identified with, or reason-
ably allocable to, a function the results of
which will benefit both the IDA and other
business activities, the cost must be allo-
cated on a reasonable basis between the
IDA and such other business activities in
proportion to the relative economic value
that the IDA and such other business ac-
tivities are anticipated to derive from such
results.
(3)Stock-based compensation—(i)In
general. As used in this section, the term
stock-based compensationmeans any
compensation providedbyacontrolled
participant to an employee or independent
contractor in the form of equity instru-
ments, options to acquire stock (stock
options), or rights with respect to (or deter-
mined by reference to) equity instruments
or stock options, including but not limited
to property to which section 83 applies
and stock options to which section 421
applies, regardless of whether ultimately
settled in the form of cash, stock, or other
property.
(ii)Identification of stock-based com-
pensation with the IDA. The determination
of whether stock-based compensation is
directly identified with, or reasonably
allocable to, the IDA is made as of the
date that the stock-based compensation
is granted. Accordingly, all stock-based
compensation that is granted during the
term of the CSA and, at date of grant,
is directly identified with, or reasonably
allocable to, the IDA is included as an
IDC under paragraph (d)(1) of this sec-
tion. In the case of a repricing or other
modification of a stock option, the deter-
mination of whether the repricing or other
modification constitutes the grant of a new
stock option for purposes of this paragraph
(d)(3)(ii) will be made in accordance with
the rules of section 424(h) and related
regulations.
(iii)Measurement and timing of stock-
based compensation IDC—(A)In general.
Except as otherwise provided in this para-
graph (d)(3)(iii), the cost attributable to
stock-based compensation is equal to the
amount allowable to the controlled partic-
ipant as a deduction for federal income tax
purposes with respect to that stock-based
compensation (for example, under section
83(h)) and is taken into account as an IDC
under this section for the taxable year for
which the deduction is allowable.
(1)Transfers to which section 421 ap-
plies. Solely for purposes of this paragraph
(d)(3)(iii)(A), section 421 does not apply
to the transfer of stock pursuant to the ex-
ercise of an option that meets the require-
ments of section 422(a) or 423(a).
(2)Deductions of foreign controlled
participants. Solely for purposes of this
paragraph (d)(3)(iii)(A), an amount is
treated as an allowable deduction of a
foreign controlled participant to the extent
that a deduction would be allowable to a
United States taxpayer.
(3)Modification of stock option.
Solely for purposes of this paragraph
(d)(3)(iii)(A), if the repricing or other
modification of a stock option is deter-
mined, under paragraph (d)(3)(ii) of this
section, to constitute the grant of a new
stock option not identified with, or reason-
ably allocable to, the IDA, the stock option
that is repriced or otherwise modified will
be treated as being exercised immediately
before the modification, provided that the
stock option is then exercisable and the
fair market value of the underlying stock
then exceeds the price at which the stock
option is exercisable. Accordingly, the
amount of the deduction that would be al-
lowable (or treated as allowable under this
paragraph (d)(3)(iii)(A)) to the controlled
participant upon exercise of the stock op-
tion immediately before the modification
must be taken into account as an IDC as
of the date of the modification.
(4)Expiration or termination of CSA.
Solely for purposes of this paragraph
(d)(3)(iii)(A), if an item of stock-based
compensation identified with, or reason-
ably allocable to, the IDA is not exercised
during the term of a CSA, that item of
stock-based compensation will be treated
as being exercised immediately before the
expiration or termination of the CSA, pro-
vided that the stock-based compensation
is then exercisable and the fair market
value of the underlying stock then exceeds
the price at which the stock-based com-
pensation is exercisable. Accordingly, the
amount of the deduction that would be
allowable (or treated as allowable under
this paragraph (d)(3)(iii)(A)) to the con-
trolled participant upon exercise of the
stock-based compensation must be taken
into account as an IDC as of the date of
the expiration or termination of the CSA.
(B)Election with respect to options
on publicly traded stock—(1)In general.
With respect to stock-based compensa-
tion in the form of options on publicly
traded stock, the controlled participants in
a CSA may elect to take into account all
IDCs attributable to those stock options
in the same amount, and as of the same
time, as the fair value of the stock options
reflected as a charge against income in
audited financial statements or disclosed
in footnotes to such financial statements,
provided that such statements are prepared
March 19, 20125152012–12 I.R.B.

in accordance with United States generally
accepted accounting principles by or on
behalf of the company issuing the publicly
traded stock.
(2)Publicly traded stock.Asusedin
this paragraph (d)(3)(iii)(B), the termpub-
licly traded stockmeans stock that is regu-
larly traded on an established United States
securities market and is issued by a com-
pany whose financial statements are pre-
pared in accordance with United States
generally accepted accounting principles
for the taxable year.
(3)Generally accepted accounting
principles. For purposes of this paragraph
(d)(3)(iii)(B), a financial statement pre-
pared in accordance with a comprehensive
body of generally accepted accounting
principles other than United States gen-
erally accepted accounting principles is
considered to be prepared in accordance
with United States generally accepted ac-
counting principles provided that either—
(i) The fair value of the stock options
under consideration is reflected in the rec-
onciliation betweensuch other accounting
principles and United States generally ac-
cepted accounting principles required to be
incorporated into the financial statement
by the securities laws governing compa-
nies whose stock is regularly traded on
United States securities markets; or
(ii) In the absence of a reconciliation
between such other accounting principles
and United States generally accepted ac-
counting principles that reflects the fair
value of the stock options under consider-
ation, such other accounting principles re-
quire that the fair value of the stock op-
tions under consideration be reflected as
a charge against income in audited finan-
cial statements or disclosed in footnotes to
such statements.
(4)Time and manner of making the
election. The election described in this
paragraph (d)(3)(iii)(B) is made by an
explicit reference to the election in the
written contract required by paragraph
(k)(1) of this section or in a written amend-
ment to the CSA entered into with the
consent of the Commissioner pursuant
to paragraph (d)(3)(iii)(C) of this sec-
tion. In the case of a CSA in existence on
August 26, 2003, the election by written
amendment to the CSA may be made
without the consent of the Commissioner
if such amendment is entered into not later
than the latest due date (with regard to
extensions) of a federal income tax return
of any controlled participant for the first
taxable year beginning after August 26,
2003.
(C)Consistency. Generally, all con-
trolled participants in a CSA taking op-
tions on publicly traded stock into account
under paragraph (d)(3)(ii), (d)(3)(iii)(A),
or (d)(3)(iii)(B) of this section must use
that same method of identification, mea-
surement and timing for all options on
publicly traded stock with respect to that
CSA. Controlled participants may change
their method only with the consent of
the Commissioner and only with respect
to stock options granted during taxable
years subsequent to the taxable year in
which the Commissioner’s consent is ob-
tained. All controlled participants in the
CSA must join in requests for the Com-
missioner’s consent under this paragraph
(d)(3)(iii)(C). Thus, for example, if the
controlled participants make the election
described in paragraph (d)(3)(iii)(B) of
this section upon the formation of the
CSA, the election may be revoked only
with the consent of the Commissioner, and
the consent will apply only to stock op-
tions granted in taxable years subsequent
to the taxable year in which consent is
obtained. Similarly, if controlled partici-
pants already have granted stock options
that have been or will be taken into ac-
count under the general rule of paragraph
(d)(3)(iii)(A) of this section, then except in
cases specified in the last sentence of para-
graph (d)(3)(iii)(B)(4)ofthissection,the
controlled participants may make the elec-
tion described in paragraph (d)(3)(iii)(B)
of this section only with the consent of the
Commissioner, and the consent will apply
only to stock options granted in taxable
years subsequent to the taxable year in
which consent is obtained.
(4)IDC share. A controlled partici-
pant’s IDC share for a taxable year is equal
to the controlled participant’s cost contri-
bution for the taxable year, divided by the
sum of all IDCs for the taxable year. A
controlled participant’s cost contribution
for a taxable year means all of the IDCs ini-
tially borne by the controlled participant,
plus all of the CST Payments that the par-
ticipant makes to other controlled partici-
pants, minus all of the CST Payments that
the participant receives from other con-
trolled participants.
(5)Examples. The following examples
illustrate this paragraph (d):
Example 1. Foreign parent (FP) and its U.S. sub-
sidiary (USS) enter into a CSA to develop a better
mousetrap. USS and FP share the costs of FP’s R&D
facility that will be exclusively dedicated to this re-
search, the salaries of the researchers at the facility,
and overhead costs attributable to the project. They
also share the cost of a conference facility that is at
the disposal of the senior executive management of
each company. Based on the facts and circumstances,
the cost of the conference facility cannot be directly
identified with, and is not reasonably allocable to, the
IDA. In this case, the cost of the conference facility
must be excluded from the amount of IDCs.
Example 2. U.S. parent (USP) and its foreign sub-
sidiary (FS) enter into a CSA to develop intangibles
for producing a new device. USP and FS share the
costs of an R&D facility, the salaries of the facil-
ity’s researchers, and overhead costs attributable to
the project. Although USP also incurs costs related
to field testing of the device, USP does not include
those costs in the IDCs that USP and FS will share
under the CSA. The Commissioner may determine,
based on the facts and circumstances, that the costs
of field testing are IDCs that the controlled partici-
pants must share.
Example 3. U.S. parent (USP) and its foreign
subsidiary (FS) enter into a CSA to develop a new
process patent. USP assigns certain employees to per-
form solely R&D to develop a new mathematical al-
gorithm to perform certain calculations. That algo-
rithm will be used both to develop the new process
patent and to develop a new design patent the devel-
opment of which is outside the scope of the CSA.
During years covered by the CSA, USP compensates
such employees with cash salaries, stock-based com-
pensation, or a combination of both. USP and FS
anticipate that the economic value attributable to the
R&D will be derived from the process patent and
the design patent in a relative proportion of 75% and
25%, respectively. Applying the principles of para-
graph (d)(2) of this section, 75% of the compensation
of such employees must be allocated to the develop-
ment of the new process patent and, thus, treated as
IDCs. With respect to the cash salary compensation,
the IDC is 75% of the face value of the cash. With
respect to the stock-based compensation, the IDC is
75% of the value of the stock-based compensation as
determined under paragraph (d)(3)(iii) of this section.
Example 4. Foreign parent (FP) and its U.S. sub-
sidiary (USS) enter into a CSA to develop a new com-
puter source code. FP has an executive officer who
oversees a research facility and employees dedicated
solely to the IDA. The executive officer also over-
sees other research facilities and employees unrelated
to the IDA, and performs certain corporate overhead
functions. The full amount of the costs of the research
facility and employees dedicated solely to the IDA
can be directly identified with the IDA and, there-
fore, are IDCs. In addition, based on the executive
officer’s records of time worked on various matters,
the controlled participants reasonably allocate 20%
of the executive officer’s compensation to supervi-
sion of the facility and employees dedicated to the
IDA, 50% of the executive officer’s compensation
to supervision of the facilities and employees unre-
lated to the IDA, and 30% of the executive officer’s
compensation to corporate overhead functions. The
2012–12 I.R.B.516March 19, 2012

controlled participants also reasonably determine that
the results of the executive officer’s corporate over-
head functions yield equal economic benefit to the
IDA and the other business activities of FP. Apply-
ing the principles of paragraph (d)(1) of this section,
the executive officer’s compensation allocated to su-
pervising the facility and employees dedicated to the
IDA (amounting to 20% of the executive officer’s to-
tal compensation) must be treated as IDCs. Apply-
ing the principles of paragraph (d)(2) of this section,
half of the executive officer’s compensation allocated
to corporate overhead functions (that is, half of 30%
of the executive officer’s total compensation), must
be treated as IDCs. Therefore, a total of 35% (20%
plus 15%) of the executive officer’s total compensa-
tion must be treated as IDCs.
(e)Reasonably anticipated benefits
share—(1)Definition—(i)In general.A
controlled participant’s share of reason-
ably anticipated benefits is equal to its
reasonably anticipated benefits divided
by the sum of the reasonably anticipated
benefits, as defined in paragraph (j)(1)(i)
of this section, of all the controlled par-
ticipants. RAB shares must be updated to
account for changes ineconomic condi-
tions, the business operations and practices
of the participants, and the ongoing de-
velopment of intangibles under the CSA.
For purposes of determining RAB shares
at any given time, reasonably anticipated
benefits must be estimated over the entire
period, past and future, of exploitation
of the cost shared intangibles, and must
reflect appropriate updates to take into
account the most reliable data regarding
past and projected future results available
at such time. RAB shares determined
for a particular purpose shall not be fur-
ther updated for that purpose based on
information not available at the time that
determination needed to be made. For
example, RAB shares determined in order
to determine IDC shares for a particular
taxable year (as set forth in paragraphs
(b)(1)(i) and (d)(4) of this section) shall
not be recomputed based on information
not available at that time. Similarly, RAB
shares determined for the purpose of using
a particular method such as the acquisition
price method (as set forth in paragraph
(g)(5)(ii) of this section) to evaluate the
arm’s length amount charged in a PCT
shall not be recomputed based on infor-
mation not available at the date of that
PCT. However, nothing in this paragraph
(e)(1)(i) shall limit the Commissioner’s
use of subsequently available information
for purposes of its allocation determina-
tions in accordance with the provisions of
paragraph (i) (Allocations by the Commis-
sioner in connection with a CSA) of this
section.
(ii)Reliability. A controlled partici-
pant’s RAB share must be determined by
using the most reliable estimate. In deter-
mining which of two or more available es-
timates is most reliable, the quality of the
data and assumptions used in the analy-
sis must be taken into account, consistent
with §1.482–1(c)(2)(ii) (Data and assump-
tions). Thus, the reliability of an estimate
will depend largely on the completeness
and accuracy of the data, the soundness of
the assumptions, and the relative effects of
particular deficiencies in data or assump-
tions on different estimates. If two esti-
mates are equally reliable, no adjustment
should be made based on differences be-
tween the estimates. The following factors
will be particularly relevant in determin-
ing the reliability of an estimate of RAB
shares:
(A) The basis used for measuring bene-
fits, as described in paragraph (e)(2)(ii) of
this section.
(B) The projections used to esti-
mate benefits, as described in paragraph
(e)(2)(iii) of this section.
(iii)Examples. The following examples
illustrate the principles of this paragraph
(e)(1):
Example 1. (i) USP and FS plan to conduct re-
search to develop Product Lines A and B. USP and FS
reasonably anticipate respective benefits from Prod-
uct Line A of 100X and 200X and respective bene-
fits from Product Line B, respectively, of 300X and
400X. USP and FS thus reasonably anticipate com-
bined benefits from Product Lines A and B of 400X
and 600X, respectively.
(ii) USP and FS could enter into a separate CSA to
develop Product Line A with respective RAB shares
of 33
1
/3percent and 66
2
/3percent (reflecting a ratio
of 100X to 200X), and into a separate CSA to de-
velop Product Line B with respective RAB shares of
42
6
/7percent and 57
1
/7percent (reflecting a ratio of
300X to 400X). Alternatively, USP and FS could en-
ter into a single CSA to develop both Product Lines
A and B with respective RAB shares of 40 percent
and 60 percent (in the ratio of 400X to 600X). If the
separate CSAs are chosen, then any costs for activi-
ties that contribute to developing both Product Line
A and Product Line B will constitute IDCs of the re-
spective CSAs as required by paragraphs (d)(1) and
(2) of this section.
Example 2. (i) USP, a US company, wholly owns
foreign subsidiary, FS. USP and FS enter into a CSA
at the start of Year 1. The CSA’s total IDCs are
$100,000 in each year for Years 1 through 4. In Year
1, USP correctly estimates its RAB share as 50%,
based on information available at the time, and there-
fore correctly computes $50,000 as its cost contribu-
tion for Year 1.
(ii) In Year 4, USP correctly estimates its RAB
share to be 70%, based on information available at
the time and, therefore, correctly computes $70,000
as its cost contribution for Year 4.
(iii) In Year 4, USP also files an amended return
for Year 1 in which USP deducts a cost contribution
of $70,000, asserting that, for this purpose, it should
revise its Year 1 estimated RAB share to 70% based
on the information that is now available to it in Year 4.
The Commissioner determines that USP is incorrect
for two reasons. First, a RAB share determined for
a particular purpose (here, to determine USP’s IDC
shares and thus USP’s cost contributions in Year 1)
should not be revised based on information not avail-
able to USP until Year 4. See paragraph (e)(1)(i) of
this section. Second, more generally, USP is not per-
mitted to file an amended return for this purpose un-
der §1.482–1(a)(3). Therefore, for both of these rea-
sons, Commissioner adjusts USP’s amended return
for Year 1 by disallowing $20,000 of the $70,000 de-
duction.
(2)Measure of benefits—(i)In general.
In order to estimate a controlled partic-
ipant’s RAB share, the amount of each
controlled participant’s reasonably antici-
pated benefits must be measured on a ba-
sis that is consistent for all such partici-
pants. See paragraph (e)(2)(ii)(E)Exam-
ple 9of this section. If a controlled par-
ticipant transfers a cost shared intangible
to another controlled taxpayer, other than
by way of a transfer described in para-
graph (f) of this section, that controlled
participant’s benefits from the transferred
intangible must be measured by reference
to the transferee’s benefits, disregarding
any consideration paid by the transferee to
the controlled participant (such as a roy-
alty pursuant to a license agreement). Rea-
sonably anticipated benefits are measured
either on a direct basis, by reference to
estimated benefits to be generated by the
use of cost shared intangibles (generally
based on additional revenues plus cost sav-
ings less any additional costs incurred), or
on an indirect basis, by reference to cer-
tain measurements that reasonably can be
assumed to relate to benefits to be gen-
erated. Such indirect bases of measure-
ment of anticipated benefits are described
in paragraph (e)(2)(ii) of this section. A
controlled participant’s reasonably antici-
pated benefits must be measured on the ba-
sis, whether direct or indirect, that most
reliably determines RAB shares. In de-
termining which of two bases of measure-
ment is most reliable, the factors set forth
in §1.482–1(c)(2)(ii) (Data and assump-
tions) must be taken into account. It nor-
mally will be expectedthat the basis that
provided the most reliable estimate for a
March 19, 20125172012–12 I.R.B.

particular year will continue to provide the
most reliable estimate in subsequent years,
absent a material change in the factors that
affect the reliability of the estimate. Re-
gardless of whether a direct or indirect ba-
sis of measurement is used, adjustments
may be required to account for material
differences in the activities that controlled
participants undertake to exploit their in-
terests in cost shared intangibles. SeeEx-
amples 4and7of paragraph (e)(2)(ii)(E)
of this section.
(ii)Indirect bases for measuring antic-
ipated benefits. Indirect bases for measur-
ing anticipated benefits from participation
in a CSA include the following:
(A)Units used, produced, or sold.
Units of items used, produced, or sold by
each controlled participant in the business
activities in which cost shared intangibles
are exploited may be used as an indirect
basis for measuring its anticipated ben-
efits. This basis of measurement will
more reliably determine RAB shares to
the extent that each controlled participant
is expected to have a similar increase in
net profit or decrease in net loss attribut-
able to the cost shared intangibles per unit
of the item or items used, produced, or
sold. This circumstance is most likely to
arise when the cost shared intangibles are
exploited by the controlled participants in
the use, production, or sale of substantially
uniform items under similar economic
conditions.
(B)Sales. Sales by each controlled par-
ticipant in the business activities in which
cost shared intangibles are exploited may
be used as an indirect basis for measur-
ing its anticipated benefits. This basis of
measurement will more reliably determine
RAB shares to the extent that each con-
trolled participant is expected to have a
similar increase in net profit or decrease in
net loss attributable to cost shared intangi-
bles per dollar of sales. This circumstance
is most likely to arise if the costs of exploit-
ing cost shared intangibles are not substan-
tial relative to the revenues generated, or if
the principal effect of using cost shared in-
tangibles is to increase the controlled par-
ticipants’ revenues (for example, through
a price premium on the products they sell)
without affecting their costs substantially.
Sales by each controlledparticipant are un-
likely to provide a reliable basis for mea-
suring RAB shares unless each controlled
participant operates at the same market
level (for example, manufacturing, distri-
bution, etc.).
(C)Operating profit. Operating profit
of each controlled participant from the ac-
tivities in which cost shared intangibles are
exploited, as determined before any ex-
pense (including amortization) on account
of IDCs, may be used as an indirect basis
for measuring anticipated benefits. This
basis of measurement will more reliably
determine RAB shares to the extent that
such profit is largely attributable to the use
of cost shared intangibles, or if the share
of profits attributable to the use of cost
shared intangibles is expected to be sim-
ilar for each controlled participant. This
circumstance is most likely to arise when
cost shared intangibles are closely asso-
ciated with the activity that generates the
profit and the activity could not be carried
on or would generate little profit without
use of those intangibles.
(D)Other bases for measuring antici-
pated benefits. Other bases for measuring
anticipated benefits may in some circum-
stances be appropriate, but only to the ex-
tent that there is expected to be a reason-
ably identifiable relationship between the
basis of measurement used and additional
revenue generated or net costs saved by the
use of cost shared intangibles. For exam-
ple, a division of costs based on employee
compensation would be considered unre-
liable unless there were a relationship be-
tween the amount of compensation and the
expected additional revenue generated or
net costs saved by the controlled partici-
pants from using the cost shared intangi-
bles.
(E)Examples. The following examples
illustrates this paragraph (e)(2)(ii):
Example 1. Controlled parties A and B enter into
a CSA to develop product and process intangibles for
already existing Product P. Without such intangibles,
A and B would each reasonably anticipate revenue,
in present value terms, of $100M from sales of Prod-
uct P until it becomes obsolete. With the intangibles,
A and B each reasonably anticipate selling the same
number of units each year, butreasonably anticipate
that the price will be higher. Because the particu-
lar product intangible is more highly regarded in A’s
market, A reasonably anticipates an increase of $20M
in present value revenue from the product intangible,
while B reasonably anticipates an increase of only
$10M in present value from the product intangible.
Further, A and B each reasonably anticipate spending
an additional amount equal to $5M in present value
in production costs to include the feature embodying
the product intangible. Finally, A and B each rea-
sonably anticipate saving an amount equal to $2M in
present value in production costs by using the process
intangible. A and B reasonably anticipate no other
economic effects from exploiting the cost shared in-
tangibles. A’s reasonably anticipated benefits from
exploiting the cost shared intangibles equal its rea-
sonably anticipated increase in revenue ($20M) plus
its reasonably anticipated cost savings ($2M) less its
reasonably anticipated increased costs ($5M), which
equals $17M. Similarly, B’s reasonably anticipated
benefits from exploiting the cost shared intangibles
equal its reasonably anticipated increase in revenue
($10M) plus its reasonably anticipated cost savings
($2M) less its reasonably anticipated increased costs
($5M), which equals $7M. Thus A’s reasonably an-
ticipated benefits are $17M and B’s reasonably antic-
ipated benefits are $7M.
Example 2. Foreign Parent (FP) and U.S. Sub-
sidiary (USS) both produce a feedstock for the manu-
facture of various high-performance plastic products.
Producing the feedstock requires large amounts of
electricity, which accounts for a significant portion
of its production cost. FP and USS enter into a CSA
to develop a new process that will reduce the amount
of electricity required to produce a unit of the feed-
stock. FP and USS currently both incur an electricity
cost of $2 per unit of feedstock produced and rates
for each are expected to remain similar in the future.
The new process, if it is successful, will reduce the
amount of electricity required by each company to
produce a unit of the feedstock by 50%. Switching to
the new process would not require FP or USS to in-
cur significant investment or other costs. Therefore,
the cost savings each company is expected to achieve
after implementing the new process are $1 per unit of
feedstock produced. Under the CSA, FP and USS di-
vide the costs of developing the new process based on
the units of the feedstock each is anticipated to pro-
duce in the future. In this case, units produced is the
most reliable basis for measuring RAB shares and di-
viding the IDCs because each controlled participant is
expected to have a similar $1 (50% of current charge
of $2) decrease in costs per unit of the feedstock pro-
duced.
Example 3. ThefactsarethesameasinExam-
ple 2, except that currently USS pays $3 per unit of
feedstock produced for electricity while FP pays $6
per unit of feedstock produced. In this case, units
produced is not the most reliable basis for measuring
RAB shares and dividing the IDCs because the par-
ticipants do not expect to have a similar decrease in
costs per unit of the feedstock produced. The Com-
missioner determines that the most reliable measure
of RAB shares may be based on units of the feed-
stock produced if FP’s units are weighted relative to
USS’s units by a factor of 2. This reflects the fact
that FP pays twice as much as USS for electricity
and, therefore, FP’s savings of $3 per unit of the feed-
stock (50% reduction of current charge of $6) would
be twice USS’s savings of $1.50 per unit of feedstock
(50% reduction of current charge of $3) from any new
process eventually developed.
Example 4. ThefactsarethesameasinEx-
ample 3, except that to supply the particular needs
of the U.S. market USS manufactures the feedstock
with somewhat different properties than FP’s feed-
stock. This requires USS to employ a somewhat dif-
ferent production process than does FP. Because of
this difference, USS would incur significant construc-
tion costs in order to adopt any new process that may
be developed under the cost sharing agreement. In
2012–12 I.R.B.518March 19, 2012

this case, units produced is not the most reliable ba-
sis for measuring RAB shares. In order to reliably
determine RAB shares, the Commissioner measures
the reasonably anticipated benefits of USS and FP on
a direct basis. USS’s reasonably anticipated benefits
are its reasonably anticipated total savings in elec-
tricity costs, less its reasonably anticipated costs of
adopting the new process. FS’s reasonably antici-
pated benefits are its reasonably anticipated total sav-
ings in electricity costs.
Example 5. U.S. Parent (USP) and Foreign Sub-
sidiary (FS) enter into a CSA to develop new anes-
thetic drugs. USP obtains the right to market any
resulting drugs in the United States and FS obtains
the right to market any resulting drugs in the rest of
the world. USP and FS determine RAB shares on
the basis of their respective total anticipated operating
profit from all drugs under development. USP antic-
ipates that it will receive a much higher profit than
FS per unit sold because the price of the drugs is not
regulated in the United States, whereas the price of
the drugs is regulated in many non-U.S. jurisdictions.
In both controlled participants’ territories, the antici-
pated operating profits are almost entirely attributable
to the use of the cost shared intangibles. In this case,
the controlled participants’ basis for measuring RAB
shares is the most reliable.
Example 6. (i) Foreign Parent (FP) and U.S. Sub-
sidiary (USS) manufacture and sell fertilizers. They
enter into a CSA to develop a new pellet form of a
common agricultural fertilizer that is currently avail-
able only in powder form. Under the CSA, USS ob-
tains the rights to produce and sell the new form of
fertilizer for the U.S. market while FP obtains the
rights to produce and sell the new form of fertilizer
in the rest of the world. The costs of developing the
new form of fertilizer are divided on the basis of the
anticipated sales of fertilizer in the controlled partic-
ipants’ respective markets.
(ii) If the research and development is successful,
the pellet form will deliver the fertilizer more effi-
ciently to crops and less fertilizer will be required to
achieve the same effect on crop growth. The pellet
form of fertilizer can be expected to sell at a price
premium over the powder form of fertilizer based on
the savings in the amount of fertilizer that needs to be
used. This price premium will be a similar premium
per dollar of sales in each territory. If the research
and development is successful, the costs of producing
pellet fertilizer are expected to be approximately the
same as the costs of producing powder fertilizer and
the same for both FP and USS. Both FP and USS op-
erate at approximately the same market levels, selling
their fertilizers largely to independent distributors.
(iii) In this case, the controlled participants’ basis
for measuring RAB shares is the most reliable.
Example 7. ThefactsarethesameasinExam-
ple 6, except that FP distributes its fertilizers directly
while USS sells to independent distributors. In this
case, sales of USS and FP are not the most reliable
basis for measuring RAB shares unless adjustments
are made to account for the difference in market lev-
els at which the sales occur.
Example 8. Foreign Parent (FP) and U.S. Sub-
sidiary (USS) enter into a CSA to develop materials
that will be used to train all new entry-level employ-
ees. FP and USS determine that the new materials
will save approximately ten hours of training time per
employee. Because their entry-level employees are
paid on differing wage scales, FP and USS decide that
they should not measure benefits based on the num-
ber of entry-level employees hired by each. Rather,
they measure benefits based on compensation paid to
the entry-level employees hired by each. In this case,
the basis used for measuring RAB shares is the most
reliable because there is a direct relationship between
compensation paid to new entry-level employees and
costs saved by FP and USS from the use of the new
training materials.
Example 9. U.S. Parent (USP), Foreign Sub-
sidiary 1 (FS1), and Foreign Subsidiary 2 (FS2) enter
into a CSA to develop computer software that each
will market and install oncustomers’ computer sys-
tems. The controlled participants measure benefits
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 tounrelated 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 controlled participant is not the
most reliable because all of the benefits received by
controlled participants are not taken into account.
In order to reliably determine RAB 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 controlled
participants’ projected benefits from sales (for exam-
ple, all controlled participants might measure their
benefits on the basis of operating profit).
(iii)Projections used to estimate ben-
efits—(A)In general. The reliability of
an estimate of RAB shares also depends
upon the reliability of projections used in
making the estimate. Projections required
for this purpose generally include a deter-
mination of the time period between the
inception of the research and development
activities under the CSA and the receipt
of benefits, a projection of the time over
which benefits will be received, and a
projection of the benefits anticipated for
each year in which it is anticipated that
the cost shared intangible will generate
benefits. A projection of the relevant basis
for measuring anticipated benefits may
require a projection of the factors that
underlie it. For example, a projection of
operating profits may require a projection
of sales, cost of sales, operating expenses,
and other factors that affect operating
profits. If it is anticipated that there will
be significant variation among controlled
participants in the timing of their receipt of
benefits, and consequently benefit shares
are expected to vary significantly over the
years in which benefits will be received,
it normally will be necessary to use the
present value of the projected benefits
to reliably determine RAB shares. See
paragraph (g)(2)(v) of this section for best
method considerations regarding discount
rates used for this purpose. If it is not
anticipated that benefit shares will signif-
icantly change over time, current annual
benefit shares may provide a reliable pro-
jection of RAB shares. This circumstance
is most likely to occur when the CSA is a
long-term arrangement, the arrangement
covers a wide variety of intangibles, the
composition of the cost shared intangibles
is unlikely to change, the cost shared in-
tangibles are unlikely to generate unusual
profits, and each controlled participant’s
share of the market is stable.
(B)Examples. The following examples
illustrate the principles of this paragraph
(e)(2)(iii):
Example 1. (i) Foreign Parent (FP) and U.S. Sub-
sidiary (USS) enter into a CSA to develop a new
car model. The controlled participants plan to spend
four years developing the new model and four years
producing and selling the new model. USS and FP
project total sales of $4 billion and $2 billion, respec-
tively, over the planned four years of exploitation of
the new model. The controlled participants deter-
mine RAB shares for each year of 66
2
/3%forUSS
and 33
1
/3% for FP, based on projected total sales.
(ii) USS typically begins producing and selling
new car models a year after FP begins producing and
selling new car models. In order to reflect USS’s
one-year lag in introducing new car models, a more
reliable projection of each participant’s RAB share
would be based on a projection of all four years of
sales for each participant, discounted to present value.
Example 2. U.S. Parent (USP) and Foreign Sub-
sidiary (FS) enter into a CSA to develop new and im-
proved household cleaning products. Both controlled
participants have sold household cleaning products
for many years and have stable worldwide market
shares. The products under development are unlikely
to produce unusual profits for either controlled par-
ticipant. The controlled participants determine RAB
shares on the basis of each controlled participant’s
current sales of household cleaning products. In this
case, the controlled participants’ RAB shares are re-
liably projected by current sales of cleaning products.
Example 3.ThefactsarethesameasinExample
2, except that FS’s market share is rapidly expanding
because of the business failure of a competitor in its
geographic area. The controlled participants’ RAB
shares are not reliably projected by current sales of
cleaning products. FS’s benefit projections should
take into account its growth in market share.
Example 4. Foreign Parent (FP) and U.S. Sub-
sidiary (USS) enter into a CSA to develop synthetic
fertilizers and insecticides. FP and USS share costs
on the basis of each controlled participant’s current
sales of fertilizers and insecticides. The market
shares of the controlled participants have been stable
for fertilizers, but FP’s market share for insecticides
has been expanding. The controlled participants’
projections of RAB shares are reliable with regard
to fertilizers, but not reliable with regard to insec-
ticides; a more reliable projection of RAB shares
would take into account the expanding market share
for insecticides.
March 19, 20125192012–12 I.R.B.

(f)Changes in participation under a
CSA—(1)In general. A change in partic-
ipation under a CSA occurs when there is
either a controlled transfer of interests or a
capability variation. A change in partici-
pation requires arm’s length consideration
under paragraph (a)(3)(ii) of this section,
and as more fully described in this para-
graph (f).
(2)Controlled transfer of interests.
A controlled transfer of interests occurs
when a participant in a CSA transfers all
or part of its interests in cost shared in-
tangibles under the CSA in a controlled
transaction, and the transferee assumes
the associated obligations under the CSA.
For example, a change in the territorial
based divisional interests or field of use
based divisional interests, as described in
paragraph (b)(4), is a controlled transfer
of interests. After the controlled transfer
of interests occurs, the CSA will still exist
if at least two controlled participants still
have interests in the cost shared intangi-
bles. In such a case, the transferee will be
treated as succeeding to the transferor’s
prior history under the CSA as pertains
to the transferred interests, including the
transferor’s cost contributions, benefits
derived, and PCT Payments attributable
to such rights or obligations. A transfer
that would otherwise constitute a con-
trolled transfer of interests for purposes of
this paragraph (f)(2) shall not constitute
a controlled transfer of interests if it also
constitutes a capability variation for pur-
poses of paragraph (f)(3) of this section.
(3)Capability variation. A capability
variation occurs when, in a CSA in which
interests in cost shared intangibles are di-
vided as described in paragraph (b)(4)(iv)
of this section, the controlled participants’
division of interests or their relative ca-
pabilities or capacities to benefit from the
cost shared intangibles are materially al-
tered. For purposes of paragraph (a)(3)(ii)
of this section, a capability variation is
considered to be a controlled transfer of
interests in cost shared intangibles, in
which any controlled participant whose
RAB share decreases as a result of the
capability variation is a transferor, and any
controlled participant whose RAB share
thus increases is the transferee of the in-
terests in cost shared intangibles.
(4)Arm’s length consideration for a
change in participation. In the event of a
change in participation, the arm’s length
amount of consideration from the trans-
feree, under the rules of §§1.482–1 and
1.482–4 through 1.482–6 and paragraph
(a)(3)(ii) of this section, will be deter-
mined consistent with the reasonably an-
ticipated incremental change in the returns
to the transferee and transferor resulting
from such change in participation. Such
changes in returns will themselves depend
on the reasonably anticipated incremental
changes in the benefits from exploiting
the cost shared intangibles, IDCs borne,
and PCT Payments (if any). However,
any arm’s length consideration required
under this paragraph (f)(4) with respect
to a capability variation shall be reduced
as necessary to prevent duplication of
an adjustment already performed under
paragraph (i)(2)(ii)(A) of this section that
resulted from the same capability varia-
tion. If an adjustment has been performed
already under this paragraph (f)(4) with
respect to a capability variation, then for
purposes of any adjustment to be per-
formed under paragraph (i)(2)(ii)(A) of
this section, the controlled participants’
projected benefit shares referred to in
paragraph (i)(2)(ii)(A) of this section shall
be considered to be the controlled partic-
ipants’ respective RAB shares after the
capability variation occurred.
(5)Examples. The following examples
illustrate the principles of this paragraph
(f):
Example 1. X, Y, and Z are the only controlled
participants in a CSA. The CSA divides interests in
cost shared intangibles on a territorial basis as de-
scribed in paragraph (b)(4)(ii) of this section. X is
assigned the territories of the Americas, Y is assigned
the territory of the UK and Australia, and Z is as-
signed the rest of the world. When the CSA is formed,
X has a platform contribution T. Under the PCTs for
T, Y and Z are each obligated to pay X royalties equal
to five percent of their respective sales. Aside from T,
there are no platform contributions. Two years after
the formation of the CSA, Y transfers to Z its inter-
est in cost shared intangibles relating to the UK ter-
ritory, and the associated obligations, in a controlled
transfer of interests described in paragraph (f)(2) of
this section. At that time the reasonably anticipated
benefits from exploiting cost shared intangibles in the
UK have a present value of $11M, the reasonably an-
ticipated IDCs to be borne relating to the UK terri-
tory have a present value of $3M, and the reasonably
anticipated PCT Payments to be made to X relating
to sales in the UK territory have a present value of
$2M. As arm’s length consideration for the change in
participation due to the controlled transfer of inter-
ests, Z must pay Y compensation with an anticipated
present value of $11M, less $3M, less $2M, which
equals $6M.
Example 2.AsinExample 2of paragraph
(b)(4)(v) of this section, companies P and S, both
members of the same controlled group, enter into a
CSA to develop product Z. P and S agree to divide
their interest in product Z based on site of manufac-
turing. P will have exclusive and perpetual rights in
product Z manufactured in facilities owned by P. S
will have exclusive and perpetual rights to product
Z manufactured in facilities owned by S. P and S
agree that neither will license manufacturing rights
in product Z to any related or unrelated party. Both
P and S maintain books and records that allow pro-
duction at all sites to be verified. Both own facilities
that will manufacture product Z and the relative
capacities of these sites are known. All facilities are
currently operating at nearcapacity and are expected
to continue to operate at near capacity when product
Z enters production so that it will not be feasible
to shift production between P’s and S’s facilities. P
and S have no plans to build new facilities and the
lead time required to plan and build a manufacturing
facility precludes the possibility that P or S will build
a new facility during the period for which sales of
Product Z are expected. When the CSA is formed,
P has a platform contribution T. Under the PCT
for T, S is obligated to pay P sales-based royalties
according to a certain formula. Aside from T, there
are no other platform contributions. Two years after
the formation of the CSA, owing to a change in plans
not reasonably foreseeable at the time the CSA was
entered into, S acquires additional facilities F for the
manufacture of Product Z. Such acquisition consti-
tutes a capability variation described in paragraph
(f)(3) of this section. Under this capability variation,
S’s RAB share increases from 50% to 60%. Accord-
ingly, there is a compensable change in participation
under paragraph (f)(3) of this section.
(g)Supplemental guidance on methods
applicable to PCTs—(1)In general.This
paragraph (g) provides supplemental guid-
ance on applying the methods listed in this
paragraph (g)(1) for purposes of evaluat-
ing the arm’s length amount charged in a
PCT. Each method will yield a value for
the compensation obligation of each PCT
Payor consistent with the product of the
combined pre-tax value to all controlled
participants of the platform contribution
that is the subject of the PCT and the PCT
Payor’s RAB share. Each method must
yield results consistent with measuring the
value of a platform contributionbyrefer-
ence to the future income anticipated to be
generated by the resulting cost shared in-
tangibles. The methods are—
(i) The comparable uncontrolled trans-
action method described in §1.482–4(c), or
the comparable uncontrolled services price
method described in §1.482–9(c), as fur-
ther described in paragraph (g)(3) of this
section;
(ii) The income method, described in
paragraph (g)(4) of this section;
2012–12 I.R.B.520March 19, 2012

(iii) The acquisition price method, de-
scribed in paragraph (g)(5) of this section;
(iv) The market capitalization method,
described in paragraph (g)(6) of this sec-
tion;
(v) The residual profit split method, de-
scribed in paragraph (g)(7) of this section;
and
(vi) Unspecified methods, described in
paragraph (g)(8) of this section.
(2)Best method analysis applicable for
evaluation of a PCT pursuant to a CSA—
(i)In general. Each method must be ap-
plied in accordance with the provisions of
§1.482–1, including the best method rule
of §1.482–1(c), the comparability analysis
of §1.482–1(d), and the arm’s length range
of §1.482–1(e), except as those provisions
are modified in this paragraph (g).
(ii)Consistency with upfront contrac-
tual terms and risk allocation–the in-
vestor model—(A)In general. Although
all of the factors entering into a best
method analysis described in §1.482–1(c)
and (d) must be considered, specific fac-
tors may be particularly relevant in the
context of a CSA. In particular, the relative
reliability of an application of any method
depends on the degree of consistency of
the analysis with theapplicable contrac-
tual terms and allocation of risk under the
CSA and this section among the controlled
participants as of the date of the PCT, un-
less a change in such terms or allocation
has been made in return for arm’s length
consideration. In this regard, a CSA in-
volves an upfront division of the risks as
to both reasonably anticipated obligations
and reasonably anticipated benefits over
the reasonably anticipated term of the
CSA Activity. Accordingly, the relative
reliability of an application of a method
also depends on the degree of consistency
of the analysis with the assumption that,
as of the date of the PCT, each controlled
participant’s aggregate net investment
in the CSA Activity (including platform
contributions, operating contributions, as
such term is defined in paragraph (j)(1)(i)
of this section, operating cost contribu-
tions, as such term is defined in paragraph
(j)(1)(i) of this section, and cost contribu-
tions) is reasonably anticipated to earn a
rate of return (which might be reflected in
a discount rate used in applying a method)
appropriate to the riskiness of the con-
trolled participant’s CSA Activity over
the entire period of such CSA Activity.
If the cost shared intangibles themselves
are reasonably anticipated to contribute
to developing other intangibles, then the
period described in the preceding sentence
includes the period, reasonably anticipated
as of the date of the PCT, of developing
and exploiting such indirectly benefited
intangibles.
(B)Example. The following example
illustrates the principles of this paragraph
(g)(2)(ii):
Example. (i) P, a U.S. corporation, has developed
a software program, DEF, which applies certain algo-
rithms to reconstruct complete DNA sequences from
partially-observed DNA sequences. S is a wholly-
owned foreign subsidiary of P. On the first day of Year
1, P and S enter into a CSA to develop a new gener-
ation of genetic tests, GHI, based in part on the use
of DEF. DEF is therefore a platform contribution of
P for which compensation is due from S pursuant to a
PCT. S makes no platform contributions to the CSA.
Sales of GHI are projected to commence two years
after the inception of the CSA and then to continue
for eight more years. Based on industry experience,
P and S are confident that GHI will be replaced by a
new type of genetic testing based on technology un-
related to DEF or GHI and that, at that point, GHI
will have no further value. P and S project that that
replacement will occur at the end of Year 10.
(ii) For purposes of valuing the PCT for P’s
platform contribution of DEF to the CSA, P and
S apply a type of residual profit split method that
is not described in paragraph (g)(7) of this section
and which, accordingly, constitutes an unspecified
method. See paragraph (g)(7)(i) (last sentence) of
this section. The principles of this paragraph (g)(2)
apply to any method for valuing a PCT, including the
unspecified method used by P and S.
(iii) Under the method employed by P and S, in
each year, a portion of the income from sales of GHI
in S’s territory is allocated to certain routine contri-
butions made by S. The residual of the profit or loss
from GHI sales in S’s territory after the routine al-
location step is divided between P and S pro rata to
their capital stocks allocable to S’s territory. Each
controlled participant’s capital stock is computed by
capitalizing, applying a capital growth factor to, and
amortizing its historical expenditures regarding DEF
allocable to S’s territory (in the case of P), or its on-
going cost contributions towards developing GHI (in
the case of S). The amortization of the capital stocks
is effected on a straight-line basis over an assumed
four-year life for the relevant expenditures. The cap-
ital stocks are grown using an assumed growth factor
that P and S consider to be appropriate.
(iv) The assumption that all expenditures amor-
tize on a straight-line basis over four years does not
appropriately reflect the principle that as of the date
of the PCT regarding DEF, every contribution to the
development of GHI, including DEF, is reasonably
anticipated to have value throughout the entire period
of exploitation of GHI which is projected to continue
through Year 10. Under this method as applied by P
and S, the share of the residual profit in S’s territory
that is allocated to P as a PCT Payment from S will
decrease every year. After Year 4, P’s capital stock
in DEF will necessarily be $0, so that P will receive
none of the residual profit or loss from GHI sales in
S’s territory after Year 4 as a PCT Payment.
(v) As a result of this limitation of the PCT
Payments to be made by S, the anticipated return to
S’s aggregate investment in the CSA, over the whole
period of S’s CSA Activity, is at a rate that is sig-
nificantly higher than the appropriate rate of return
for S’s CSA Activity (as determined by a reliable
method). This discrepancy is not consistent with
the investor model principle that S should anticipate
a rate of return to its aggregate investment in the
CSA, over the whole period of its CSA Activity,
appropriate for the riskiness of its CSA Activity. The
inconsistency of the method with the investor model
materially lessens its reliability for purposes of a best
method analysis. See §1.482–1(c)(2)(ii)(B).
(iii)Consistency of evaluation with
realistic alternatives—(A)In general.
The relative reliability of an application
of a method also depends on the degree
of consistency of the analysis with the
assumption that uncontrolled taxpayers
dealing at arm’s length would have eval-
uated the terms of the transaction, and
only entered into such transaction, if no
alternative is preferable. This condition
is not met, therefore, where for any con-
trolled participant the total anticipated
present value of its income attributable to
its entering into the CSA, as of the date
of the PCT, is less than the total antic-
ipated present value of its income that
could be achieved through an alternative
arrangement realistically available to that
controlled participant. In principle, this
comparison is made on a post-tax basis
but, in many cases, a comparison made
on a pre-tax basis will yield equivalent
results. See also paragraph (g)(2)(v)(B)(1)
of this section (Discount rate variation
between realistic alternatives).
(B)Examples. The following examples
illustrate the principles of this paragraph
(g)(2)(iii):
Example 1. (i) P, a corporation, and S, a wholly-
owned subsidiary of P, enter into a CSA to develop
a personal transportation device (the product). Un-
der the arrangement, P will undertake all of the R&D,
and manufacture and market the product in Country
X. S will make CST Payments to P for its appropriate
share of P’s R&D costs, and manufacture and market
the product in the rest of the world. P owns existing
patents and trade secrets that are reasonably antici-
pated to contribute to the development of the product.
Therefore the rights in the patents and trade secrets
are platform contributions for which compensation is
due from S as part of a PCT.
(ii) S’s manufacturing and distribution activities
under the CSA will be routine in nature, and identical
to the activities it would undertake if it alternatively
licensed the product from P.
(iii) Reasonably reliable estimates indicate that P
could develop the product without assistance from
March 19, 20125212012–12 I.R.B.

S and license the product outside of Country X for
a royalty of 20% of sales. Based on reliable finan-
cial projections that include all future development
costs and licensing revenue that are allocable to the
non-Country X market, and using a discount rate ap-
propriate for the riskiness of P’s role as a licensor
(see paragraph (g)(2)(v) of this section), the post-tax
present value of this licensing alternative to P for the
non-Country X market (measured as of the date of
the PCT) would be $500 million. Thus, based on this
realistic alternative, the anticipated post-tax present
value under the CSA to P in the non-Country X mar-
ket (measured as of the date of the PCT), taking into
account anticipated development costs allocable to
the non-Country X market, and anticipated CST Pay-
ments and PCT Payments from S, and using a dis-
count rate appropriate for the riskiness of P’s role as
a participant in the CSA, should not be less than $500
million.
Example 2. (i) The facts are the same as inExam-
ple 1, except that there are no reliable estimates of the
value to P from the licensing alternative to the CSA.
Further, reasonably reliable estimates indicate that an
arm’s length return for S’s routine manufacturing and
distribution activities is a 10% mark-up on total costs
of goods sold plus operating expenses related to those
activities. Finally, the Commissioner determines that
the respective activities undertaken by P and S (other
than licensing payments, cost contributions, and PCT
Payments) would be identical regardless of whether
the arrangement was undertaken as a CSA (cost shar-
ing alternative) or as a long-term licensing arrange-
ment (licensing alternative). In particular, in both al-
ternatives, P would perform all research activities and
S would undertake routine manufacturing and distri-
bution activities associated with its territory.
(ii) P undertakes an economic analysis that de-
rives S’s cost contributions under the CSA, based on
reliable financial projections. Based on this and fur-
ther economic analysis, P determines S’s PCT Pay-
ment as a certain lump sum amount to be paid as of
thedateofthePCT(DateD).
(iii) Based on reliable financial projections that
include S’s cost contributions and that incorporate S’s
PCT Payment, as computed by P, and using a dis-
count rate appropriate for the riskiness of S’s role
as a CSA participant (see paragraphs (g)(2)(v) and
(4)(vi)(F) of this section), the anticipated post-tax net
present value to S in the cost sharing alternative (mea-
sured as of Date D) is $800 million. Further, based on
these same reliable projections (but incorporating S’s
licensing payments instead of S’s cost contributions
and PCT Payment), and using a discount rate appro-
priate for the riskiness of S’s role as a long-term li-
censee, the anticipated post-tax net present value to S
in the licensing alternative (measured as of Date D)
is $100 million. Thus, S’s anticipated post-tax net
present value is $700 million greater in the cost shar-
ing alternative than in the licensing alternative. This
result suggests that P’s anticipated post-tax present
value must be significantly less under the cost sharing
alternative than under the licensing alternative. This
means that the reliability of P’s analysis as described
in paragraph (ii) of thisExample 2is reduced, because
P would not be expected to enter into a CSA if its al-
ternative of being a long-term licensor is preferable.
Example 3. (i) The facts are the same as in para-
graphs (i) and (ii) ofExample 2. In addition, based
on reliable financial projections that include S’s cost
contributions and S’s PCT Payment, and using a dis-
count rate appropriate for the riskiness of S’s role as a
CSA participant, the anticipated post-tax net present
value to S under the CSA (measured as of the date of
the PCT) is $50 million. Also, instead of entering the
CSA, S has the realistic alternative of manufacturing
and distributing product Z unrelated to the personal
transportation device, with the same anticipated 10%
mark-up on total costs that it would anticipate for its
routine activities inExample 2. Under its realistic al-
ternative, at a discount rate appropriate for the risk-
iness of S’s role with respect to product Z, S antici-
pates a present value of $100 million.
(ii) Because the lump sum PCT Payment made by
S results in S having a considerably lower anticipated
net present value than S could achieve through an
alternative arrangement realistically available to it,
the reliability of P’s calculation of the lump sum PCT
Payment is reduced.
(iv)Aggregation of transactions.The
combined effect of multiple contempo-
raneous transactions, consisting either
of multiple PCTs, or of one or more
PCT and one or more other transactions
in connection with a CSA that are not
governed by this section (such as trans-
actions involving cross operating con-
tributions or make-or-sell rights), may
require evaluation in accordance with
the principles of aggregation described
in §1.482–1(f)(2)(i). In such cases, it
may be that the multiple transactions are
reasonably anticipated, as of the date of
the PCT(s), to be so interrelated that the
method that provides the most reliable
measure of an arm’s length charge is a
method under this section applied on an
aggregate basis for the PCT(s) and other
transactions. A section 482 adjustment
may be made by comparing the aggregate
arm’s length charge so determined to the
aggregate paymentsactually made for the
multiple transactions. In such a case, it
generally will not be necessary to allo-
cate separately the aggregate arm’s length
charge as between various PCTs or as be-
tween PCTs and such other transactions.
However, such an allocation may be nec-
essary for other purposes, such as applying
paragraph (i)(6) (Periodic adjustments) of
this section. An aggregate determination
of the arm’s length charge for multiple
transactions will often yield a payment
for a controlled participant that is equal
to the aggregate value of the platform
contributions and other resources, capa-
bilities, and rights covered by the multiple
transactions multiplied by that controlled
participant’s RAB share. Because RAB
shares only include benefits from cost
shared intangibles, the reliability of an
aggregate determination of payments for
multiple transactions may be reduced to
the extent that it includes transactions cov-
ering resources, capabilities, and rights
for which the controlled participants’ ex-
pected benefit shares differ substantially
from their RAB shares.
(v)Discount rate–(A)In general.The
best method analysis in connection with
certain methods or forms of payment may
depend on a rate or rates of return used
to convert projected results of transactions
to present value, or to otherwise convert
monetary amounts at one or more points in
time to equivalent amounts at a different
point or points in time. For this purpose,
a discount rate or rates should be used
that most reliably reflect the market-corre-
lated risks of activities or transactions and
should be applied to the best estimates of
the relevant projected results, based on all
the information potentially available at the
time for which the present value calcula-
tion is to be performed. Depending on
the particular facts and circumstances, the
market-correlated risk involved and thus,
the discount rate, may differ among a com-
pany’s various activities or transactions.
Normally, discount rates are most reliably
determined by reference to market infor-
mation.
(B)Considerations in best method
analysis of discount rate—(1)Discount
rate variation between realistic alterna-
tives. Realistic alternatives may involve
varying risk exposure and, thus, may be
more reliably evaluated using different
discount rates. See paragraphs (g)(4)(i)(F)
and (vi)(F) of this section. In some cir-
cumstances, a party may have less risk as a
licensee of intangibles needed in its opera-
tions, and so require a lower discount rate,
than it would have by entering into a CSA
to develop such intangibles, which may
involve the party’s assumption of addi-
tional risk in funding its cost contributions
to the IDA. Similarly, self-development
of intangibles and licensing out may be
riskier for the licensor, and so require a
higher discount rate, than entering into a
CSA to develop such intangibles, which
would relieve the licensor of the obligation
to fund a portion of the IDCs of the IDA.
(2) [Reserved].
(3)Discount rate variation between
forms of payment. Certain forms of pay-
ment may involve different risks than
others. For example, ordinarily a royalty
2012–12 I.R.B.522March 19, 2012

computed on a profits base would be more
volatile, and so require a higher discount
rate to discount projected payments to
present value, than a royalty computed on
a sales base.
(4)Post-tax rate. In general, discount
rate estimates that may be inferred from
the operations of the capital markets are
post-tax discount rates. Therefore, an anal-
ysis would in principle apply post-tax dis-
count rates to income net of expense items
including taxes (post-tax income). How-
ever, in certain circumstances the result of
applying a post-tax discount rate to post-
tax income is equivalent to the product of
the result of applying a post-tax discount
rate to income net of expense items other
than taxes (pre-tax income), and the dif-
ference of one minus the tax rate (as de-
fined in paragraph (j)(1)(i) of this section).
Therefore, in such circumstances, calcula-
tion of pre-tax income, rather than post-tax
income, may be sufficient. See, for exam-
ple, paragraph (g)(4)(i)(G) of this section.
(C)Example. The following example
illustrates the principles of this paragraph
(g)(2)(v):
Example. (i) P and S form a CSA to develop in-
tangible X, which will be used in product Y. P will
develop X, and S will make CST Payments as its cost
contributions. At the start of the CSA, P has a plat-
form contribution, for which S commits to make a
PCT Payment of 5% of its sales of product Y. As
part of the evaluation of whether that PCT Payment is
arm’s length, the Commissioner considers whether P
had a more favorable realistic alternative (see para-
graph (g)(2)(iii) of this section). Specifically, the
Commissioner compares P’s anticipated post-tax dis-
counted present value of the financial projections un-
der the CSA (taking into account S’s PCT Payment
of 5% of its sales of product Y) with P’s anticipated
post-tax discounted present value of the financial pro-
jections under a reasonably available alternative li-
censing that consists of developing intangible X on
its own and then licensing X to S or to an uncon-
trolled party similar to S. In undertaking the analysis,
the Commissioner determines that, because it would
be funding the entire development of the intangible,
P undertakes greater risks in the licensing alternative
than in the cost sharing alternative (in the cost shar-
ing alternative P would be funding only part of the
development of the intangible).
(ii) The Commissioner determines that, as be-
tween the two scenarios, all of the components of
P’s anticipated financial flows are identical, except
for the CST and PCT Payments under the CSA,
compared to the licensing payments under the li-
censing alternative. Accordingly, the Commissioner
concludes that the differences in market-correlated
risks between the two scenarios, and therefore the
differences in discount rates between the two scenar-
ios, relate to the differences in these components of
the financial projections.
(vi)Financial projections. The reliabil-
ity of an estimate of the value of a platform
or operating contribution in connection
with a PCT will often depend upon the
reliability of projections used in making
the estimate. Such projections should
reflect the best estimates of the items pro-
jected (normally reflecting a probability
weighted average of possible outcomes
and thus also reflecting non-market-cor-
related risk). Projections necessary for
this purpose may include a projection of
sales, IDCs, costs of developing operating
contributions, routine operating expenses,
and costs of sales. Some method applica-
tions directly estimate projections of items
attributable to separate development and
exploitation by the controlled participants
within their respective divisions. Other
method applications indirectly estimate
projections of items from the perspective
of the controlled group as a whole, rather
than from the perspective of a particular
participant, and then apportion the items
soestimatedonsomeassumedbasis.
For example, in some applications, sales
might be directly projected by division,
but worldwide projections of other items
such as operating expenses might be ap-
portioned among divisions in the same
ratio as the divisions’ respective sales.
Which approach is more reliable depends
on which provides the most reliable mea-
sure of an arm’s length result, considering
the competing perspectives under the facts
and circumstances in light of the com-
pleteness and accuracy of the underlying
data, the reliability of the assumptions,
and the sensitivity of the results to possible
deficiencies in the data and assumptions.
For these purposes, projections that have
been prepared for non-tax purposes are
generally more reliable than projections
that have been prepared solely for pur-
poses of meeting the requirements in this
paragraph (g).
(vii)Accounting principles—(A)In
general. Allocations or other valuations
done for accountingpurposes may provide
a useful starting point but will not be con-
clusive for purposes of the best method
analysis in evaluating the arm’s length
charge in a PCT, particularly where the
accounting treatment of an asset is incon-
sistent with its economic value.
(B)Examples. The following examples
illustrate the principles of this paragraph
(g)(2)(vii):
Example 1. (i) USP, a U.S. corporation and FSub,
a wholly-owned foreign subsidiary of USP, enter into
a CSA in Year 1 to develop software programs with
application in the medical field. Company X is an
uncontrolled software company located in the United
States that is engaged in developing software pro-
grams that could significantly enhance the programs
being developed by USP and FSub. Company X
is still in a startup phase, so it has no currently ex-
ploitable products or marketing intangibles and its
workforce consists of a team of software develop-
ers. Company X has negligible liabilities and tangible
property. In Year 2, USP purchases Company X as
part of an uncontrolled transaction in order to acquire
its in-process technology and workforce for purposes
of the development activities of the CSA. USP files
a consolidated return thatincludes Company X. For
accounting purposes, $50 million of the $100 million
acquisition price is allocated to the in-process tech-
nology and workforce, and the residual $50 million
is allocated to goodwill.
(ii) The in-process technology and workforce of
Company X acquired by USP are reasonably antici-
pated to contribute to developing cost shared intangi-
bles and therefore the rights in the in-process technol-
ogy and workforce of Company X are platform con-
tributions for which FSub must compensate USP as
part of a PCT. In determining whether to apply the
acquisition price or another method for purposes of
evaluating the arm’s length charge in the PCT, rel-
evant best method analysis considerations must be
weighed in light of the general principles of para-
graph (g)(2) of this section. The allocation for ac-
counting purposes raises an issue as to the reliability
of using the acquisition price method in this case be-
cause it suggests that a significant portion of the value
of Company X’s nonroutine contributions to USP’s
business activities is allocable to goodwill, which is
often difficult to value reliably and which, depending
on the facts and circumstances, might not be attribut-
able to platform contributions that are to be compen-
sated by PCTs. See paragraph (g)(5)(iv)(A) of this
section.
(iii) Paragraph (g)(2)(vii)(A) of this section pro-
vides that accounting treatment may be a starting
point, but is not determinative for purposes of assess-
ing or applying methods to evaluate the arm’s length
charge in a PCT. The facts here reveal that Com-
pany X has nothing of economic value aside from
its in-process technology and assembled workforce.
The $50 million of the acquisition price allocated
to goodwill for accounting purposes, therefore, is
economically attributable to either of, or both, the
in-process technology and the workforce. That
moots the potential issue under the acquisition price
method of the reliability of valuation of assets not
to be compensated by PCTs, since there are no such
assets. Assuming the acquisition price method is
otherwise the most reliable method, the aggregate
value of Company X’s in-process technology and
workforce is the full acquisition price of $100 mil-
lion. Accordingly, the aggregate value of the arm’s
length PCT Payments due from FSub to USP for
the platform contributions consisting of the rights in
Company X’s in-process technology and workforce
will equal $100 million multiplied by FSub’s RAB
share.
Example 2. (i) The facts are the same as inExam-
ple 1, except that Company X is a mature software
March 19, 20125232012–12 I.R.B.

business in the United States with a successful cur-
rent generation of software that it markets under a
recognized trademark, in addition to having the re-
search team and new generation software in process
that could significantly enhance the programs being
developed under USP’s and FSub’s CSA. USP con-
tinues Company X’s existing business and integrates
the research team and the in-process technology into
the efforts under its CSA with FSub. For accounting
purposes, the $100 million price for acquiring Com-
pany X is allocated $50 million to existing software
and trademark, $25 million to in-process technology
and research workforce, and the residual $25 million
to goodwill and going concern value.
(ii) In this case an analysis of the facts indicates
a likelihood that, consistent with the allocation un-
der the accounting treatment (although not necessar-
ily in the same amount), a significant amount of the
nonroutine contributions to the USP’s business ac-
tivities consist of goodwill and going concern value
economically attributable to the existing U.S. soft-
ware business rather than to the platform contribu-
tions consisting of the rights in the in-process tech-
nology and research workforce. In addition, an anal-
ysis of the facts indicates that a significant amount of
the nonroutine contributions to USP’s business activ-
ities consist of the make-or-sell rights under the ex-
isting software and trademark, which are not platform
contributions and might be difficult to value. Accord-
ingly, further consideration must be given to the ex-
tent to which these circumstances reduce the relative
reliability of the acquisition price method in compar-
ison to other potentially applicable methods for eval-
uating the PCT Payment.
Example 3. (i) USP, a U.S. corporation, and FSub,
a wholly-owned foreign subsidiary of USP, enter into
a CSA in Year 1 to develop Product A. Company Y
is an uncontrolled corporation that owns Technology
X, which is critical to the development of Product
A. Company Y currently markets Product B, which
is dependent on Technology X. USP is solely inter-
ested in acquiring Technology X, but is only able to
do so through the acquisition of Company Y in its en-
tirety for $200 million in an uncontrolled transaction
in Year 2. For accounting purposes, the acquisition
price is allocated as follows: $120 million to Product
B and the underlying Technology X, $30 million to
trademark and other marketing intangibles, and the
residual $50 million to goodwill and going concern
value. After the acquisition of Company Y, Technol-
ogy X is used to develop Product A. No other part
of Company Y is used in any manner. Immediately
after the acquisition, product B is discontinued, and,
therefore, the accompanying marketing intangibles
become worthless. None of the previous employees
of Company Y is retained.
(ii) The Technology X of Company Y acquired
by USP is reasonably anticipated to contribute to de-
veloping cost shared intangibles and is therefore a
platform contribution for which FSub must compen-
sate USP as part of a PCT. Although for account-
ing purposes a significant portion of the acquisition
price of Company Y was allocated to items other than
Technology X, the facts demonstrate that USP had
no intention of using and therefore placed no eco-
nomic value on any part of Company Y other than
Technology X. If USP was willing to pay $200 mil-
lion for Company Y solely for purposes of acquiring
Technology X, then assuming the acquisition price
method is otherwise the most reliable method, the
value of Technology X is the full $200 million ac-
quisition price. Accordingly, the value of the arm’s
length PCT Payment due from FSub to USP for the
platform contribution consisting of the rights in Tech-
nology X will equal the product of $200 million and
FSub’s RAB share.
(viii)Valuations of subsequent
PCTs—(A)Date of subsequent PCT.The
date of a PCT may occur subsequent to
the inception of the CSA. For example,
an intangible initially developed outside
the IDA may only subsequently become
a platform contribution because that later
time is the earliest date on which it is
reasonably anticipated to contribute to
developing cost shared intangibles within
the IDA. In such case, the date of the
PCT, and the analysis of the arm’s length
amount charged in the subsequent PCT, is
as of such later time.
(B)Best method analysis for subse-
quent PCT. In cases where PCTs occur on
different dates, the determination of the
arm’s length amount charged, respectively,
in the prior and subsequent PCTs must
be coordinated in a manner that provides
the most reliable measure of an arm’s
length result. In some circumstances, a
subsequent PCT may be reliably evaluated
independently of other PCTs, as may be
possible for example, under the acquisition
price method. In other circumstances, the
results of prior and subsequent PCTs may
be interrelated and so a subsequent PCT
may be most reliably evaluated under the
residual profit split method of paragraph
(g)(7) of this section. In those cases, for
purposes of allocating the present value
of nonroutine residual divisional profit
or loss, and so determining the present
value of the subsequent PCT Payments, in
accordance with paragraph (g)(7)(iii)(C)
of this section, the PCT Payor’s interest
in cost shared intangibles, both already
developed and in process, are treated as
additional PCT Payoroperating contribu-
tions as of the date of the subsequent PCT.
(ix)Arm’s length range—(A)In gen-
eral. The guidance in §1.482–1(e) re-
garding determination of an arm’s length
range, as modified by this section, applies
in evaluating the arm’s length amount
charged in a PCT under a transfer pricing
method provided in this section (appli-
cable method). Section 1.482–1(e)(2)(i)
provides that the arm’s length range is
ordinarily determined by applying a single
pricing method selected under the best
method rule to two or more uncontrolled
transactions of similar comparability and
reliability although use of more than one
method may be appropriate for the pur-
poses described in §1.482–1(c)(2)(iii).
The rules provided in §1.482–1(e) and this
section for determining an arm’s length
range shall not override the rules provided
in paragraph (i)(6) of this section for pe-
riodic adjustments by the Commissioner.
The provisions in paragraphs (g)(2)(ix)(C)
and (D) of this section apply only to ap-
plicable methods that are based on two
or more input parameters as described in
paragraph (g)(2)(ix)(B) of this section.
For an example of how the rules of this
section for determining an arm’s length
range of PCT Payments are applied, see
paragraph (g)(4)(viii) of this section.
(B)Methods based on two or more in-
put parameters. An applicable method
may determine PCT Payments based on
calculations involving two or more param-
eters whose values depend on the facts and
circumstances of the case (input parame-
ters). For some input parameters (market-
based input parameters), the value is most
reliably determined by reference to data
that derives from uncontrolled transactions
(market data). For example, the value of
the return to a controlled participant’s rou-
tine contributions, as such term is defined
in paragraph (j)(1)(i) of this section, to the
CSA Activity (which value is used as an
input parameter in the income method de-
scribed in paragraph (g)(4) of this section)
may in some cases be most reliably deter-
mined by reference to the profit level of
a company with rights, resources, and ca-
pabilities comparable to those routine con-
tributions. See §1.482–5. As another ex-
ample, the value for the discount rate that
reflects the riskiness of a controlled par-
ticipant’s role in the CSA (which value is
used as an input parameter in the income
method described in paragraph (g)(4) of
this section) may in some cases be most re-
liably determined by reference to the stock
beta of a company whose overall risk is
comparable to the riskiness of the con-
trolled participant’s role in the CSA.
(C)Variable input parameters.For
some market-based input parameters
(variable input parameters), the param-
eter’s value is most reliably determined
by considering two or more observa-
tions of market data that have, or with
adjustment can be brought to, a similar
2012–12 I.R.B.524March 19, 2012

reliability and comparability, as described
in §1.482–1(e)(2)(ii) (for example, profit
levels or stock betas of two or more com-
panies). See paragraph (g)(2)(ix)(B) of
this section.
(D)Determination of arm’s length PCT
Payment. For purposes of applying this
paragraph (g)(2)(ix), each input parameter
is assigned a single most reliable value,
unless it is a variable input parameter as
described in paragraph (g)(2)(ix)(C) of this
section. The determination of the arm’s
length payment depends on the number of
variable input parameters.
(1)No variable input parameters.If
there are no variable input parameters,
the arm’s length PCT Payment is a single
value determined by using the single most
reliable value determined for each input
parameter.
(2)One variable input parameter.If
there is exactly one variable input param-
eter, then under the applicable method,
the arm’s length range of PCT Payments
is the interquartile range, as described in
§1.482–1(e)(2)(iii)(C), of the set of PCT
Payment values calculated by selecting—
(i) Iteratively, the value of the vari-
able input parameter that is based on each
observation as described in paragraph
(g)(2)(ix)(C) of this section; and
(ii) The single most reliable values for
each other input parameter.
(3)More than one variable input pa-
rameter. If there are two or more vari-
able input parameters, then under the ap-
plicable method, thearm’s length range of
PCT Payments is the interquartile range, as
described in §1.482–1(e)(2)(iii)(C), of the
set of PCT Payment values calculated iter-
atively using every possible combination
of permitted choices of values for the in-
put parameters. For input parameters other
than a variable input parameter, the only
such permitted choice is the single most
reliable value. For variable input param-
eters, such permitted choices include any
value that is—
(i) Based on one of the observations
described in paragraph (g)(2)(ix)(C) of this
section; and
(ii) Within the interquartile range (as
described in §1.482–1(e)(2)(iii)(C)) of the
set of all values so based.
(E)Adjustments.Section
1.482–1(e)(3), applied as modified by this
paragraph (g)(2)(ix), determines when the
Commissioner may make an adjustment
to a PCT Payment due to the taxpayer’s
results being outside the arm’s length
range. Adjustment will be to the median,
as defined in §1.482–1(e)(3). Thus, the
Commissioner is not requiredtoestablish
an arm’s length range prior to making an
allocation under section 482.
(x)Valuation undertaken on a pre-tax
basis. PCT Payments in general may in-
crease the PCT Payee’s tax liability and de-
crease the PCT Payor’s tax liability. The
arm’s length amount of a PCT Payment de-
termined under the methods in this para-
graph (g) is the value of the PCT Pay-
ment itself, without regard to such tax ef-
fects. Therefore, the methods under this
section must be applied, with suitable ad-
justments if needed, to determine the PCT
Payments on a pre-tax basis. See para-
graphs (g)(2)(v)(B) and (4)(i)(G) of this
section.
(3)Comparable uncontrolled transac-
tion method. The comparable uncontrolled
transaction (CUT) method described in
§1.482–4(c), and the comparable uncon-
trolled services price (CUSP) method
described in §1.482–9(c), may be applied
to evaluate whether the amount charged
in a PCT is arm’s length by reference to
the amount charged in a comparable un-
controlled transaction. Although all of
the factors entering into a best method
analysis described in §1.482–1(c) and (d)
must be considered, comparability and re-
liability under this method are particularly
dependent on similarity of contractual
terms, degree to which allocation of risks
is proportional to reasonably anticipated
benefits from exploiting the results of
intangible development, similar period
of commitment as to the sharing of in-
tangible development risks, and similar
scope, uncertainty, and profit potential of
the subject intangible development, in-
cluding a similar allocation of the risks
of any existing resources, capabilities, or
rights,aswellasoftherisksofdeveloping
other resources, capabilities, or rights that
would be reasonably anticipated to con-
tribute to exploitation within the parties’
divisions, that is consistent with the actual
allocation of risks between the controlled
participants as provided in the CSA in ac-
cordance with this section. When applied
in the manner described in §1.482–4(c)
or 1.482–9(c), the CUT or CUSP method
will typically yield an arm’s length total
value for the platform contribution that is
the subject of the PCT. That value must
then be multiplied by each PCT Payor’s
respective RAB share in order to deter-
mine the arm’s length PCT Payment due
from each PCT Payor. The reliability of
a CUT or CUSP that yields a value for
the platform contribution only in the PCT
Payor’s division will be reduced to the
extent that value is not consistent with the
total worldwide value of the platform con-
tribution multiplied by the PCT Payor’s
RAB share.
(4)Income method—(i)In gen-
eral—(A)Equating cost sharing and li-
censing alternatives. The income method
evaluates whether the amount charged in
a PCT is arm’s length by reference to a
controlled participant’s best realistic al-
ternative to entering into a CSA. Under
this method, the arm’s length charge for a
PCT Payment will be an amount such that
a controlled participant’s present value, as
of the date of the PCT, of its cost sharing
alternative of entering into a CSA equals
the present value of its best realistic al-
ternative. In general, the best realistic
alternative of the PCT Payor to entering
into the CSA would be to license intangi-
bles to be developed by an uncontrolled
licensor that undertakes the commitment
to bear the entire risk of intangible devel-
opment that would otherwise have been
shared under the CSA. Similarly, the best
realistic alternative of the PCT Payee to
entering into the CSA would be to under-
take the commitment to bear the entire
risk of intangible development that would
otherwise have been shared under the
CSA and license the resulting intangibles
to an uncontrolled licensee. Paragraphs
(g)(4)(i)(B) through (vi) of this section de-
scribe specific applications of the income
method, but do not exclude other possible
applications of this method.
(B)Cost sharing alternative.ThePCT
Payor’s cost sharing alternative corre-
sponds to the actual CSA in accordance
with this section, with the PCT Payor’s
obligation to make the PCT Payments to
be determined and its commitment for the
duration of the IDA to bear cost contribu-
tions.
(C)Licensing alternative. The licens-
ing alternative is derived on the basis of
a functional and risk analysis of the cost
sharing alternative, but with a shift of the
risk of cost contributions to the licensor.
Accordingly, the PCT Payor’s licensing
March 19, 20125252012–12 I.R.B.

alternative consists of entering into a li-
cense with an uncontrolled party, for a
term extending for what would be the du-
ration of the CSA Activity, to license the
make-or-sell rights in to-be-developed re-
sources, capabilities,orrightsoftheli-
censor. Under such license, the licensor
would undertake the commitment to bear
the entire risk of intangible development
that would otherwise have been shared un-
der the CSA. Apart from any difference in
the allocation of the risks of the IDA, the li-
censing alternative should assume contrac-
tual provisions with regard to non-over-
lapping divisional intangible interests, and
with regard to allocations of other risks,
that are consistent with the actual CSA in
accordance with this section. For exam-
ple, the analysis under the licensing alter-
native should assume a similar allocation
of the risks of any existing resources, capa-
bilities, or rights, as well as of the risks of
developing other resources, capabilities, or
rights that would be reasonably anticipated
to contribute to exploitation within the par-
ties’ divisions, that is consistent with the
actual allocation of risks between the con-
trolled participants as provided in the CSA
in accordance with thissection. Accord-
ingly, the financial projections associated
with the licensing and cost sharing alter-
natives are necessarily the same except for
the licensing payments to be made under
the licensing alternative and the cost con-
tributions and PCT Payments to be made
under the CSA.
(D)Only one controlled participant
with nonroutine platform contributions.
This method involves only one of the con-
trolled participants providing nonroutine
platform contributions as the PCT Payee.
For a method under which more than
one controlled participant may be a PCT
Payee, see the application of the residual
profit method pursuant to paragraph (g)(7)
of this section.
(E)Income method payment forms.The
income method may be applied to deter-
mine PCT Payments in any form of pay-
ment (for example, lump sum, royalty on
sales, or royalty on divisional profit). For
converting to another form of payment, see
generally paragraph (h) (Form of payment
rules) of this section.
(F)Discount rates appropriate to cost
sharing and licensing alternatives.The
present value of the cost sharing and li-
censing alternatives, respectively, should
be determined using the appropriate dis-
count rates in accordance with paragraphs
(g)(2)(v) and (g)(4)(vi)(F) of this section.
See, for example, §1.482–7(g)(2)(v)(B)(1)
(Discount rate variation between realistic
alternatives). In circumstances where the
market-correlated risks as between the
cost sharing and licensing alternatives are
not materially different, a reliable analysis
maybepossiblebyusingthesamedis-
count rate with respect to both alternatives.
(G)The effect of taxation on deter-
mining the arm’s length amount.(1)In
principle, the present values of the cost
sharing and licensing alternatives should
be determined by applying post-tax dis-
count rates to post-tax income (including
the post-tax value to the controlled par-
ticipant of the PCT Payments). If such
approach is adopted, then the post-tax
value of the PCT Payments must be appro-
priately adjusted in order to determine the
arm’s length amount of the PCT Payments
on a pre-tax basis. See paragraph (g)(2)(x)
of this section.
(2) In certain circumstances, post-tax
income may be derived as the product of
the result of applying a post-tax discount
rate to pre-tax income, and a factor equal
to one minus the tax rate (as defined in
(j)(1)(i)). See paragraph (g)(2)(v)(B) of
this section.
(3) To the extent that a controlled par-
ticipant’s tax rate is not materially affected
by whether it enters into the cost sharing
or licensing alternative (or reliable adjust-
ments may be made for varying tax rates),
the factor (that is, one minus the tax rate)
may be cancelled from both sides of the
equation of the cost sharing and licensing
alternative presentvalues. Accordingly,
in such circumstance it is sufficient to ap-
ply post-tax discount rates to projections of
pre-tax income for the purpose of equating
the cost sharing and licensing alternatives.
The specific applications of the income
method described in paragraphs (g)(4)(ii)
through (iv) of this section and the exam-
ples set forth in paragraph (g)(4)(viii) of
this section assume that a controlled par-
ticipant’s tax rate is not materially affected
by whether it enters into the cost sharing or
licensing alternative.
(ii)Evaluation of PCT Payor’s cost
sharing alternative. The present value of
the PCT Payor’s cost sharing alternative
is the present value of the stream of the
reasonably anticipated residuals over the
duration of the CSA Activity of divisional
profits or losses, minus operating cost
contributions, minus cost contributions,
minus PCT Payments.
(iii)Evaluation of PCT Payor’s licens-
ing alternative—(A)Evaluation based
on CUT. The present value of the PCT
Payor’s licensing alternative may be de-
termined using the comparable uncon-
trolled transaction method, as described in
§1.482–4(c)(1) and (2). In this case, the
present value of the PCT Payor’s licens-
ing alternative is the present value of the
stream, over what would be the duration
of the CSA Activity under the cost sharing
alternative, of the reasonably anticipated
residuals of the divisional profits or losses
that would be achieved under the cost
sharing alternative, minus operating cost
contributions that would be made under
the cost sharing alternative, minus the
licensing payments as determined under
the comparable uncontrolled transaction
method.
(B)Evaluation based on CPM.The
present value of the PCT Payor’s licensing
alternative may be determined using the
comparable profits method, as described
in §1.482–5. In this case, the present value
of the licensing alternative is determined
as in paragraph (g)(4)(iii)(A) of this sec-
tion, except that the PCT Payor’s licensing
payments, as defined in paragraph (j)(1)(i)
of this section, are determined in each
period to equal the reasonably anticipated
residuals of the divisional profits or losses
that would be achieved under the cost
sharing alternative, minus operating cost
contributions that would be made under
the cost sharing alternative, minus market
returns for routine contributions, as de-
fined in paragraph (j)(1)(i) of this section.
However, treatment of net operating con-
tributions as operating cost contributions
shall be coordinated with the treatment
of other routine contributions pursuant to
this paragraph so as to avoid duplicative
market returns to such contributions.
(iv)Lump sum payment form.Where
the form of PCT Payment is a lump sum as
of the date of the PCT, then, based on para-
graphs (g)(4)(i) through (iii) of this sec-
tion, the PCT Payment equals the differ-
ence between—
(A) The present value, using the dis-
count rate appropriate for the cost sharing
alternative, of the stream of the reasonably
anticipated residuals over the duration of
2012–12 I.R.B.526March 19, 2012

the CSA Activity of divisional profits or
losses, minus cost contributions and oper-
ating cost contributions; and
(B) The present value of the licensing
alternative.
(v) [Reserved].
(vi)Best method analysis considera-
tions.(A)Coordination with §1.482–1(c).
Whether results derived from this method
are the most reliable measure of an arm’s
length result is determined using the fac-
tors described under the best method rule
in §1.482–1(c). Thus, comparability and
the quality of data, the reliability of the as-
sumptions, and the sensitivity of the results
to possible deficiencies in the data and as-
sumptions, must be considered in deter-
mining whether this method provides the
most reliable measure of an arm’s length
result.
(B)Assumptions Concerning Tax Rates.
This method will be more reliable to the
extent that the controlled participants’
respective tax rates are not materially af-
fected by whether they enter into the cost
sharing or licensing alternative. Even
if this assumption of invariant tax rates
across alternatives does not hold, this
method may still be reliable to the extent
that reliable adjustments can be made to
reflect the variation in tax rates.
(C)Coordination with §1.482–4(c)(2).
If the licensing alternative is evaluated
using the comparable uncontrolled trans-
actions method, as described in paragraph
(g)(4)(iii)(A) of this section, any additional
comparability and reliability considera-
tions stated in §1.482–4(c)(2) may apply.
(D)Coordination with §1.482–5(c).
If the licensing alternative is evaluated
using the comparableprofits method, as
described in paragraph (g)(4)(iii)(B) of
this section, any additional comparabil-
ity and reliability considerations stated in
§1.482–5(c) may apply.
(E)Certain Circumstances Concerning
PCT Payor. This method may be used
even if the PCT Payor furnishes signifi-
cant operating contributions, or commits
to assume the risk of significant operating
cost contributions, to the PCT Payor’s
division. However, in such a case, any
comparable uncontrolled transactions de-
scribed in paragraph (g)(4)(iii)(A) of this
section, and any comparable transactions
used under §1.482–5(c) as described in
paragraphs (g)(4)(iii)(B) of this section,
should be consistent with such contri-
butions (or reliable adjustments must be
made for material differences).
(F)Discount rates.
(1)Reflection of similar risk profiles
of cost sharing alternative and licensing
alternative. Because the financial pro-
jections associated with the licensing and
cost sharing alternatives are the same,
except for the licensing payments to be
made under the licensing alternative and
the cost contributions and PCT Payments
to be made under the cost sharing alter-
native, the analysis of the risk profile and
financial projections for a realistic alter-
native to the cost sharing alternative must
be closely associated with the risk profile
and financial projections associated with
the cost sharing alternative, differing only
in the treatment of licensing payments,
cost contributions, and PCT Payments.
When using discount rates in applying
the income method, this means that even
if different discount rates are warranted
for the two alternatives, the risk profiles
for the two discount rates are closely re-
lated to each other because the discount
rate for the licensing alternative and the
discount rate for the cost sharing alter-
native are both derived from the single
probability-weighted financial projections
associated with the CSA Activity. The dif-
ference, if any, in market-correlated risks
between the licensing and cost sharing
alternatives is due solely to the different
effects on risks of the PCT Payor making
licensing paymentsunder the licensing
alternative, on the one hand, and the PCT
Payor making cost contributions and PCT
Payments under the cost sharing alter-
native, on the other hand. That is, the
difference in the risk profile between the
two scenarios solely reflects the incremen-
tal risk, if any, associated with the cost
contributions taken on by the PCT Payor
in developing the cost shared intangible
under the cost sharing alternative, and
the difference, if any, in risk associated
with the particular payment forms of the
licensing payments and the PCT Pay-
ments, in light of the fact that the licensing
payments in the licensing alternative are
partially replaced by cost contributions
and partially replaced by PCT Payments
in the cost sharing alternative, each with
its own payment form. An analysis under
the income method that uses a different
discount rate for the cost sharing alterna-
tive than for the licensing alternative will
be more reliable the greater the extent to
which the difference, if any, between the
two discount rates reflects solely these
differences in the risk profiles of these two
alternatives. See, for example, paragraph
(g)(2)(iii),Example 2of this section.
(2) [Reserved].
(vii)Routine platform and operating
contributions. For purposes of this para-
graph (g)(4), any routine contributions that
are platform or operating contributions, the
valuation and PCT Payments for which
are determined and made independently of
the income method, are treated similarly
to cost contributions and operating cost
contributions, respectively. Accordingly,
wherever used in this paragraph (g)(4), the
term “routine contributions” shall not in-
clude routine platform or operating contri-
butions, and wherever the terms “cost con-
tributions” and “operating cost contribu-
tions” appear in this paragraph, they shall
include net routine platform contributions
and net routine operating contributions, re-
spectively. Net routine platform contribu-
tions are the value of a controlled partici-
pant’s total reasonably anticipated routine
platform contributions, plus its reasonably
anticipated PCT Payments to other con-
trolled participants in respect of their rou-
tine platform contributions, minus the rea-
sonably anticipated PCT Payments it is to
receive from other controlled participants
in respect of its routine platform contri-
butions. Net routine operating contribu-
tions are the value of a controlled par-
ticipant’s total reasonably anticipated rou-
tine operating contributions, plus its rea-
sonably anticipated arm’s length compen-
sation to other controlled participants in
respect of their routine operating contri-
butions, minus the reasonably anticipated
arm’s length compensation it is to receive
from other controlled participants in re-
spect of its routine operating contributions.
(viii)Examples. The following exam-
ples illustrate the principles of this para-
graph (g)(4):
Example 1. (i) For simplicity of calculation in this
Example 1, all financial flows are assumed to occur at
the beginning of each period. USP, a software com-
pany, has developed version 1.0 of a new software
application that it is currently marketing. In Year 1
USP enters into a CSA with its wholly-owned for-
eign subsidiary, FS, to develop future versions of the
software application. Under the CSA, USP will have
the rights to exploit the future versions in the United
States, and FS will have the rights to exploit them in
the rest of the world. The future rights in version 1.0,
and USP’s development team, are reasonably antici-
March 19, 20125272012–12 I.R.B.

pated to contribute to the development of future ver-
sions and therefore the rights in version 1.0 and the re-
search and development team are platform contribu-
tions for which compensation is due from FS as part
of a PCT. USP does not transfer the current exploita-
tion rights in version 1.0 to FS. FS will not perform
any research or development activities and does not
furnish any platform contributions nor does it control
any operating intangibles at the inception of the CSA
that would be relevant to the exploitation of version
1.0 or future versions of the software.
(ii) FS undertakes financial projections in its ter-
ritory of the CSA:
(1)
Year
(2)
Sales
(3)
Operating costs
(4)
Cost contributions
(5)
Operating income under cost sharing
alternative (excluding PCT)
100
50-50
200
50-50
3200100
5050
4400200
50150
5
60030060240
6
65032565
260
7
700
350
70280
8
75037575
300
9
75037575
300
10
675
33868269
1160830461243
12
547
273
55
219
13410
205
41164
14308
154
31123
15
231
115
2393
FS anticipates that activity on this application will
cease after Year 15. The application was derived from
software developed by Company Q, an uncontrolled
party. FS has a license under Company Q’s copyright,
but that license expires after Year 15 and will not be
renewed.
(iii) In evaluating the cost sharing alternative, FS
concludes that the cost sharing alternative represents
a riskier alternative for FS than the licensing alterna-
tive because, in cost sharing, FS will take on the ad-
ditional risks associated with cost contributions. Tak-
ing this difference into account, FS concludes that the
appropriate discount rate to apply in assessing the li-
censing alternative, based on discount rates of com-
parable uncontrolled companies undertaking compa-
rable licensing transactions, would be 13% per year,
whereas the appropriate discount rate to apply in as-
sessing the cost sharing alternative would be 15% per
year. FS determines that the arm’s length rate USP
would have charged an uncontrolled licensee for a li-
cense of future versions of the software (if USP had
further developed version 1.0 on its own) is 35% of
the sales price, as determined under the CUT method
in §1.482–4(c). FS also determines that the tax rate
applicable to it will be the same in the licensing alter-
native as in the CSA. Accordingly, the financial pro-
jections associated with the licensing alternative are:
(6)
Year
(7)
Sales
(8)
Operating costs
(9)
Licensing payments
(10)
Operating income under licensing
alternative
(11)
Operating income under cost sharing
alternative minus operating income
under licensing alternative
10 000
-50
20 000
-50
3200100703020
44002001406090
5
60030021090
150
6
650325
22897163
7
700
350245105175
8
750375
263112188
9
750375
263112188
10
675
338236101168
1160830421391
152
12
547
27319183136
2012–12 I.R.B.528March 19, 2012

(6)
Year
(7)
Sales
(8)
Operating costs
(9)
Licensing payments
(10)
Operating income under licensing
alternative
(11)
Operating income under cost sharing
alternative minus operating income
under licensing alternative
13410
205
14461103
14308
154
10846
77
15
231
115
81
3558
(iv) Based on these projections and applying the
appropriate discount rate, FS determines that under
the cost sharing alternative, the present value of the
stream of residuals of its anticipated divisional prof-
its, reduced by the anticipated operating cost contri-
butions and cost contributions, but not reduced by any
PCT Payments (that is, the stream of anticipated op-
erating income as shown in column 5) would be $889
million. Under the licensing alternative, the present
value of the stream of residuals of its anticipated di-
visional profits and losses minus the operating cost
contributions (that is, the stream of anticipated op-
erating income before licensing payments, which is
the present value of column 7 reduced by column 8)
would be $1.419 billion, and the present value of the
licensing payments would be $994 million. There-
fore, the total value of the licensing alternative would
be $425 million. In order for the present value of
the cost sharing alternative to equal the present value
of the licensing alternative, the present value of the
PCT Payments must equal $464 million. Therefore,
the taxpayer makes and reports PCT Payments with a
present value of $464 million.
Example 2.Arm’s length range. (i) The facts
are the same as inExample 1. The Commissioner
accepts the financial projections undertaken by FS.
Further, the Commissioner determines that the licens-
ing discount rate and the CUT licensing rate are most
reliably determined by reference to comparable un-
controlled discount rates and license rates, respec-
tively. The observations that are in the interquartile
range of the respective input parameters (see para-
graph (g)(2)(ix) of this section) are as follows:
Observations that are within interquartile rangeComparable uncontrolled discount rate
111%
212%
3 (Median)13%
4
15%
5
17%
Observations that are within interquartile rangeComparable uncontrolled licensing rate
130%
232%
3 (Median)
35%
437%
5
40%
(ii) Following the principles of paragraph
(g)(2)(ix) of this section, the Commissioner under-
takes 25 different applications of the income method,
using each combination of the discount rate and li-
censing rate parameters. In undertaking this analysi
s,
the Commissioner assumes that the ratio of the me-
dian discount rate for the cost sharing alternative to
the median discount rate for the licensing alternati
ve
(that is, 15% to 13%) is maintained. The results of
the 25 applications of the income method, sorted in
ascending order of calculated present value of the
PCT Payment, are as follows:
Income method
application number:
Comparable
uncontrolled licensing
discount rate
Comparable
uncontrolled CSA
discount rate
Comparable
uncontrolled licensing
rate
Calculated lump sum
PCT Payment
Interquartile range of
PCT Payments
117%19.6%30%217
217%19.6%32%263
3
15%
17.3%30%264
4
15%
17.3%32%
315
5
13%
15%
30%321
617%19.6%
35%
331
7
12%13.8%30%
354LQ = 354
817%19.6%37%376
913%
15%
32%378
March 19, 20125292012–12 I.R.B.

Income method
application number:
Comparable
uncontrolled licensing
discount rate
Comparable
uncontrolled CSA
discount rate
Comparable
uncontrolled licensing
rate
Calculated lump sum
PCT Payment
Interquartile range of
PCT Payments
1011%12.7%30%391
11
15%
17.3%
35%
391
1212%13.8%32%
415
13
15%
17.3%37%442Median = 442
1417%19.6%40%444
15
11%12.7%32%
455
1613%
15%35%
464
1712%13.8%
35%505
18
15%
17.3%40%
517
1913%
15%
37%
520UQ = 520
2011%12.7%
35%551
2112%13.8%37%
566
2213%
15%
40%
605
2311%12.7%37%
615
2412%13.8%40%
655
25
11%12.7%40%710
(iii) Accordingly, the Commissioner determines
that a taxpayer will not be subject to adjustment if
its initial (ex ante) determination of the present value
of PCT Payments is between $354 million and $520
million (the lower and upper quartile results as shown
in the last column). Because FS’s determination of
the present value of the PCT Payments, $464 million,
is within the interquartile range, no adjustments are
warranted.
Example 3. (i) For simplicity of calculation in this
Example 3, all financial flows are assumed to occur
at the beginning of each period. USP, a U.S. soft-
ware company, has developed version 1.0 of a new
software application, employed to store and retrieve
complex data sets in certain types of storage media.
Version 1.0 is currently being marketed. In Year 1,
USPentersintoaCSAwithitswholly-ownedfor-
eign subsidiary, FS, to develop future versions of the
software application. Under the CSA, USP will have
the exclusive rights to exploit the future versions in
the U.S., and FS will have the exclusive rights to ex-
ploit them in the rest of the world. USP’s rights in
version 1.0, and its development team, are reason-
ably anticipated to contribute to the development of
future versions of the software application and, there-
fore, the rights in version 1.0 are platform contribu-
tions for which compensation is due from FS as part
of a PCT. USP also transfers the current exploita-
tion rights in version 1.0 to FS and the arm’s length
amount of the compensation for such transfer is de-
termined in the aggregate with the arm’s length PCT
Payments in thisExample 3. FS does not furnish any
platform contributions to the CSA nor does it control
any operating intangibles at the inception of the CSA
that would be relevant to the exploitation of version
1.0 or future versions of the software. It is reasonably
anticipated that FS will have gross sales of $1000X in
its territory for 5 years attributable to its exploitation
of version 1.0 and the cost shared intangibles, after
which time the software application will be rendered
obsolete and unmarketable by the obsolescence of the
storage medium technology to which it relates. FS’s
costs reasonably attributable to the CSA, other than
cost contributions and operating cost contributions,
are anticipated to be $250X per year. Certain oper-
ating cost contributions that will be borne by FS are
reasonably anticipated to equal $200Xper annumfor
5 years. In addition, FS is reasonably anticipated to
pay cost contributions of $200X per year as a con-
trolled participant in the CSA.
(ii) FS concludes that its realistic alternative
would be to license software from an uncontrolled
licensor that would undertake the commitment to
bear the entire risk of software development. Ap-
plying CPM using the profit levels experienced by
uncontrolled licensees with contractual provisions
and allocations of risk that are comparable to those
of FS’s licensing alternative, FS determines that it
could, as a licensee, reasonably expect a (pre-tax)
routine return equal to 14% of gross sales or $140X
per year for 5 years. The remaining net revenue
would be paid to the uncontrolled licensor as a li-
cense fee of $410X per year. FS determines that the
discount rate that would be applied to determine the
present value of income and costs attributable to its
participation in the licensing alternative would be
12.5% as compared to the 15% discount rate that
would be applicable in determining the present value
of the net income attributable to its participation
in the CSA (reflecting the increased risk borne by
FS in bearing a share of the R&D costs in the cost
sharing alternative). FS also determines that the tax
rate applicable to it will be the same in the licensing
alternative as in the CSA.
(iii) On these facts, the present value to FS of
entering into the cost sharing alternative equals
the present value of the annual divisional profits
($1,000X minus $250X) minus operating cost con-
tributions ($200X) minus cost contributions ($200X)
minus PCT Payments, determined over 5 years by
discounting at a discount rate of 15%. Thus, the
present value of the residuals, prior to subtracting the
present value of the PCT Payments, is $1349X.
(iv) On these facts, the present value to FS of en-
tering into the licensing alternative would be $561X
determined by discounting, over 5 years, annual di-
visional profits ($1,000X minus $250X) minus oper-
ating cost contributions ($200X) and licensing pay-
ments ($410X) at a discount rate of 12.5% per an-
num. The present value of the cost sharing alterna-
tive must also equal $561X but equals $1349X prior
to subtracting the present value of the PCT Payments.
Consequently, the PCT Payments must have a present
value of $788X.
Example 4.Pre-tax PCT Payment derived from
post-tax information. (i) For simplicity of calculation
in thisExample 4, it is assumed that all payments are
made at the end of each year. Domestic controlled
participant USP has developed a technology, Z, that
it would like to exploit for three years in a CSA. USP
enters into a CSA with its wholly-owned foreign sub-
sidiary, FS, that provides for PCT Payments from FS
to USP with respect to USP’s platform contribution to
the CSA of Z in the form of three annual installment
payments due from FS to USP on the last day of each
of the first three years of the CSA. FS makes no plat-
form contributions to the CSA. Prior to entering into
the CSA, FS considers that it has the realistic alter-
native available to it of licensing Z from USP rather
than entering into a CSA with USP to further develop
Z for three years.
(ii) FS undertakes financial projections for both
the licensing and cost sharing alternatives for ex-
ploitation of Z in its territory of the CSA. These
projections are set forth in the following tables. The
example assumes that there is a reasonably antici-
pated effective tax rate of 25% in each of years 1
through 3 under both the licensing and cost sharing
alternatives. FS determines that the appropriate
post-tax discount rate underthe licensing alternative
2012–12 I.R.B.530March 19, 2012

is 12.5%, and that the appropriate post-tax discount
rate under the cost sharing alternative is 15%.
Licensing AlternativePresent ValueYear 1Year 2Year 3
(12.5% DR)
(1)Sales
$1000$1100$1210
(2)License Fee400440484
(3)Operating costs
500550605
(4)Operating Income
$261
100110121
(5)Tax (25%)25
2830
(6)Post-tax income
$196$75$82$91
Cost Sharing AlternativePresent ValueYear 1Year 2Year 3
(15% DR)
(7)Sales
$1000$1100$1210
(8)Cost Contributions200220242
(9)PCT Payments
D
A
B
C
(10)Operating costs
500550605
(11)Operating income Excluding PCT
$749
300330363
(12)Operating income
HEF
G
(13)
Tax
(14)Post-tax income excluding PCT
$562$225$248$272
(15)
Post-tax income
LIJK
(iii) Under paragraph (g)(4) of this section, the
arm
’s length charge for a PCT Payment will be an
amount such that a controlled participant’s present
value, as of the date of the PCT of its cost sharing
al
ternative of entering into a CSA equals the present
value of its best realistic alternative. This requires
that L, the present value of the post-tax income under
th
e CSA, equals the present value of the post-tax in-
come under the licensing alternative, or $196.
(iv) FS determines that PCT Payments for Z
sh
ould be $196 in Year 1 (A), $215 in Year 2 (B),
and$236inYear3(C).Byusingtheseamountsfor
A, B, and C in the table above, FS is able to derive
t
he values of E, F, G, I, J, and K in the table above.
Based on these PCT Payments for Z, the post-tax
income will be $78 in Year 1 (I), $86 in Year 2 (J),
a
nd $95 in Year 3 (K). When this post-tax income
stream is discounted at the appropriate rate for the
cost sharing alternative (15%), the net present value
is $196 (L). The present value of the PCT Payments,
when discounted at the appropriate post-tax rate, is
$488 (D).
(v) The Commissioner undertakes an audit of the
PCT Payments made by FS to USP for Z in Years
1 through 3. The Commissioner concludes that the
PCT Payments for Z are arm’s length in accordance
with this paragraph (g)(4).
Example 5.Pre-tax PCT Payment derived from
post-tax information. (i) The facts are the same as
in paragraphs (i) and (ii) ofExample 4. In addition,
under this paragraph (g)(4), the arm’s length charge
for a PCT Payment will be an amount such that a con-
trolled participant’s present value, as of the date of the
PCT of its cost sharing alternative equals the present
val
ue of its best realistic alternative. This requires
that L, the present value of the post-tax income under
the CSA, equals the present value of the post-tax in-
co
me under the licensing alternative, or $196.
(ii) FS determines that the post-tax present value
of the cost sharing alternative (excluding PCT Pay-
me
nts) is $562. The post-tax present value of the li-
censing alternative is $196. Accordingly, payments
with a post-tax present value of $366 are required.
(i
ii) The Commissioner undertakes an audit of the
PCT Payments made by FS to USP for Z in Years 1
through 3. In correspondence to the Commissioner,
U
SP maintains that the arm’s length PCT Payment for
Z should have a present value of $366 (D).
(iv) The Commissioner considers that if FS makes
P
CT Payments for Z with a present value of $366,
then the post-tax present value under the CSA (con-
sidering the deductibility of the PCT Payments) will
b
e $287, substantially higher than the post-tax present
value of the licensing arrangement, $196. The Com-
missioner determines that, under the specific facts
and assumptions of this example, the present value of
the post-tax payments may be grossed up by a factor
of (one minus the tax rate), resulting in a present value
of pre-tax payments of $488. Accordingly, FS must
make yearly PCT Payments (A, B, and C) such that
the present value of the Payments is $488 (D). (When
FS’s post-tax income after these PCT Payments for Z
is discounted at the appropriate rate for the cost shar-
ing alternative (15%), the net present value is $196
(L), which is equal to the present value of post-tax
income under the licensingalternative.) The Com-
missioner concludes that the calculations that it has
mad
e for the PCT Payments for Z are arm’s length
in accordance with this paragraph (g)(4) and, accord-
ingly, makes the appropriate adjustments to USP’s in-
co
me tax return to account for the gross-up required
by paragraph (g)(2)(x) of this section.
Example 6.Pre-tax PCT Payment derived from
pr
e-tax information. (i) The facts are the same as in
paragraphs (i) and (ii) ofExample 4. In addition, un-
der paragraph (g)(4) of this section, the arm’s length
ch
arge for a PCT Payment will be an amount such that
a controlled participant’s present value, as of the date
of the PCT of its cost sharing alternative of entering
i
nto a CSA equals the present value of its best real-
istic alternative. This requires that “L,” the present
value of the post-tax income under the CSA, equals
t
he present value of the post-tax income under the li-
censing alternative, or $196.
(ii) Under the specific facts and assumptions of
t
hisExample 6(see paragraph (g)(4)(i)(G) of this sec-
tion), and using the same (post-tax) discount rates as
inExample 4, the present value of pre-tax income un-
der the licensing alternative (that is, the operating in-
come) is $261, and the present value of pre-tax in-
come under the cost sharing alternative (excluding
PCT Payments) is $749. Accordingly, FS determines
that its PCT Payments for Z should have a present
value equal to the difference between the two, or $488
(D). Such PCT Payments for Z result in a present
value of post-tax income under the cost sharing alter-
native of $196 (L), which is equal to the present value
of post-tax income under the licensing alternative.
March 19, 20125312012–12 I.R.B.

(iii) The Commissioner undertakes an audit of the
PCT Payments for Z made by FS to USP in Years
1 through 3. The Commissioner concludes that the
PCT Payments for Z are arm’s length in accordance
with this paragraph (g)(4).
Example 7.Application of income method with
a terminal value calculation. (i) For simplicity of
calculation in thisExample 7, all financial flows are
assumed to occur at the beginning of each period.
USP’s research and development team, Q, has devel-
oped a technology, Z, for which it has several appli-
cations on the market now and several planned for
release at future dates. In Year 1, USP, enters into
a CSA with its wholly-owned subsidiary, FS, to de-
velop future applications of Z. Under the CSA, USP
will have the rights to further develop and exploit the
future applications of Z in the United States, and FS
will have the rights to further develop and exploit the
future applications of Z in the rest of the world. Both
Q and the rights to further develop and exploit future
applications of Z are reasonably anticipated to con-
tribute to the development of future applications of
Z. Therefore, both Q and therights to further develop
and exploit the future applications of Z are platform
contributions for which compensation is due from FS
to USP as part of a PCT. USP does not transfer the
current exploitation rights for current applications of
Z to FS. FS will not perform any research or develop-
ment activities on Z and does not furnish any platform
contributions to the CSA, nor does it control any op-
erating intangibles at the inception of the CSA that
would be relevant to the exploitation of either current
or future applications of Z.
(ii) At the outset of the CSA, FS undertakes an
analysis of the PCTs involving Q and the rights with
respect to Z in order to determine the arm’s length
PCT Payments owing from FS to USP under the CSA.
In that evaluation, FS concludes that the cost shar-
ing alternative represents a riskier alternative for FS
than the licensing alternative. FS further concludes
that the appropriate discount rate to apply in assess-
ing the licensing alternative, based on discount rates
of comparable uncontrolled companies undertaking
comparable licensing transactions, would be 13% per
annum, whereas the appropriate discount rate to ap-
ply in assessing the cost sharing alternative would be
14% per annum. FS undertakes financial projections
and anticipates making $100 million in sales during
the first two years of the CSA in its territory with
sales in Years 3 through 8 increasing to $200 million,
$400 million, $600 million, $650 million, $700 mil-
lion, and $750 million, respectively. After Year 8,
FS expects its sales of all products based upon ex-
ploitation of Z in the rest of the world to grow at 3%
per annum for the future. FS and USP do not antici-
pate cessation of the CSA Activity with respect to Z
at any determinable date. FS anticipates that its man-
ufacturing and distribution costs for exploiting Z (in-
cluding its operating cost contributions), will equal
60% of gross sales of Z from Year 1 onwards, and an-
ticipates its cost contributions will equal $25 million
per annum for Years 1 and 2, $50 million per annum
for Years 3 and 4, and 10% of gross sales per annum
thereafter.
(iii) Based on this analysis, FS determines that
the arm’s length royalty rate that USP would have
charged an uncontrolled licensee for a license of fu-
ture applications of Z if USP had further developed
future applications of Z on its own is 30% of the
sales price of the Z-based product, as determined un-
der the comparable uncontrolled transaction method
in §1.482–4(c). In light of the expected sales growth
and anticipation that the CSA Activity will not cease
as of any determinable date, FS’s determination in-
cludes a terminal value calculation. FS further de-
termines that under the cost sharing alternative, the
present value of FS’s divisional profits, reduced by
the present values of the anticipated operating cost
contributions and cost contributions, would be $1,361
million. Under the licensing alternative, the present
value of the operating divisional profits and losses,
reduced by the operating cost contributions, would be
$2,113 million, and the present value of the licens-
ing payments would be $1,585 million. Therefore,
the total value of the licensing alternative would be
$528 million. In order for the present value of the
cost sharing alternative to equal the present value of
the licensing alternative, the present value of the PCT
Payments must equal $833 million. Accordingly, FS
pays USP a lump sum PCT Payment of $833 million
in Year 1 for USP’s platform contributions of Z and
Q.
(iv) The Commissioner undertakes an audit of the
PCTsandconcludes,basedonhisownanalysis,that
this lump sum PCT Payment is within the interquar-
tile range of arm’s length results for these platform
contributions. The calculations made by FS in deter-
mining the PCT Payment in thisExample 7are set
forth in the following tables:
COST SHARING ALTERNATIVE
Time Period
(Y = Year,
TV=TerminalValue)Y1Y2Y3Y4Y5Y6Y7Y8TV
DiscountPeriod01234
5
6
77
Items of Income/ Expense at Beginning of Year
1Sales100 100 200 400 600
650
700
750
(3% annual growth in each year from
previous year)
2Routine Cost and Operating Cost Contributions
(60% of sales amount in row 1 of relevant
year)
6060120 240 360 390 420
450
(60% of annual sales in row 1 for each
year)
3Cost Contributions (10% of sales amount in
row 1 for relevant year after Year 5)
25255050
60
65
70
75
(10% of annual sales in row 1 for each
year)
4Profit = amount in row 1 reduced by amounts
in rows 2 and 3
1515
30110 180
195
210
225
(row1minusrows2and3foreach
year)
5
PV (using 14% discount rate)
15
13.2 23.1 74.2 107 101
95.7
89.9 842
6
TOTAL PV of Cost Sharing Alternative = Sum of all PV amounts in Row 5 for all Time Periods = $1,361 million.
LICENSING ALTERNATIVE
Time Period
(Y = Year,
TV=TerminalValue)Y1Y2Y3Y4Y5Y6Y7Y8TV
DiscountPeriod01234
5
6
77
Items of Income/ Expense at Beginning of Year
2012–12 I.R.B.532March 19, 2012

LICENSING ALTERNATIVE
Time Period
(Y = Year,
TV=TerminalValue)Y1Y2Y3Y4Y5Y6Y7Y8TV
7
Sales100 100 200 400 600
650
700
750
(3% annual growth in each year from
previous year)
8Routine Cost and Operating Cost Contributions
(60% of sales amount in row 7 of relevant
year)
6060120 240 360 390 420
450
(60% of annual sales in row 7 for each
year)
9Operating Profit = amount in Row 7 reduced
by amount in Row 8
404080160 240 260 280 300 (Row 7 minus row 8 for each year)
10PV of row 9 (using 13% discount rate)40
35.4
62.7 111 147 141
135
128 1313
11
TOTAL PV FOR ALL AMOUNTS IN ROW 10 = $2,112.7 million
12Licensing Payments (30% of sales amount in
row 7)
303060120 180
195
210
225
(30% of amount in row 7 for each
year)
13PV of amount in row 12 (using 13% discount
rate)
30
26.5
4783.2 110 106 101
95.6 985
14
TOTAL PV FOR ALL AMOUNTS IN ROW 13 = $1,584.5 million.
15
TOTAL PV of Licensing Alternative = Row 11 minus Row 14 = $528 million.
CALCULATION OF PCT PAYMENT
16TOTAL PV OF COST SHARING ALTERNATIVE
(FROM ROW 6 ABOVE) =
$1,361 million
17TOTAL PV OF LICENSING ALTERNATIVE
(FROM ROW 15 ABOVE) =
$528 million
18LUMP SUM PCT PAYMENT = ROW 16 – ROW
17 =
$833 million
(5)Acquisition price method—(i)In
general. The acquisition price method
applies the comparable uncontrolled trans-
action method of §1.482–4(c), or the
comparable uncontrolled services price
method described in §1.482–9(c), to eval-
uate whether the amount charged in a
PCT, or group of PCTs, is arm’s length
by reference to the amount charged (the
acquisition price) for the stock or asset
purchase of an entire organization or por-
tion thereof (the target) in an uncontrolled
transaction. The acquisition price method
is ordinarily used where substantially all
the target’s nonroutine contributions, as
such term is defined in paragraph (j)(1)(i)
of this section, made to the PCT Payee’s
business activities are covered by a PCT
or group of PCTs.
(ii)Determination of arm’s length
charge. Under this method, the arm’s
length charge for a PCT or group of PCTs
covering resources, capabilities, and rights
of the target is equal to the adjusted ac-
quisition price, as divided among the
controlled participants according to their
respective RAB shares.
(iii)Adjusted acquisition price.Thead-
justed acquisition price is the acquisition
price of the target increased by the value of
the target’s liabilities on the date of the ac-
quisition, other than liabilities not assumed
in the case of an asset purchase, and de-
creased by the value of the target’s tangi-
ble property on that date and by the value
on that date of any other resources, capa-
bilities, and rights not covered by a PCT or
group of PCTs.
(iv)Best method analysis considera-
tions. The comparability and reliability
considerations stated in §1.482–4(c)(2) ap-
ply. Consistent with those considerations,
the reliability of applying the acquisition
price method as a measure of the arm’s
length charge for the PCT Payment nor-
mally is reduced if—
(A) A substantial portion of the tar-
get’s nonroutine contributions to the PCT
Payee’s business activities is not required
to be covered by a PCT or group of PCTs,
and that portion of the nonroutine contri-
butions cannot reliably be valued;
(B) A substantial portion of the target’s
assets consists of tangible property that
cannot reliably be valued; or
(C) The date on which the target is ac-
quired and the date of the PCT are not con-
temporaneous.
(v)Example. The following example
illustrates the principles of this paragraph
(g)(5):
Example. USP, a U.S. corporation, and its newly
in
corporated, wholly-ownedforeign subsidiary (FS)
enter into a CSA at the start of Year 1 to develop
Group Z products. Under the CSA, USP and FS will
ha
ve the exclusive rights to exploit the Group Z prod-
ucts in the U.S. and the rest of the world, respectively.
At the start of Year 2, USP acquires Company X for
c
ash consideration worth $110 million. At this time
USP’s RAB share is 60%, and FS’s RAB share is 40%
and is not reasonably anticipated to change as a result
o
f this acquisition. Company X joins in the filing of a
U.S. consolidated income tax return with USP. Under
paragraph (j)(2)(i) of this section, Company X and
U
SP are treated as one taxpayer for purposes of this
section. Accordingly, the rights in any of Company
X’s resources and capabilities that are reasonably an-
ticipated to contribute to the development activities
of the CSA will be considered platform contributions
furnished by USP. Company X’s resources and ca-
pabilities consist of its workforce, certain technol-
ogy intangibles, $15 million of tangible property and
March 19, 20125332012–12 I.R.B.

other assets and $5 million in liabilities. The tech-
nology intangibles, as well as Company X’s work-
force, are reasonably anticipated to contribute to the
development of the Group Z products under the CSA
and, therefore, the rights in the technology intangi-
bles and the workforce are platform contributions for
which FS must make a PCT Payment to USP. None
of Company X’s existing intangible assets or any of
its workforce are anticipated to contribute to activi-
ties outside the CSA. For purposes of this example, it
is assumed that no additional adjustment on account
of tax liabilities is needed. Applying the acquisition
price method, the value of USP’s platform contribu-
tions is the adjusted acquisition price of $100 million
($110 million acquisition price plus $5 million liabil-
ities less $15 million tangible property and other as-
sets). FS must make a PCT Payment to USP for these
platform contributions with a reasonably anticipated
present value of $40 million, which is the product of
$100 million (the value of the platform contributions)
and 40% (FS’s RAB share).
(6)Market capitalization method—(i)
In general. The market capitalization
method applies the comparable uncon-
trolled transaction method of §1.482–4(c),
or the comparable uncontrolled services
price method described in §1.482–9(c), to
evaluate whether the amount charged in
a PCT, or group of PCTs, is arm’s length
by reference to the average market capi-
talization of a controlled participant (PCT
Payee) whose stock is regularly traded
on an established securities market. The
market capitalization method is ordinarily
used where substantially all of the PCT
Payee’s nonroutine contributions to the
PCT Payee’s business are covered by a
PCT or group of PCTs.
(ii)Determination of arm’s length
charge. Under the market capitalization
method, the arm’s length charge for a PCT
or group of PCTs covering resources, ca-
pabilities, and rights of the PCT Payee is
equal to the adjusted average market capi-
talization, as divided among the controlled
participants according to their respective
RAB shares.
(iii)Average market capitalization.The
average market capitalization is the av-
erage of the daily market capitalizations
of the PCT Payee over a period of time
beginning 60 days before the date of the
PCT and ending on the date of the PCT.
The daily market capitalization of the PCT
Payee is calculated on each day its stock
is actively traded as the total number of
shares outstanding multiplied by the ad-
justed closing price of the stock on that
day. The adjusted closing price is the daily
closing price of the stock, after adjust-
ments for stock-based transactions (divi-
dends and stock splits) and other pending
corporate (combination and spin-off) re-
structuring transactions for which reliable
arm’s length adjustments can be made.
(iv)Adjusted average market capital-
ization. The adjusted average market cap-
italization is the average market capital-
ization of the PCT Payee increased by the
value of the PCT Payee’s liabilities on the
date of the PCT and decreased by the value
on such date of the PCT Payee’s tangible
property and of any other resources, capa-
bilities, or rights of the PCT Payee not cov-
ered by a PCT or group of PCTs.
(v)Best method analysis considera-
tions. The comparability and reliability
considerations stated in §1.482–4(c)(2) ap-
ply. Consistent with those considerations,
the reliability of applying the comparable
uncontrolled transaction method using the
adjusted market capitalization of a com-
pany as a measure of the arm’s length
charge for the PCT Payment normally is
reduced if—
(A) A substantial portion of the PCT
Payee’s nonroutine contributions to its
business activities is not required to be
covered by a PCT or group of PCTs, and
that portion of the nonroutine contribu-
tions cannot reliably be valued;
(B) A substantial portion of the PCT
Payee’s assets consists of tangible property
that cannot reliably be valued; or
(C) Facts and circumstances demon-
strate the likelihood of a material diver-
gence between the average market capi-
talization of the PCT Payee and the value
of its resources, capabilities, and rights
for which reliable adjustments cannot be
made.
(vi)Examples. The following examples
illustrate the principles of this paragraph
(g)(6):
Example 1. (i) USP, a publicly traded U.S. com-
pany, and its newly incorporated wholly-owned for-
eign subsidiary (FS) enter into a CSA on Date 1 to de-
velop software. At that time USP has in-process soft-
ware but has no software ready for the market. Under
the CSA, USP and FS will have the exclusive rights
to exploit the software developed under the CSA in
the United States and the rest of the world, respec-
tively. On Date 1, USP’s RAB share is 70% and FS’s
RAB share is 30%. USP’s assembled team of re-
searchers and its in-process software are reasonably
anticipated to contribute to the development of the
software under the CSA. Therefore, the rights in the
research team and in-process software are platform
contributions for which compensation is due from FS.
Further, these rights are not reasonably anticipated to
contribute to any business activity other than the CSA
Activity.
(ii) On Date 1, USP had an average market capi-
talization of $205 million, tangible property and other
assets that can be reliably valued worth $5 million,
and no liabilities. Aside from those assets, USP had
no assets other than its research team and in-process
software. Applying the market capitalization method,
the value of USP’s platform contributions is $200
million ($205 million average market capitalization
of USP less $5 million of tangible property and other
assets). The arm’s length value of the PCT Payments
FS must make to USP for the platform contributions,
before any adjustment on account of tax liability as
described in paragraph (g)(2)(ii) of this section, is
$60 million, which is the product of $200 million (the
value of the platform contributions) and 30% (FS’s
RAB share on Date 1).
Example 2.Aggregation with make-or-sell rights.
(i) The facts are the same as inExample 1, except
that on Date 1 USP also has existing software ready
for the market. USP separately enters into a license
agreement with FS for make-or-sell rights for all ex-
isting software outside the United States. No market-
inghasoccurred,andUSPhasnomarketingintan-
gibles. This license of current make-or-sell rights is
a transaction governed by §1.482–4. However, af-
ter analysis, it is determined that the arm’s length
PCT Payments and the arm’s length payments for
the make-or-sell license may be most reliably deter-
mined in the aggregate using the market capitaliza-
tion method, under principles described in paragraph
(g)(2)(iv) of this section, and it is further determined
that those principles are most reliably implemented
by computing the aggregate arm’s length charge as
the product of the aggregate value of the existing and
in-process software and FS’s RAB share on Date 1.
(ii) Applying the market capitalization method,
the aggregate value of USP’s platform contributions
and the make-or-sell rights in its existing software is
$250 million ($255 million average market capital-
ization of USP less $5 million of tangible property
and other assets). The total arm’s length value of
the PCT Payments and licensing payments FS must
make to USP for the platform contributions and cur-
rent make-or-sell rights, before any adjustment on ac-
count of tax liability, if any, is $75 million, which is
the product of $250 million (the value of the platform
contributions and the make-or-sell rights) and 30%
(FS’s RAB share on Date 1).
Example 3.Reduced reliability. The facts are the
same as inExample 1except that USP also has sig-
nificant nonroutine assets that will be used solely in a
nascent business division that is unrelated to the sub-
ject of the CSA and that cannot themselves be reliably
valued. Those nonroutine contributions are not plat-
form contributions and accordingly are not required
to be covered by a PCT. The reliability of using the
market capitalization method to determine the value
of USP’s platform contributions to the CSA is sig-
nificantly reduced in thiscase because that method
would require adjusting USP’s average market cap-
italization to account for the significant nonroutine
contributions that are not required to be covered by
aPCT.
(7)Residual profit split method—(i)In
general. The residual profit split method
evaluates whether the allocation of com-
bined operating profit or loss attributable
to one or more platform contributions sub-
2012–12 I.R.B.534March 19, 2012

ject to a PCT is arm’s length by reference
to the relative value of each controlled
participant’s contribution to that combined
operating profit or loss. The combined
operating profit or loss must be derived
from the most narrowly identifiable busi-
ness activity (relevant business activity) of
the controlled participants for which data
are available that include the CSA Ac-
tivity. The residual profit split method
may not be used where only one controlled
participant makes significant nonroutine
contributions (including platform or oper-
ating contributions) to the CSA Activity.
The provisions of §1.482–6 shall apply to
CSAs only to the extent provided and as
modified in this paragraph (g)(7). Any
other application to a CSA of a residual
profit method not described in paragraphs
(g)(7)(ii) and (iii) of this section will con-
stitute an unspecifiedmethod for purposes
of sections 482 and 6662(e) and the regu-
lations under those sections.
(ii)Appropriate share of profits and
losses. The relative value of each con-
trolled participant’s contribution to the
success of the relevant business activ-
ity must be determined in a manner that
reflects the functions performed, risks as-
sumed, and resources employed by each
participant in the relevant business ac-
tivity, consistent with the best method
analysis described in §1.482–1(c) and (d).
Such an allocation is intended to corre-
spond to the division of profit or loss that
would result from an arrangement between
uncontrolled taxpayers, each performing
functions similar to those of the various
controlled participants engaged in the rele-
vant business activity. The profit allocated
to any particular controlled participant is
not necessarily limited to the total operat-
ing profit of the group from the relevant
business activity. For example, in a given
year, one controlled participant may earn a
profit while another controlled participant
incurs a loss. In addition, it may not be as-
sumed that the combined operating profit
or loss from the relevant business activity
should be shared equally, or in any other
arbitrary proportion.
(iii)Profit split—(A)In general.Un-
der the residual profit split method, the
present value of each controlled partic-
ipant’s residual divisional profit or loss
attributable to nonroutine contributions
(nonroutine residual divisional profit or
loss) is allocated between the controlled
participants that eachfurnish significant
nonroutine contributions (including plat-
form or operating contributions) to the
relevant business activity in that division.
(B)Determine nonroutine residual di-
visional profit or loss. The present value
of each controlled participant’s nonroutine
residual divisional profit or loss must be
determined to reflect the most reliable
measure of an arm’s length result. The
present value of nonroutine residual di-
visional profit or loss equals the present
value of the stream of the reasonably an-
ticipated residuals over the duration of the
CSA Activity of divisional profit or loss,
minus market returns for routine contribu-
tions, minus operating cost contributions,
minus cost contributions, using a discount
rate appropriate to such residuals in ac-
cordance with paragraph (g)(2)(v) of this
section. As used in this paragraph (g)(7),
the phrase “market returns for routine
contributions” includes market returns for
operating cost contributions and excludes
market returns for cost contributions.
(C)Allocate nonroutine residual divi-
sional profit or loss—(1)In general.The
present value of nonroutine residual di-
visional profit or loss in each controlled
participant’s division must be allocated
among all of the controlled participants
based upon the relative values, deter-
mined as of the date of the PCTs, of the
PCT Payor’s as compared to the PCT
Payee’s nonroutine contributions to the
PCT Payor’s division. For this purpose,
the PCT Payor’s nonroutine contribution
consists of the sum of the PCT Payor’s
nonroutine operating contributions and
thePCTPayor’sRABshareofthePCT
Payor’s nonroutine platform contributions.
For this purpose, the PCT Payee’s non-
routine contribution consists of the PCT
Payor’s RAB share of the PCT Payee’s
nonroutine platform contributions.
(2)Relative value determination.The
relative values of the controlled partici-
pants’ nonroutine contributions must be
determined so as to reflect the most re-
liable measure of an arm’s length result.
Relative values may be measured by exter-
nal market benchmarks that reflect the fair
market value of such nonroutine contribu-
tions. Alternatively, the relative value of
nonroutine contributions may be estimated
by the capitalized cost of developing the
nonroutine contributions and updates, as
appropriately grown or discounted so that
all contributions may be valued on a com-
parable dollar basis as of the same date.
If the nonroutine contributions by a con-
trolled participant are also used in other
business activities (such as the exploitation
of make-or-sell rights described in para-
graph (c)(4) of this section), an allocation
of the value of the nonroutine contribu-
tions must be made on a reasonable basis
among all the business activities in which
they are used in proportion to the relative
economic value that the relevant business
activity and such other business activities
are anticipated to derive over time as the
result of such nonroutine contributions.
(3)Determination of PCT Payments.
Any amount of the present value of a con-
trolled participant’s nonroutine residual di-
visional profit or loss that is allocated to
another controlled participant represents
the present value of the PCT Payments due
to that other controlled participant for its
platform contributions to the relevant busi-
ness activity in the relevant division. For
purposes of paragraph (j)(3)(ii) of this sec-
tion, the present value of a PCT Payor’s
PCT Payments under this paragraph shall
be deemed reduced to the extent of the
present value of any PCT Payments owed
to it from other controlled participants un-
der this paragraph (g)(7). The resulting
remainder may be converted to a fixed
or contingent formof payment in accor-
dance with paragraph (h) (Form of pay-
ment rules) of this section.
(4)Routine platform and operating
contributions. For purposes of this para-
graph (g)(7), any routine platform or
operating contributions, the valuation and
PCT Payments for which are determined
and made independently of the residual
profit split method, are treated similarly
to cost contributions and operating cost
contributions, respectively. Accordingly,
wherever used in this paragraph (g)(7),
the term “routine contributions” shall not
include routine platform or operating con-
tributions, and wherever the terms “cost
contributions” and “operating cost contri-
butions” appear in this paragraph (g)(7),
they shall include net routine platform
contributions and net routine operating
contributions, respectively, as defined
in paragraph (g)(4)(vii) of this section.
However, treatment of net operating con-
tributions as operating cost contributions
shall be coordinated with the treatment
of other routine contributions pursuant to
March 19, 20125352012–12 I.R.B.

paragraphs (g)(4)(iii)(B) and (7)(iii)(B)
of this section so as to avoid duplicative
market returns to such contributions.
(iv)Best method analysis considera-
tions—(A)In general. Whether results
derived from this method are the most
reliable measure of the arm’s length result
is determined using the factors described
under the best method rule in §1.482–1(c).
Thus, comparability and quality of data,
reliability of assumptions, and sensitivity
of results to possible deficiencies in the
data and assumptions, must be consid-
ered in determining whether this method
provides the most reliable measure of an
arm’s length result. The application of
these factors to the residual profit split in
the context of the relevant business ac-
tivity of developing and exploiting cost
shared intangibles is discussed in para-
graphs (g)(7)(iv)(B) through (D) of this
section.
(B)Comparability. The derivation of
the present value of nonroutine residual
divisional profit or loss includes a carve-
out on account of market returns for rou-
tine contributions. Thus, the compara-
bility considerationsthat are relevant for
that purpose include those that are rele-
vant for the methods that are used to de-
termine market returns for the routine con-
tributions.
(C)Data and assumptions.Therelia-
bility of the results derived from the resid-
ual profit split is affected by the quality of
the data and assumptions used to apply this
method. In particular, the following fac-
tors must be considered:
(1) The reliability of the allocation of
costs, income, and assets between the rel-
evant business activity and the controlled
participants’ other activities that will af-
fect the reliability of the determination of
the divisional profit or loss and its allo-
cation among the controlled participants.
See §1.482–6(c)(2)(ii)(C)(1).
(2) The degree of consistency between
the controlled participants and uncon-
trolled taxpayers inaccounting practices
that materially affect the items that deter-
mine the amount and allocation of operat-
ing profit or loss affects the reliability of
the result. See §1.482–6(c)(2)(ii)(C)(2).
(3) The reliability of the data used and
the assumptions made in estimating the
relative value of the nonroutine contribu-
tions by the controlled participants. In par-
ticular, if capitalized costs of development
are used to estimate the relative value of
nonroutine contributions, the reliability of
the results is reduced relative to the relia-
bility of other methods that do not require
such an estimate. This is because, in any
given case, the costs of developing a non-
routine contribution may not be related to
its market value and because the calcula-
tion of the capitalized costs of develop-
ment may require the allocation of indirect
costs between the relevant business activ-
ity and the controlled participant’s other
activities, which may affect the reliability
of the analysis.
(D)Other factors affecting reliability.
Like the methods described in §§1.482–3
through 1.482–5 and §1.482–9(c), the
carveout on account of market returns for
routine contributions relies exclusively
on external market benchmarks. As indi-
cated in §1.482–1(c)(2)(i), as the degree
of comparability between the controlled
participants and uncontrolled transactions
increases, the relative weight accorded the
analysis under this method will increase.
In addition, to the extent the allocation
of nonroutine residual divisional profit or
loss is not based on external market bench-
marks, the reliability of the analysis will be
decreased in relationto an analysis under a
method that relies on market benchmarks.
Finally, the reliability of the analysis un-
der this method may be enhanced by the
fact that all the controlled participants are
evaluated under the residual profit split.
However, the reliability of the results of an
analysis based on information from all the
controlled participants is affected by the
reliability of the data and the assumptions
pertaining to each controlled participant.
Thus, if the data and assumptions are sig-
nificantly more reliable with respect to
one of the controlled participants than with
respect to the others, a different method,
focusing solely on the results of that party,
may yield more reliable results.
(v)Examples. The following examples
illustrate the principles of this paragraph
(g)(7):
Example 1. (i) For simplicity of calculation in this
Example 1, all financial flows are assumed to occur at
the beginning of each period. USP, a U.S. electronic
data storage company, has partially developed tech-
nology for a type of extremely small compact storage
devices (nanodisks) which are expected to provide a
significant increase in data storage capacity in various
types of portable devices such as cell phones, MP3
players, laptop computers and digital cameras. At the
same time, USP’s wholly-owned subsidiary, FS, has
developed significant marketing intangibles outside
the United States in the form of customer lists, on-
going relations with various OEMs, and trademarks
that are well recognized by consumers due to a long
history of marketing successful data storage devices
and other hardware used in various types of consumer
electronics. At the beginning of Year 1, USP en-
ters into a CSA with FS to develop nanodisk tech-
nologies for eventual commercial exploitation. Un-
der the CSA, USP will have the right to exploit nan-
odisks in the United States, while FS will have the
right to exploit nanodisks in the rest of the world. The
partially developed nanodisk technologies owned by
USP are reasonably anticipated to contribute to the
development of commercially exploitable nanodisks
and therefore the rights in the nanodisk technologies
constitute platform contributions of USP for which
compensation is due under PCTs. FS does not have
any platform contributions for the CSA. Due to the
fact that nanodisk technologies have yet to be incor-
porated into any commercially available product, nei-
ther USP nor FS transfers rights to make or sell cur-
rent products in conjunction with the CSA.
(ii) Because only in FS’s territory do both con-
trolled participants make significant nonroutine con-
tributions, USP and FS determine that they need to
determine the relative value of their respective con-
tributions to residual divisional profit or loss attrib-
utable to the CSA Activity only in FS’s territory. FS
anticipates making no nanodisk sales during the first
year of the CSA in its territory with revenues in Year 2
reaching $200 million. Revenues through Year 5 are
reasonably anticipated to increase by 50% per year.
The annual growth rate for revenues is then expected
to decline to 30%per annumin Years 6 and 7, 20%
per annumin Years 8 and 9 and 10%per annumin
Year 10. Revenues are then expected to decline 10%
in Year 11 and 5%per annum, thereafter. The rou-
tine costs (defined here as costs other than cost con-
tributions, routine platform and operating contribu-
tions, and nonroutine contributions) that are allocable
to this revenue in calculating FS’s divisional profit or
loss, are anticipated to equal $40 million for the first
year of the CSA and $130 for the second year and
$200 and $250 million in Years 3 and 4. Total op-
erating expenses attributable to product exploitation
(including operating cost contributions) equal 52% of
sales per year. FS undertakes routine distribution ac-
tivities in its markets that constitute routine contri-
butions to the relevant business activity of exploiting
nanodisk technologies. USP and FS estimate that the
total market return on these routine contributions will
amount to 6% of the routine costs. FS expects its cost
contributions to be $60 million in Year 1, rise to $100
million in Years 2 and 3, and then decline again to $60
million in Year 4. Thereafter, FS’s cost contributions
are expected to equal 10% of revenues.
(iii) USP and FS determine the present value of
the stream of the reasonably anticipated residuals in
FS’s territory over the duration of the CSA Activity
of the divisional profit or loss (revenues minus rou-
tine costs), minus the market returns for routine con-
tributions, the operating cost contributions, and the
cost contributions. USP and FS determine, based on
the considerations discussed in paragraph (g)(2)(v)
of this section, that the appropriate discount rate is
17.5%per annum. Therefore, the present value of the
nonroutine residual divisional profit is $1,395 mil-
lion.
2012–12 I.R.B.536March 19, 2012

(iv) After analysis, USP and FS determine that
the relative value of the nanodisk technologies con-
tributed by USP to CSA (giving effect only to its
value in FS’s territory) is roughly 150% of the value
of FS’s marketing intangibles (which only have
value in FS’s territory). Consequently, 60% of the
nonroutine residual divisional profit is attributable to
USP’s platform contribution. Therefore, FS’s PCT
Payments should have an expected present value
equal to $837 million (.6 x $1,395 million).
(v) The calculations for thisExample 1are dis-
played in the following table:
Time Period
(Y = Year)
(TV = Terminal Value)Y1Y2Y3Y4Y5Y6Y7Y8Y9 Y10 Y11 TV
DiscountPeriod01234
5
6
7
891010
[1] Sales0200 300
450 675
878 1141 1369 1643 1807 1626
...
[2] Growth Rate
——
50% 50% 50%
30% 30% 20% 20% 10% -10%
...
[3] Exploitation Costs and Operating Cost Contributions (52%
of Sales [1])
40130 200
250 351 456 593
712
854
940 846
...
[4] Return on [3] (6% of [3])2.4812
15
21273643
515651
...
[5] Cost Contributions (10% of Sales [1] after Year 5)
60100 100606888114 137 164 181 163
...
[6] Residual Profit = [1] minus {[3] + [4] + [5]}
-102 -38-12
125 235
306 398 477
573
630
567 2395
[7] Residual Profit [6] Discounted at 17.5% discount rate
-102 -32-9
77
124 137
151 154 158
148 113 477
[8] Sum of all amounts in [7] for all time periods = $1,395 million
[9] Relative value in FS’s division of USP’s nanotechnology to FS’s marketing intangibles = 150%
[10] Profit Split (USP)
60% = 1.5 x [11]
[11] Profit Split (FS)40%
[12] FS’s PCT Payments
[8] x [10] = $1,395 million x 60% = $837 million
Exam
ple 2. (i) For simplicity of calculation in this
Example 2, all financial flows are assumed to occur
at the beginning of each period. USP is a U.S. auto-
mob
ile manufacturing company that has completed
significant research on the development of diesel-
electric hybrid engines that, if they could be suc-
ces
sfully manufactured, would result in providing a
significant increased fuel economy for a wide va-
riety of motor vehicles. Successful commercializa-
ti
on of the diesel-electric hybrid engine will require
the development of a new class of advanced battery
that will be light, relatively cheap to manufacture and
ye
t capable of holding a substantial electric charge.
FS, a foreign subsidiary of USP, has completed sig-
nificant research on developing lithium-ion batteries
t
hat appear likely to have the requisite characteris-
tics. At the beginning of Year 1, USP enters into a
CSA with FS to further develop diesel-electric hy-
b
rid engines and lithium-ion battery technologies for
eventual commercial exploitation. Under the CSA,
USP will have the right to exploit the diesel-elec-
tric hybrid engine and lithium-ion battery technolo-
gies in the United States, while FS will have the right
to exploit such technologies in the rest of the world.
The partially developed diesel-electric hybrid engine
and lithium-ion battery technologies owned by USP
and FS, respectively, are reasonably anticipated to
contribute to the development of commercially ex-
ploitable automobile engines and therefore the rights
in both these technologies constitute platform contri-
butions of USP and of FS for which compensation
is due under PCTs. At the time of inception of the
CSA, USP owns operating intangibles in the form
of self-developed marketing intangibles which have
significant value in the United States, but not in the
rest of the world, and that are relevant to exploit-
ing the cost shared intangibles. Similarly, FS owns
self-developed marketing intangibles which have sig-
nifi
cant value in the rest of the world, but not in the
United States, and that are relevant to exploiting the
cost shared intangibles. Although the new class of
die
sel-electric hybrid engine using lithium-ion batter-
ies is not yet ready for commercial exploitation, com-
ponents based on this technology are beginning to
be i
ncorporated in current-generation gasoline-elec-
tric hybrid engines and the rights to make and sell
such products are transferred from USP to FS and
vi
ce-versain conjunction with the inception of the
CSA, following the same territorial division as in the
CSA.
(i
i) USP’s estimated RAB share is 66.7%. Dur-
ing Year 1, it is anticipated that sales in USP’s terri-
tory will be $1000X in Year 1. Sales in FS’s terri-
to
ry are anticipated to be $500X. Thereafter, as rev-
enue from the use of components in gasoline-electric
hybrids is supplemented by revenues from the pro-
d
uction of complete diesel-electric hybrid engines us-
ing lithium-ion battery technology, anticipated sales
in both territories will increase rapidly at a rate of
5
0% per annum through Year 4. Anticipated sales
are then anticipated to increase at a rate of 40%per
annumfor another 4 years. Sales are then anticipated
to increase at a rate of 30%per annumthrough Year
10. Thereafter, sales are anticipated to decrease at
arateof5%per annumfor the foreseeable future
as new automotive drivetrain technologies displace
diesel-electric hybrid engines and lithium-ion batter-
ies. Total operating expenses attributable to product
exploitation (including operating cost contributions)
equal 40% of sales per year for both USP and FS. USP
and FS estimate that the total market return on these
routine contributions to the CSA will amount to 6% of
these operating expenses. USP is expected to bear
2
/3
of the total cost contributions for the foreseeable fu-
ture. Cost contributions are expected to total $375X
in Year 1 (of which $250X are borne by USP) and in-
crea
se at a rate of 25%per annumthrough Year 6. In
Years 7 through 10, cost contributions are expected
to increase 10% a year. Thereafter, cost contributions
are
expected to decrease by 5% a year for the foresee-
able future.
(iii) USP and FS determine the present value of
the
stream of FS’s reasonably anticipated residual di-
visional profit, which is the stream of FS’s reason-
ably anticipated divisional profit or loss, minus the
ma
rket returns for routine contributions, minus op-
erating cost contributions, minus cost contributions.
USP and FS determine, based on the considerations
di
scussed in paragraph (g)(2)(v) of this section, that
the appropriate discount rate is 12% per year. There-
fore, the present value of the nonroutine residual di-
vi
sional profit in USP’s territory is $41,727X and in
CFC’s territory is $20,864X.
(iv) After analysis, USP and FS determine that,
i
n the United States the relative value of the tech-
nologies contributed by USP and FS to the CSA and
of the operating intangibles used by USP in the ex-
p
loitation of the cost shared intangibles (reported as
equaling 100 in total), equals: USP’s platform contri-
bution (59.5); FS’s platform contribution (25.5); and
U
SP’s operating intangibles (15). Consequently, the
present value of the arm’s length amount of the PCT
Payments that USP should pay to FS for FS’s plat-
form contribution is $10,640X (.255 x $41,727X).
Similarly, USP and FS determine that, in the rest of
the world, the relative value of the technologies con-
tributed by USP and FS to the CSA and of the op-
erating intangibles used by FS in the exploitation of
the cost shared intangibles can be divided as follows:
USP’s platform contribution (63); FS’s platform con-
tribution (27); and FS’s operating intangibles (10).
Consequently, the present value of the arm’s length
amount of the PCT Payments that FS should pay to
USP for USP’s platform contribution is $13,144X
March 19, 20125372012–12 I.R.B.

(.63 x $20,864X). Therefore, FS is required to make a net payment to USP with a present value of $2,504X
($13,144X – 10,640X).
(v) The calculations for thisExample 2are dis-
played in the following tables:
CALCULATION OF USP’s PCT PAYMENT TO FS
Time Period
(Y = Year)
(TV = Terminal Value)Y1Y2Y3Y4Y5Y6Y7Y8Y9 Y10 TV
DiscountPeriod01234
5
6
7
899
[1] Sales1000
1500 2250 3375 4725 6615
9261
12965 16855
21912
...
[2] Growth Rate
—
50% 50% 50%
40% 40% 40% 40% 30% 30%
...
[3] Exploitation Costs and Operating Cost Contribu-
tions (40% of Sales [1])
400 600 900
1350
1890 2646 3704
5186
6742
8765
...
[4] Return on [3] = 6% of [3]2436
54
81113
159
222 311
405 526
...
[5] Cost Contributions250
313 391 488 610 763 839 923
1015
1117
...
[6] Residual Profit = [1] minus {[3] + [4] + [5]}
326
552 905 1456
2111 3047
4495 6545
8693
11504
64287
[7] Residual Profit [6] Discounted at 12% discount rate326 492 722 1036 1342 1729 2277 2961
3511
4148 23183
[8] Sum of all amounts in [7] for all time periods = $41,727X
Profit Split for Calculation of USP’s PCT Payment to FS:
[Total of US contributions = 74.5%]
[9] USP’s Platform Contribution = 59.5%
[10] FS’s Platform Contribution = 25.5%
[11] USP’s Operating Intangibles = 15%
[12] USP’s PCT Payment to FS = [8] x [10] = $41,727X multiplied by 25.5% = $10,640X
CALCULATION OF FS’s NET PCT PAYMENTS TO USP
Time Period
(Y = Year)
(TV = Terminal Value)Y1Y2Y3Y4Y5Y6Y7Y8Y9 Y10 TV
DiscountPeriod01234
5
6
7
899
[13] Sales
500 750 1125
1688 2363 3308 4631 6483 8428
10956
...
[14] Growth Rate
—
50% 50% 50%
40% 40% 40% 40% 30% 30%
...
[15] Exploitation Costs and Operating Cost Contribu-
tions (40% of Sales [13])
200 300
450 675 945
1323
1852 2593
3371 4382
...
[16] Return on [15] = 6% of [15]
12182741
57
79111
156
202 263
...
[17] Cost Contributions
125 156 195
244
305
381 420 462
508 559
...
[18] Residual Profit = [13] minus {[15] + [16] + [17]}
163 276
453
728
1056 1524
2248 3272 4347
5752
32144
[19] Residual Profit [18] Discounted at 12% discount rate163 246 361
518
671
865
1139 1480
1755
2074
11591
[20] Sum of all amounts in [19] for all time periods = $20,864X
Profit Split for Calculation of FS’s PCT Payment to USP: [Total of FS’s contributions = 37%
]
[21] USP’s Platform Contribution = 63%
[22] FS’s Platform Contribution = 27%
[23] FS’s Operating Intangibles =10%
[24] FS’s PCT Payment to USP = [20] x [21] = $20,864X multiplied by 63% = $13,144X
[25] FS’s Net PCT Payment to USP = [24] minus [12] = $13,144X minus $10,640X = $2,504X
(8)Unspecified methods. Methods not
specified in paragraphs (g)(3) through (7)
of this section may be used to evaluate
whether the amount charged for a PCT is
arm’s length. Any method used under this
paragraph (g)(8) must be applied in accor-
dance with the provisions of §1.482–1 and
of paragraph (g)(2) of this section. Consis-
tent with the specified methods, an unspec-
ified method should take into account the
general principle that uncontrolled taxpay-
ers evaluate the terms of a transaction by
considering the realistic alternatives to that
transaction, and only enter into a particu-
lar transaction if none of the alternatives is
preferable to it. Therefore, in establishing
whether a PCT achieved an arm’s length
result, an unspecified method should pro-
2012–12 I.R.B.538March 19, 2012

vide information on the prices or profits
that the controlled participant could have
realized by choosing a realistic alternative
to the CSA. See paragraph (k)(2)(ii)(J) of
this section. As with any method, an un-
specified method will not be applied unless
it provides the most reliable measure of
an arm’s length result under the principles
of the best method rule. See §1.482–1(c)
(Best method rule). In accordance with
§1.482–1(d) (Comparability), to the extent
that an unspecified method relies on inter-
nal data rather than uncontrolled compara-
bles, its reliability will be reduced. Sim-
ilarly, the reliability of a method will be
affected by the reliability of the data and
assumptions used to apply the method, in-
cluding any projections used.
(h)Form of payment rules—(1)CST
Payments. CST Payments may not be paid
in shares of stock in the payor (or stock in
any member of the controlled group that
includes the controlled participants).
(2)PCT Payments—(i)In general.The
consideration under a PCT for a platform
contribution may take one or a combina-
tion of both of the following forms:
(A) Payments of a fixed amount (fixed
payments), either paid in a lump sum pay-
ment or in installment payments spread
over a specified period, with interest cal-
culated in accordance with §1.482–2(a)
(Loans or advances).
(B) Payments contingent on the ex-
ploitation of cost shared intangibles by the
PCT Payor (contingent payments).
Accordingly, controlled participants
have flexibility to adopt a form and period
of payment, provided that such form and
period of payment are consistent with an
arm’s length charge as of the date of the
PCT. See also paragraphs (h)(2)(iv) and
(3) of this section.
(ii)No PCT Payor Stock.PCTPay-
ments may not be paid in shares of stock in
the PCT Payor (or stock in any member of
the controlled group that includes the con-
trolled participants).
(iii)Specified form of payment—(A)In
general. The form of payment selected
(subject to the rules of this paragraph (h))
for any PCT, including, in the case of
contingent payments, the contingent base
and structure of the payments as set forth
in paragraph (h)(2)(iii)(B) of this section,
must be specified no later than the due
date of the applicable tax return (includ-
ing extensions) for the later of the taxable
year of the PCT Payor or PCT Payee that
includes the date of that PCT.
(B)Contingent payments. In accor-
dance with paragraph (k)(1)(iv)(A) of this
section, a provision of a written contract
described in paragraph (k)(1) of this sec-
tion, or of the additional documentation
described in paragraph (k)(2) of this sec-
tion, that provides for payments for a PCT
(or group of PCTs) to be contingent on
the exploitation of cost shared intangibles
will be respected as consistent with eco-
nomic substance only if the allocation be-
tween the controlled participants of the
risks attendant on such form of payment
is determinable before the outcomes of
such allocation that would have materi-
ally affected the PCT pricing are known or
reasonably knowable. A contingent pay-
ment provision must clearly and unam-
biguously specify the basis on which the
contingent payment obligations are to be
determined. In particular, the contingent
payment provision must clearly and un-
ambiguously specify the events that give
rise to an obligation to make PCT Pay-
ments, the royalty base (such as sales or
revenues), and the computation used to
determine the PCT Payments. The roy-
alty base specified must be one that per-
mits verification of its proper use by refer-
ence to books and records maintained by
the controlled participants in the normal
course of business (for example, books and
records maintained for financial account-
ing or business management purposes).
(C)Examples. The following examples
illustrate the principles of this paragraph
(h)(2).
Example 1. A CSA provides that PCT Payments
with respect to a particular platform contribution shall
be contingent payments equal to 15% of the revenues
from sales of products that incorporate cost shared in-
tangibles. The terms further permit (but do not re-
quire) the controlled participants to adjust such con-
tingent payments in accordance with a formula set
forth in the arrangement so that the 15% rate is subject
to adjustment by the controlled participants at their
discretion on an after-the-fact, uncompensated basis.
The Commissioner may impute payment terms that
are consistent with economic substance with respect
to the platform contribution because the contingent
payment provision does not specify the computation
used to determine the PCT Payments.
Example 2. Taxpayer, an automobile manu-
facturer, is a controlled participant in a CSA that
involves research and development to perfect cer-
tain manufacturing techniques necessary to the
actual manufacture of a state-of-the-art, hybrid fuel
injection system known as DRL337. The arrange-
ment involves the platform contribution of a design
patent covering DRL337. Pursuant to paragraph
(h)(2)(iii)(B) of this section, the CSA provides for
PCT Payments with respect to the platform contribu-
tion of the patent in the form of royalties contingent
on sales of automobiles that contain the DRL337
system. However, Taxpayer’s system of book- and
record-keeping does notenable Taxpayer to track
which automobile sales involve automobiles that
contain the DRL337 system. Because Taxpayer has
not complied with paragraph (h)(2)(iii)(B) of this
section, the Commissioner may impute payment
terms that are consistent with economic substance
and susceptible to verification by the Commissioner.
Example 3. (i) Controlled participants A and B
enter into a CSA that provides for PCT Payments
from A to B with respect to B’s platform contribu-
tion, Z, in the form of three annual installment pay-
ments due from A to B on the last day of each of the
first three years of the CSA.
(ii) On audit, based on all the facts and circum-
stances, the Commissioner determines that the in-
stallment PCT Payments are consistent with an arm’s
length charge as of the date of the PCT. Accordingly,
the Commissioner does not make an adjustment with
respect to the PCT Payments in any year.
Example 4. (i) The facts are the same as inEx-
ample 3except that the CSA contains an additional
term with respect to the PCT Payments. Under this
provision, A and B further agreed that, if the present
value (as of the CSA Start Date) of A’s actual divi-
sional operating profit or loss during the three-year
period is less than the present value (as of the CSA
Start Date) of the divisional operating profit or loss
that the parties projected for A upon formation of the
CSA for that period, then the third installment pay-
ment shall be subject to a compensating adjustment
in the amount necessary to reduce the present value
(as of the CSA Start Date) of the aggregate PCT Pay-
ments for those three years to the amount that would
have been calculated if the actual results had been
used for the calculation instead of the projected re-
sults.
(ii) This provision further specifies that A will
pay B an additional amount, $Q, in the first year of
the CSA to compensate B for taking on additional
downside risk through the contingent payment term
described in paragraph (i) of thisExample 4.
(iii) During the first two years, A pays B install-
ment payments as agreed, as well as the additional
amount, $Q. In the third year, A and B determine that
the present value (as of the CSA Start Date) of A’s
actual divisional operating profit or loss during the
three-year period is less than the present value (as of
the CSA Start Date) of the divisional operating profit
or loss that the parties projected for A upon forma-
tion of the CSA for that period. A reduces the PCT
Payment to B in the third year in the amount neces-
sary to reduce the present value (as of the CSA Start
Date) of the aggregate PCT Payments for those three
years to the amount that would have been calculated
if the actual results had been used for the calculation
instead of the projected results.
(iv) On audit, based on all the facts and circum-
stances, the Commissioner determines that the in-
stallment PCT Payments agreed to be paid by A to
B were consistent with an arm’s length charge as of
thedateofthePCT.TheCommissionerfurtherde-
termines that the contingency was sufficiently spec-
ified such that its occurrence or nonoccurrence was
March 19, 20125392012–12 I.R.B.

unambiguous and determinable; that the projections
were reliable; and that the contingency did, in fact,
occur. Finally, the Commissioner determines, based
on all the facts and circumstances, that $Q was within
the arm’s length range for the additional allocation of
risk to B. Accordingly, no adjustment is made with
respect to the installment PCT Payments, or the addi-
tional PCT Payment for the contingent payment term,
in any year.
Example 5. (i)ThefactsarethesameasinEx-
ample 4except that the CSA states the amount that A
will pay B for the contingent payment term is $X, an
amount that is less than $Q, and A pays B $X in the
firstyearoftheCSA.
(ii) On audit, based on all the facts and circum-
stances, the Commissioner determines that the in-
stallment PCT Payments agreed to be paid by A to
B were consistent with an arm’s length charge as of
the date of the PCT. The Commissioner further deter-
mines that the contingency was sufficiently specified
such that its occurrence or nonoccurrence was unam-
biguous and determinable; that the projections were
reliable; and that the contingency did, in fact, occur.
However, the Commissioner also determines, based
on all the facts and circumstances, that the additional
PCT Payment of $X from A to B for the contingent
payment term was not an arm’s length charge for the
additional allocation of risk as of the CSA Start Date
in connection with the contingent payment term. Ac-
cordingly, the Commissioner makes an adjustment to
B’s results equal to the difference between $X and
the median of the arm’s length range of charges for
the contingent payment term.
Example 6. (i)ThefactsarethesameasinEx-
ample 3except that A and B further agreed that, if
thepresentvalue(asoftheCSAStartDate)ofA’s
actual divisional operating profit or loss during the
three-year period is either less or greater than the
present value (as of the CSA Start Date) of the di-
visional operating profit or loss that the parties pro-
jected for A upon formation of the CSA for that pe-
riod, then A may make a compensating adjustment
to the third installment payment in the amount neces-
sary to reduce (if actual divisional operating profit or
loss is less than the projections) or increase (if actual
divisional operating profit or loss exceeds the projec-
tions) the present value (as of the CSA Start Date) of
the aggregate PCT Payments for those three years to
the amount that would have been calculated if the ac-
tual results had been used for the calculation instead
of the projected results.
(ii) On audit, the Commissioner determines
that the contingent payment term lacks economic
substance under §§ 1.482–1(d)(3)(iii)(B) and
1.482–7(h)(2)(iii)(B). It lacks economic substance
because the allocation of the risks between A and
B was indeterminate as of the CSA Start Date due
to the elective nature of the potential compensat-
ing adjustments. Specifically, the parties agreed
upfront only that A might make compensating ad-
justments to the installment payments. By the terms
of the agreement, A could decide whether to make
such adjustments after the outcome of the risks was
known or reasonably knowable. Even though the
contingency and potential compensating adjustments
were clearly defined in the CSA, no compensating
adjustments were required by the CSA regardless of
the occurrence or nonoccurrence of the contingency.
As a result, the contingent payment terms did not
clearly and unambiguously specify the events that
give rise to an obligation to make PCT Payments,
and, accordingly, the obligation to make compen-
sating adjustments pursuant to the contingency was
indeterminate. The contingent payment term allows
the taxpayer to make adjustments that are favorable
to its overall tax position in those years where the
agreement allows it to make such adjustments, but
decline to exercise its right to make any adjustment
in those years in which such an adjustment would be
unfavorable to its overall tax position. Such terms
do not reflect a substantive upfront allocation of risk.
In addition, the vagueness of the agreement makes
it impossible to determine whether such contingent
payment term warrants an additional arm’s length
charge and, if so, how much.
(iii) Accordingly, the Commissioner may
disregard the contingent payment term under
§§ 1.482–1(d)(3)(ii)(B)(1) and 1.482–7(k)(1)(iv)
and may impute other contractual terms in its place
consistent with the economic substance of the CSA.
Example 7. (i) The facts are the same as inExam-
ple 6except that the contingent payment term pro-
vides that, if the present value (as of the CSA Start
Date) of A’s actual divisional operating profit or loss
during the three-year period is either less or greater
than the present value (as of the CSA Start Date) of
the divisional operating profit or loss that the parties
projected for A upon formation of the CSA for that
period, then A will make a compensating adjustment
to the third installment payment. The CSA does not
specify the amount of (or a formula for) any such
compensating adjustments.
(ii) On audit, the Commissioner determines
that the contingent payment term lacks economic
substance under §§ 1.482–1(d)(3)(iii)(B) and
1.482–7(h)(2)(iii)(B). It lacks economic substance
because the allocation of the risks between A and B
was indeterminate as of the CSA Start Date due to
the failure to specify the amount of (or a formula for)
the compensating adjustments that must be made
if a contingency occurs. The basis on which the
compensating adjustments were to be determined
was neither clear nor unambiguous. Even though
the contingency was clearly defined in the CSA and
the requirement of a compensating adjustment in
the event of a contingency was clearly specified in
the CSA, the parties had no agreement regarding
the amount of such compensating adjustments. As a
result, the computation used to determine the PCT
Payments was indeterminate. The parties could
choose to make a small positive compensating ad-
justment if the actual results turned out to be much
greater than the projections, and could choose to
make a significant negative compensating adjust-
ment if the actual results turned out to be less than the
projections. Such terms do not reflect a substantive
upfront allocation of risk. In addition, the vagueness
of the agreement makes it impossible to determine
whether such contingent payment term warrants an
additional arm’s length charge and, if so, how much.
(iii) Accordingly, the Commissioner may
disregard the contingent price term under
§§ 1.482–1(d)(3)(ii)(B)(1) and 1.482–7(k)(1)(iv)
and may impute other contractual terms in its place
consistent with economic substance of the CSA.
(iv)Conversion from fixed to contingent
form of payment. With regard to a conver-
sion of a fixed present value to a contingent
form of payment, see paragraphs (g)(2)(v)
(Discount rate) and (vi) (Financial projec-
tions) of this section.
(3)Coordination of best method rule
and form of payment. A method described
in paragraph (g)(1) of this section eval-
uates the arm’s length amount charged
in a PCT in terms of a form of payment
(method payment form). For example, the
method payment form for the acquisition
price method described in paragraph (g)(5)
of this section, and for the market capi-
talization method described in paragraph
(g)(6) of this section, is fixed payment.
Applications of the income method pro-
vide different method payment forms. See
paragraphs (g)(4)(i)(E) and (iv) of this
section. The method payment form may
not necessarily correspond to the form of
payment specified pursuant to paragraphs
(h)(2)(iii) and (k)(2)(ii)(l) of this section
(specified payment form). The determina-
tion under §1.482–1(c) of the method that
provides the most reliable measure of an
arm’s length result is to be made without
regard to whether the respective method
payment forms under the competing meth-
ods correspond to the specified payment
form. If the method payment form of the
method determined under §1.482–1(c) to
provide the most reliable measure of an
arm’s length result differs from the spec-
ified payment form, then the conversion
from such method payment form to such
specified payment form will be made to
the satisfaction of the Commissioner.
(i)Allocations by the Commissioner in
connection with a CSA—(1)In general.
The Commissioner may make allocations
to adjust the results of a controlled transac-
tion in connection with a CSA so that the
results are consistent with an arm’s length
result, in accordance with the provisions of
this paragraph (i).
(2)CST allocations—(i)In general.
The Commissioner may make allocations
to adjust the results of a CST so that the
results are consistent with an arm’s length
result, including any allocations to make
each controlled participant’s IDC share, as
determined under paragraph (d)(4) of this
section, equal to that participant’s RAB
share, as determined under paragraph
(e)(1) of this section. Such allocations
may result from, for purposes of CST de-
terminations, adjustments to—
2012–12 I.R.B.540March 19, 2012

(A) Redetermine IDCs by adding any
costs (or cost categories) that are directly
identified with, or are reasonably allocable
to, the IDA, or by removing any costs (or
cost categories) that are not IDCs;
(B) Reallocate costs between the IDA
and other business activities;
(C) Improve the reliability of the se-
lection or application of the basis used
for measuring benefits for purposes of
estimating a controlled participant’s RAB
share;
(D) Improve the reliability of the pro-
jections used to estimate RAB shares,
including adjustments described in para-
graph (i)(2)(ii) of this section; and
(E) Allocate among the controlled par-
ticipants any unallocated interests in cost
shared intangibles.
(ii)Adjustments to improve the relia-
bility of projections used to estimate RAB
shares—(A)Unreliable projections.A
significant divergence between projected
benefit shares and benefit shares adjusted
to take into account any available actual
benefits to date (adjusted benefit shares)
may indicate that the projections were not
reliable for purposes of estimating RAB
shares. In such a case, the Commissioner
may use adjusted benefit shares as the
most reliable measure of RAB shares and
adjust IDC shares accordingly. The pro-
jected benefit shares will not be considered
unreliable, as applied in a given taxable
year, based on a divergence from adjusted
benefit shares for every controlled partic-
ipant that is less than or equal to 20% of
the participant’s projected benefits share.
Further, the Commissioner will not make
an allocation based on such divergence if
the difference is due to an extraordinary
event, beyond the control of the controlled
participants, which could not reasonably
have been anticipated at the time that costs
were shared. The Commissioner generally
may adjust projections of benefits used to
calculate benefit shares in accordance with
the provisions of §1.482–1. In particular,
if benefits are projected over a period of
years, and the projections for initial years
of the period prove to be unreliable, this
may indicate that the projections for the
remaining years of the period are also un-
reliable and thus should be adjusted. For
purposes of this paragraph (i)(2)(ii)(A),
all controlled participants that are not U.S.
persons are treated as a single controlled
participant. Therefore, an adjustment
basedonanunreliableprojectionofRAB
shares will be made to the IDC shares
of foreign controlled participants only if
there is a matching adjustment to the IDC
shares of controlled participants that are
U.S. persons. Nothing in this paragraph
(i)(2)(ii)(A) prevents the Commissioner
from making an allocation if a taxpayer
did not use the most reliable basis for mea-
suring anticipated benefits. For example,
if the taxpayer measures its anticipated
benefits based on units sold, and the Com-
missioner determines that another basis
is more reliable for measuring anticipated
benefits, then the fact that actual units
sold were within 20% of the projected unit
sales will not preclude an allocation under
this section.
(B)Foreign-to-foreign adjustments.
Adjustments to IDC shares based on an
unreliable projection also may be made
among foreign controlled participants if
the variation between actual and projected
benefits has the effect of substantially re-
ducing U.S. tax.
(C)Correlative adjustments to PCTs.
Correlative adjustments will be made to
any PCT Payments of a fixed amount that
were determined based on RAB shares that
are subsequently adjusted on a finding that
they were based on unreliable projections.
No correlative adjustments will be made
to contingent PCT Payments regardless of
whether RAB shares were used as a param-
eter in the valuation of those payments.
(D)Examples. The following examples
illustrate the principles of this paragraph
(i)(2)(ii):
Example 1. U.S. Parent (USP) and Foreign Sub-
sidiary (FS) enter into a CSA to develop new food
products, dividing costs on the basis of projected
sales two years in the future. In Year 1, USP and
FS project that their sales in Year 3 will be equal,
and they divide costs accordingly. In Year 3, the
Commissioner examines the controlled participants’
method for dividing costs. USP and FS actually ac-
counted for 42% and 58% of total sales, respectively.
The Commissioner agrees that sales two years in the
future provide a reliable basis for estimating bene-
fit shares. Because the differences between USP’s
and FS’s adjusted and projected benefit shares are
less than 20% of their projected benefit shares, the
projection of future benefits for Year 3 is reliable.
Example 2. The facts are the same as inExam-
ple 1, except that in Year 3 USP and FS actually
accounted for 35% and 65% of total sales, respec-
tively. The divergence between USP’s projected and
adjusted benefit shares is greater than 20% of USP’s
projected benefit share and is not due to an extra-
ordinary event beyond the control of the controlled
participants. The Commissioner concludes that the
projected benefit shares were unreliable, and uses ad-
justed benefit shares as the basis for an adjustment to
the cost shares borne by USP and FS.
Example 3. U.S. Parent (USP), a U.S. corpo-
ration, and its foreign subsidiary (FS) enter into a
CSA in Year 1. They project that they will begin
to receive benefits from cost shared intangibles in
Years 4 through 6, and that USP will receive 60%
of total benefits and FS 40% of total benefits. In
Years 4 through 6, USP and FS actually receive
50% each of the total benefits. In evaluating the
reliability of the controlled participants’ projections,
the Commissioner compares the adjusted benefit
shares to the projected benefit shares. Although
USP’s adjusted benefit share (50%) is within 20%
of its projected benefit share (60%), FS’s adjusted
benefit share (50%) is not within 20% of its projected
benefit share (40%). Based on this discrepancy, the
Commissioner may conclude that the controlled par-
ticipants’ projections were unreliable and may use
adjusted benefit shares as the basis for an adjustment
to the cost shares borne by USP and FS.
Example 4. Three controlled taxpayers, USP,
FS1, and FS2 enter into a CSA. FS1 and FS2 are for-
eign. USP is a domestic corporation that controls all
the stock of FS1 and FS2. The controlled participants
project that they will share the total benefits of the
cost shared intangibles in the following percentages:
USP 50%; FS1 30%; and FS2 20%. Adjusted benefit
shares are as follows: USP 45%; FS1 25%; and FS2
30%. In evaluating the reliability of the controlled
participants’ projections, the Commissioner com-
pares these adjusted benefit shares to the projected
benefit shares. For this purpose, FS1 and FS2 are
treated as a single controlled participant. The ad-
justed benefit share received by USP (45%) is within
20% of its projected benefit share (50%). In addition,
the non-US controlled participant’ adjusted benefit
share (55%) is also within 20% of their projected
benefit share (50%). Therefore, the Commissioner
concludes that the controlled participant’s projec-
tions of future benefits were reliable, despite the fact
that FS2’s adjusted benefit share (30%) is not within
20% of its projected benefit share (20%).
Example 5. ThefactsarethesameasinExam-
ple 4. In addition, the Commissioner determines that
FS2 has significant operating losses and has no earn-
ings and profits, and that FS1 is profitable and has
earnings and profits. Based on all the evidence, the
Commissioner concludes that the controlled partici-
pants arranged that FS1 would bear a larger cost share
than appropriate in order to reduce FS1’s earnings
and profits and thereby reduce inclusions USP oth-
erwise would be deemed to have on account of FS1
under subpart F. Pursuant to paragraph (i)(2)(ii)(B) of
this section, the Commissioner may make an adjust-
ment solely to the cost shares borne by FS1 and FS2
because FS2’s projection of future benefits was un-
reliable and the variation between adjusted and pro-
jected benefits had the effect of substantially reducing
USP’s U.S. income tax liability (on account of FS1
subpart F income).
Example 6. (i)(A) Foreign Parent (FP) and U.S.
Subsidiary (USS) enter into a CSA in 1996 to de-
velop a new treatment for baldness. USS’s interest in
any treatment developed is the right to produce and
sell the treatment in the U.S. market while FP retains
rights to produce and sell the treatment in the rest of
the world. USS and FP measure their anticipated ben-
efits from the CSA based on their respective projected
March 19, 20125412012–12 I.R.B.

future sales of the baldness treatment. The following
sales projections are used:
Sales
[In millions of dollars]
YearUSSFP
1
5
10
22020
33030
44040
5
4040
64040
7
4040
82020
91010
10
55
(B) In Year 1, the first year of sales, USS is pro-
jected to have lower sales than FP due to lags in U.S.
regulatory approval for the baldness treatment. In
each subsequent year, USS and FP are projected to
have equal sales. Sales are projected to build over
the first three years of the period, level off for several
years, and then decline over the final years of the pe-
riod as new and improved baldness treatments reach
the market.
(ii) To account for USS’s lag in sales in the Year 1,
the present discounted value of sales over the period
is used as the basis for measuring benefits. Based on
the risk associated with this venture, a discount rate of
10 percent is selected. The present discounted value
of projected sales is determined to be approximately
$154.4 million for USS and $158.9 million for FP. On
this basis USS and FP are projected to obtain approx-
imately 49.3% and 50.7% of the benefit, respectively,
and the costs of developing the baldness treatment are
shared accordingly.
(iii) (A) In Year 6, the Commissioner examines
the CSA. USS and FP have obtained the following
sales results through Year 5:
Sales
[In millions of dollars]
YearUSSFP
1017
217
35
3
25
41
43841
5
3941
(B) USS’s sales initially grew more slowly than
projected while FP’s sales grew more quickly. In
each of the first three years of the period, the share
of total sales of at least one of the parties diverged
by over 20% from its projected share of sales. How-
ever, by Year 5 both parties’ sales had leveled off at
approximately their projected values. Taking into ac-
count this leveling off of sales and all the facts and
circumstances, the Commissioner determines that it
is appropriate to use the original projections for the
remaining years of sales. Combining the actual re-
sults through Year 5 with the projections for subse-
quent years, and using a discount rate of 10%, the
present discounted value of sales is approximately
$141.6 million for USS and $187.3 million for FP.
This result implies that USS and FP obtain approxi-
mately 43.1% and 56.9%, respectively, of the antici-
pated benefits from the baldness treatment. Because
these adjusted benefit shares are within 20% of the
benefit shares calculated based on the original sales
projections, the Commissioner determines that, based
on the difference between adjusted and projected ben-
efit shares, the original projections were not unreli-
able. No adjustment is made based on the difference
between adjusted and projected benefit shares.
Example 7. (i) The facts are the same as inExam-
ple 6, except that the actual sales results through Year
5 are as follows:
Sales
[In millions of dollars]
YearUSSFP
1017
217
35
3
25
44
434
54
5
36
55
(ii) Based on the discrepancy between the projec-
tions and the actual results and on consideration of all
the facts, the Commissioner determines that for the remaining years the following sales projections are
more reliable than the original projections:
2012–12 I.R.B.542March 19, 2012

Sales
[In millions of dollars]
YearUSSFP
636
55
7
36
55
81828
9914
10
4.5
7
(iii) Combining the actual results through Year 5
with the projections for subsequent years, and using
a discount rate of 10%, the present discounted value
of sales is approximately $131.2 million for USS and
$229.4 million for FP. This result implies that USS
and FP obtain approximately 35.4% and 63.6%, re-
spectively, of the anticipated benefits from the bald-
ness treatment. These adjusted benefit shares diverge
by greater than 20% from the benefit shares calcu-
lated based on the original sales projections, and the
Commissioner determines that, based on the differ-
ence between adjusted and projected benefit shares,
the original projections were unreliable. The Com-
missioner adjusts cost shares for each of the taxable
years under examination to conform them to the re-
calculated shares of anticipated benefits.
(iii)Timing of CST allocations.Ifthe
Commissioner makes an allocation to ad-
just the results of a CST, the allocation
must be reflected for tax purposes in the
year in which the IDCs were incurred.
When a CST payment is owed by one con-
trolled participant to another controlled
participant, the Commissioner may make
appropriate allocations to reflect an arm’s
length rate of interest for the time value of
money, consistent with the provisions of
§1.482–2(a) (Loans or advances).
(3)PCT allocations. The Commis-
sioner may make allocations to adjust the
results of a PCT so that the results are
consistent with an arm’s length result in
accordance with the provisions of the ap-
plicable sections of the regulations under
section 482, as determined pursuant to
paragraph (a)(2) of this section.
(4)Allocations regarding changes in
participation under a CSA. The Commis-
sioner may make allocations to adjust the
results of any controlled transaction de-
scribed in paragraph (f) of this section if
the controlled participants do not reflect
arm’s length results in relation to any such
transaction.
(5)Allocations when CSTs are consis-
tently and materially disproportionate to
RAB shares. If a controlled participant
bears IDC shares that are consistently
and materially greater or lesser than its
RAB share, then the Commissioner may
conclude that the economic substance of
the arrangement between the controlled
participants is inconsistent with the terms
of the CSA. In such a case, the Com-
missioner may disregard such terms and
impute an agreement that is consistent
with the controlled participants’ course
of conduct, under which a controlled par-
ticipant that bore a disproportionately
greater IDC share received additional
interests in the cost shared intangibles.
See §§1.482–1(d)(3)(ii)(B) (Identifying
contractual terms) and 1.482–4(f)(3)(ii)
(Identification of owner). Such additional
interests will consist of partial undivided
interests in the other controlled partici-
pant’s interest in the cost shared intangible.
Accordingly, that controlled participant
must receive arm’s length consideration
from any controlled participant whose
IDC share is less than its RAB share over
time, under the provisions of §§1.482–1
and 1.482–4 through 1.482–6 to provide
compensation for the latter controlled par-
ticipants’ use of such partial undivided
interest.
(6)Periodic adjustments—(i)In gen-
eral. Subject to the exceptions in para-
graph (i)(6)(vi) of this section, the Com-
missioner may make periodic adjustments
for an open taxable year (the Adjustment
Year) and for all subsequent taxable years
for the duration of the CSA Activity with
respect to all PCT Payments, if the Com-
missioner determines that, for a particular
PCT (the Trigger PCT), a particular con-
trolled participant that owes or owed a
PCT Payment relating to that PCT (such
controlled participant being referred to
as the PCT Payor for purposes of this
paragraph (i)(6)) has realized an Actually
Experienced Return Ratio (AERR) that is
outside the Periodic Return Ratio Range
(PRRR). The satisfaction of the condi-
tion stated in the preceding sentence is
referred to as a Periodic Trigger. See para-
graphs (i)(6)(ii) through (vi) of this section
regarding the PRRR, the AERR, and peri-
odic adjustments. In determining whether
to make such adjustments, the Commis-
sioner may consider whether the outcome
as adjusted more reliably reflects an arm’s
length result under all the relevant facts
and circumstances, including any informa-
tion known as of the Determination Date.
The Determination Date is the date of the
relevant determination by the Commis-
sioner. The failure of the Commissioner
to determine for an earlier taxable year
that a PCT Payment was not arm’s length
will not preclude the Commissioner from
making a periodic adjustment for a subse-
quent year. A periodic adjustment under
this paragraph (i)(6) may be made without
regard to whether the taxable year of the
Trigger PCT or any other PCT remains
open for statute of limitations purposes or
whether a periodic adjustment has previ-
ously been made with respect to any PCT
Payment.
(ii)PRRR. Except as provided in the
next sentence, thePRRRwill consist of re-
turn ratios that are not less than .667 nor
more than 1.5. Alternatively, if the con-
trolled participants have not substantially
complied with the documentation require-
ments referenced in paragraph (k) of this
section, as modified, if applicable, by para-
graphs (m)(2) and (3) of this section, the
PRRR will consist of return ratios that are
not less than .8 nor more than 1.25.
(iii)AERR—(A)In general.TheAERR
is the present value of total profits (PVTP)
divided by the present value of invest-
ment (PVI). In computing PVTP and PVI,
present values are computed using the ap-
plicable discount rate (ADR), and all infor-
mation available as of the Determination
Date is taken into account.
(B)PVTP.ThePVTPis the present
value, as of the CSA Start Date, as de-
fined in section (j)(1)(i) of this section, of
the PCT Payor’s actually experienced divi-
sional profits or losses from the CSA Start
Date through the end of the Adjustment
Year.
March 19, 20125432012–12 I.R.B.

(C)PVI.ThePVIis the present value, as
of the CSA Start Date, of the PCT Payor’s
investment associated with the CSA Activ-
ity, defined as the sum of its cost contribu-
tions and its PCT Payments, from the CSA
Start Date through the end of the Adjust-
ment Year. For purposes of computing the
PVI, PCT Payments means all PCT Pay-
ments due from a PCT Payor before net-
ting against PCT Payments due from other
controlled participants pursuant to para-
graph (j)(3)(ii) of this section.
(iv)ADR—(A)In general. Except as
provided in paragraph (i)(6)(iv)(B) of this
section, the ADR is the discount rate pur-
suant to paragraph (g)(2)(v)ofthissection,
subject to such adjustments as the Com-
missioner determines appropriate.
(B)Publicly traded companies.Ifthe
PCT Payor meets the conditions of para-
graph (i)(6)(iv)(C) of this section, the ADR
is the PCT Payor WACC as of the date of
the Trigger PCT. However, if the Commis-
sioner determines, or the controlled partic-
ipants establish to the satisfaction of the
Commissioner, that a discount rate other
than the PCT Payor WACC better reflects
thedegreeofriskoftheCSAActivityasof
such date, the ADR is such other discount
rate.
(C)Publicly traded.APCTPayor
meets the conditions of this paragraph
(i)(6)(iv)(C) if—
(1) Stock of the PCT Payor is publicly
traded; or
(2) Stock of the PCT Payor is not pub-
licly traded, provided the PCT Payor is in-
cluded in a group of companies for which
consolidated financial statements are pre-
pared; and a publicly traded company in
such group owns, directly or indirectly,
stock in PCT Payor. Stock of a company
is publicly traded within the meaning of
this paragraph (i)(6)(iv)(C) if such stock is
regularlytradedonanestablishedUnited
States securities market and the company
issues financial statements prepared in ac-
cordance with United States generally ac-
cepted accounting principles for the tax-
able year.
(D)PCT Payor WACC.ThePCT Payor
WACCis the WACC, as defined in para-
graph (j)(1)(i) of this section, of the PCT
Payor or the publiclytraded company de-
scribed in paragraph (i)(6)(iv)(C)(2)(ii)of
this section, as the case may be.
(E)Generally accepted accounting
principles. For purposes of paragraph
(i)(6)(iv)(C) of this section, a financial
statement prepared in accordance with
a comprehensive body of generally ac-
cepted accounting principles other than
United States generally accepted account-
ing principles is considered to be prepared
in accordance with United States generally
accepted accounting principles provided
that the amounts of debt, equity, and
interest expense are reflected in any rec-
onciliation between such other accounting
principles and United States generally ac-
cepted accounting principles required to
be incorporated intothe financial state-
ment by the securities laws governing
companies whose stock is regularly traded
on United States securities markets.
(v)Determination of periodic adjust-
ments. In the event of a Periodic Trigger,
subject to paragraph (i)(6)(vi) of this
section, the Commissioner may make pe-
riodic adjustments with respect to all PCT
Payments between all PCT Payors and
PCT Payees for the Adjustment Year and
all subsequent years for the duration of
the CSA Activity pursuant to the residual
profit split method as provided in para-
graph (g)(7) of this section, subject to the
further modifications in this paragraph
(i)(6)(v). A periodic adjustment may be
made for a particular taxable year without
regard to whether the taxable years of the
Trigger PCT or other PCTs remain open
for statute of limitation purposes.
(A)In general. Periodic adjustments
are determined by the following steps:
(1) First, determine the present value,
as of the date of the Trigger PCT, of
the PCT Payments under paragraph
(g)(7)(iii)(C)(3) of this section pursuant
to the Adjusted RPSM as defined in para-
graph (i)(6)(v)(B) of this section (first step
result).
(2) Second, convert the first step re-
sult into a stream of contingent payments
on a base of reasonably anticipated divi-
sional profits or losses over the entire dura-
tion of the CSA Activity, using a level roy-
alty rate (second step rate). See paragraph
(h)(2)(iv) of this section (Conversion from
fixed to contingent form of payment). This
conversion is made based on all informa-
tion known as of the Determination Date.
(3) Third, apply the second step rate to
the actual divisional profit or loss for tax-
able years preceding and including the Ad-
justment Year to yield a stream of con-
tingent payments forsuch years, and con-
vert such stream to a present value as of
the CSA Start Date under the principles of
paragraph (g)(2)(v) of this section (third
step result). For this purpose, the second
step rate applied to a loss for a particular
year will yield a negative contingent pay-
ment for that year.
(4) Fourth, convert any actual PCT Pay-
ments up through the Adjustment Year to
a present value as of the CSA Start Date
under the principles of paragraph (g)(2)(v)
of this section. Then subtract such amount
from the third step result. Determine the
nominal amount in the Adjustment Year
that would have a present value as of the
CSA Start Date equal to the present value
determined in the previous sentence to de-
termine the periodic adjustment in the Ad-
justment Year.
(5) Fifth, apply the second step rate to
the actual divisional profit or loss for each
taxable year after the Adjustment Year up
to and including the taxable year that in-
cludes the Determination Date to yield a
stream of contingent payments for such
years. For this purpose, the second step
rate applied to a loss will yield a negative
contingent payment for that year. Then
subtract from each such payment any ac-
tual PCT Payment made for the same year
to determine the periodic adjustment for
such taxable year.
(6) For each taxable year subsequent
to the year that includes the Determina-
tion Date, the periodic adjustment for such
taxable year (which is in lieu of any PCT
Payment that would otherwise be payable
for that year under the taxpayer’s position)
equals the second step rate applied to the
actual divisional profit or loss for that year.
For this purpose, the second step rate ap-
plied to a loss for a particular year will
yield a negative contingent payment for
that year.
(7) If the periodic adjustment for any
taxable year is a positive amount, then it
is an additional PCT Payment owed from
the PCT Payor to the PCT Payee for such
year. If the periodic adjustment for any
taxable year is a negative amount, then it
is an additional PCT Payment owed by the
PCT Payee to the PCT Payor for such year.
(B)Adjusted RPSM as of Determina-
tion Date. The Adjusted RPSM is the
residual profit split method pursuant to
paragraph (g)(7) of this section applied to
determine the present value, as of the date
of the Trigger PCT, of the PCT Payments
2012–12 I.R.B.544March 19, 2012

under paragraph (g)(7)(iii)(C)(3)ofthis
section, with the following modifications.
(1) Actual results up through the Deter-
mination Date shall be substituted for what
otherwise were the projected results over
such period, as reasonably anticipated as
of the date of the Trigger PCT.
(2) Projected results for the balance of
the CSA Activity after the Determination
Date, as reasonably anticipated as of the
Determination Date, shall be substituted
for what otherwise were the projected re-
sults over such period, as reasonably an-
ticipated as of the date of the Trigger PCT.
(3) The requirement in paragraph
(g)(7)(i) of this section, that at least two
controlled participants make significant
nonroutine contributions, does not apply.
(vi)Exceptions to periodic adjust-
ments–(A)Controlled participants estab-
lish periodic adjustment not warranted.
No periodic adjustment will be made under
paragraphs (i)(6)(i) and (v) of this section
if the controlled participants establish to
the satisfaction of the Commissioner that
all the conditions described in one of para-
graphs (i)(6)(vi)(A)(1)through(4)ofthis
section apply with respect to the Trigger
PCT.
(1)Transactions involving the same
platform contribution as in the Trigger
PCT.
(i) The same platform contribution is
furnished to an uncontrolled taxpayer un-
der substantially the same circumstances
as those of the relevant Trigger PCT and
with a similar form of payment as the Trig-
ger PCT;
(ii)Thistransactionservesasthebasis
for the application of the comparable un-
controlled transaction method described in
paragraph (g)(3) of this section, in the first
year and all subsequent years in which sub-
stantial PCT Payments relating to the Trig-
ger PCT were required to be paid; and
(iii) The amount of those PCT Pay-
ments in that first year was arm’s length.
(2)Results not reasonably anticipated.
The differential between the AERR and
the nearest bound of the PRRR is due to
extraordinary events beyond the control of
the controlled participants that could not
reasonably have been anticipated as of the
date of the Trigger PCT.
(3)Reduced AERR does not cause Peri-
odic Trigger. The Periodic Trigger would
not have occurred had the PCT Payor’s di-
visional profits or losses used to calculate
its PVTP both taken into account expenses
on account of operating cost contributions
and routine platform contributions, and ex-
cluded those profits or losses attributable
to the PCT Payor’s routine contributions
to its exploitation of cost shared intangi-
bles, nonroutine contributions to the CSA
Activity, operating cost contributions, and
routine platform contributions.
(4)Increased AERR does not cause Pe-
riodic Trigger—(i) The Periodic Trigger
would not have occurred had the divisional
profits or losses of the PCT Payor used to
calculate its PVTP included its reasonably
anticipated divisional profits or losses af-
ter the Adjustment Year from the CSA Ac-
tivity, including fromits routine contribu-
tions, its operating cost contributions, and
its nonroutine contributions to that activ-
ity, and had the cost contributions and PCT
Payments of the PCT Payor used to cal-
culate its PVI included its reasonably an-
ticipated cost contributions and PCT Pay-
ments after the Adjustment Year. The rea-
sonably anticipated amounts in the previ-
ous sentence are determined based on all
information available as of the Determina-
tion Date.
(ii) For purposes of this paragraph
(i)(6)(vi)(A)(4), the controlled partic-
ipants may, if they wish, assume that
the average yearly divisional profits or
losses for all taxable years prior to and
including the Adjustment Year, in which
there has been substantial exploitation of
cost shared intangibles resulting from the
CSA (exploitation years), will continue
to be earned in each year over a period
of years equal to 15 minus the number of
exploitation years prior to and including
the Determination Date.
(B)Circumstances in which Periodic
Trigger deemed not to occur.NoPeriodic
Trigger will be deemed to have occurred
at the times and in the circumstances de-
scribed in paragraph (i)(6)(vi)(B)(1)or(2)
of this section.
(1)10-year period. In any year subse-
quent to the 10-year period beginning with
the first taxable year in which there is sub-
stantial exploitation of cost shared intangi-
bles resulting from the CSA, if the AERR
determined is within the PRRR for each
year of such 10-year period.
(
2)5-year period. In any year of the
5-year period beginning with the first tax-
able year in which there is substantial ex-
ploitation of cost shared intangibles result-
ing from the CSA, if the AERR falls below
the lower bound of the PRRR.
(vii)Examples. The following exam-
ples illustrate the rules of this paragraph
(i)(6):
Example 1. (i) For simplicity of calculation in
thisExample 1, all financial flows are assumed to oc-
cur at the beginning of the year. At the beginning
of Year 1, USP, a publicly traded U.S. company, and
FS, its wholly-owned foreign subsidiary, enter into
a CSA to develop new technology for cell phones.
USP has a platform contribution, the rights for an
in-process technology that when developed will im-
prove the clarity of calls, for which compensation is
due from FS. FS has no platform contributions to the
CSA, no operating contributions, and no operating
cost contributions. USP and FS agree to fixed PCT
payments of $40 million in Year 1 and $10 million
per year for Years 2 through 10. At the beginning
of Year 1, the weighted average cost of capital of the
controlled group that includes USP and FS is 15%. In
Year 9, the Commissioner audits Years 5 through 7 of
the CSA and considers whether any periodic adjust-
ments should be made. USP and FS have substan-
tially complied with the documentation requirements
of paragraph (k) of this section.
(ii) FS experiences the results reported in the fol-
lowing table from its participation in the CSA through
Year 7. In the table, all present values (PV) are re-
ported as of the CSA Start Date, which is the same as
the date of the PCT (and reflect a 15% discount rate as
discussed in paragraph (iii) of thisExample 1). Thus,
in any year the present value of the cumulative invest-
ment is PVI and of the cumulative divisional profit or
loss is PVTP. All amounts in this table and the tables
that follow are reported in millions of dollars and cost
contributions are referred to as “CCs” (for simplicity
of calculation in thisExample 1, all financial flows
are assumed to occur at the beginning of the year).
abcd e f g h
YearSalesNon-CC CostsCCsPCT PaymentsInvestment (d+e)
Divisional Profit
or Loss (b-c)
AERR
(PVTP/PVI) (g/f)
100
15
40
55
0
2001710270
March 19, 20125452012–12 I.R.B.

abcd e f g h
YearSalesNon-CC CostsCCsPCT PaymentsInvestment (d+e)
Divisional Profit
or Loss (b-c)
AERR
(PVTP/PVI) (g/f)
3001810280
4
705
66220103046
5
886718221032168
61,113680241034433
7
1,179747271037432
PV through
Year 5
97084669691381240.90
PV through
Year 6
1,523
1,1848174
155
3402.20
PV through
Year 7
2,033
1,507
9378171
526
3.09
(iii) Because USP is publicly traded in the United
States and
is a member of the controlled group to
which FS (the PCT Payor) belongs, for purposes of
calculating the AERR for FS, the present values of
its PVTP an
d PVI are determined using an ADR of
15%, the weighted average cost of capital of the con-
trolled group. (It is assumed that no other rate was de-
termined
or established, under paragraph (i)(6)(iv)(B)
of this section, to better reflect the relevant degree of
risk.) At a 15% discount rate, the PVTP, calculated as
of Year 1,
and based on actual profits realized by FS
through Year 7 from exploiting the new cell phone
technology developed by the CSA, is $526 million.
The PVI,
based on FS’s cost contributions and its PCT
Payments, is $171 million. The AERR for FS is equal
to its PVTP divided by its PVI, $526 million/$171
million, or 3.09. There is a Periodic Trigger because
FS’s AERR o
f 3.09 falls outside the PRRR of .67 to
1.5, the applicable PRRR for controlled participants
complying with the documentation requirements of
this secti
on.
(iv) At the time of the Determination Date, it is
determined that the first Adjustment Year in which
a Periodic
Trigger occurred was Year 6, when the
AERR of FS was determined to be 2.20. It is also
determined that for Year 6 none of the exceptions
to period
ic adjustments described in paragraph
(i)(6)(vi) of this section applies. The Commissioner
exercises its discretion under paragraph (i)(6)(i) of
this sec
tion to make periodic adjustments using Year
6 as the Adjustment Year. Therefore, the arm’s length
PCT Payments from FS to USP shall be determined
for each taxable year using the adjusted residual
profit spl
it method described in paragraphs (g)(7)
and (i)(6)(v)(B) of this section. Periodic adjustments
will be made for each year to the extent the PCT
Payments a
ctually made by FS differ from the PCT
Payment calculation under the adjusted residual
profit split method.
(v) It is de
termined, as of the Determination Date,
that the cost shared intangibles will be exploited
through Year 10. FS’s return for routine contribu-
tions (de
termined by the Commissioner, based on
the return for comparable functions undertaken by
comparable uncontrolled companies, to be 8% of
non-CC c
osts), and its actual and projected results,
are described in the following table.
abc d efg
YearSalesNon-CC Costs
Divisional profit or
loss (b-c)CCsRoutine Return
Residual Profit
(d-e-f)
100 0
15
0
-15
200 0 170-17
300 0 180-18
4
705
6624320
53
-30
5
88671816822
57
89
61,11368043324
54355
7
1,1797474322760
345
81,2388224162966321
91,3008944063272302
10
1,365
974391
35
78278
Cumulative PV
through Year 10 as
of CSA Start Date
3,312
2,385
927124191612
(vi) The periodic adjustments are calculated in
a series of steps set out in paragraph (i)(6)(v)(A) of
this section. First, a lump sum for the PCT Payment
is determined using the adjusted residual profit split
method. Under the method, based on the consider-
ations discussed in paragraph (g)(2)(v) of this sec-
tion, the appropriate discount rate is 15% per year.
The nonroutine residual divisional profit or loss de-
scribed in paragraph (g)(7)(iii)(B) of this section is
$612 million. Further, under paragraph (g)(7)(iii)(C)
of this section, the entire nonroutine residual divi-
sional profit constitutes the PCT Payment because
only USP has nonroutine contributions.
(vii) In step two, the first step result ($612 mil-
lion) is converted into a level royalty rate based on
the reasonably anticipated divisional profit or losses
of the CSA Activity, the PV of which is reported in
the table above (net PV of divisional profit or loss
for Years 1 through 10 is $927 million). Conse-
quently, the step two result is a level royalty rate of
2012–12 I.R.B.546March 19, 2012

66.0% ($612/$927) of the divisional profit in Years
1 through 10.
(viii) In step three, the Commissioner calculates
the PCT Payments due through Year 6 by applying the
step two royalty rate to the actual divisional profits for
each year and then determines the aggregate PV of
these PCT Payments as of the CSA Start Date ($224
million as reported in the following table). In step
four, the PCT Payments actually made through Year
6 are similarly converted to PV as of the CSA Start
Date ($74 million) and subtracted from the amount
determined in step three ($224 million - $74 million
= $150 million). That difference of $150 million, rep-
resenting a net PV as of the CSA Start Date, is then
converted to a nominal amount, as of the Adjustment
Year, of equivalent present value (again using a dis-
count rate of 15%). That nominal amount is $302
million (not shown in the table), and is the periodic
adjustment in Year 6.
abcde
YearDivisional ProfitRoyalty Rate
Nominal Royalty Due under
adjusted RPSM (b*c)Nominal Payments made
Year 1066.0%
$0$40
Year 2066.0%
$0$10
Year 3066.0%
$0$10
Year 44366.0%
$28$10
Year 5
16866.0%
$111$10
Year 643366.0%
$286$10
Cumulative PV as of Year 1
$224$74
(ix) Under step five, the royalties due from FS to
USP for Year 7 (the year after the Adjustment Year)
through Year 9 (the year including the Determina-
tion Date) are determined. (These determinations are
made for Years 8 and 9 after the divisional profit for
those years becomes available.) For each year, the pe-
riodic adjustment is a PCT Payment due in addition
to the $10 million PCT Payment that must otherwise
be paid under the CSA as described in paragraph (i)
of thisExample 1. That periodic adjustment is calcu-
lated as the product of the step two royalty rate and the
divisional profit, minus the $10 million that was oth-
erwise paid for that year. The calculations are shown
in the following table:
ab cdEf
YearDivisional profitRoyalty rateRoyalty due (b*c)PCT Payments otherwise paidPeriodic adjustment (d-e)
7
43266.0%
$285$10$275
841666.0%
$275$10$265
940666.0%
$268$10$258
(x) Under step six, the periodic adjustment for
Year 10 (the only exploitation year after the year con-
taining the Determination Date) will be determined
by applying the step two royalty rate to the divisional
profit. This periodic adjustment is a PCT Payment
payable from FS to USP, and is in lieu of the $10
payment otherwise due. The calculations are shown
in the following table, based on a divisional profit of
$391 million. USP and FS experienced the following
results in Year 10.
YearDivisional profitRoyalty rateRoyalty due
PCT Payment called for
under original agreement
but not madePeriodic adjustment
1039166.0%
$258$10 (not paid)$258
Ex
ample 2. The facts are the same as in para-
graphs (i) through (iii) ofExample 1. At the time
of the Determination Date, it is determined that the
f
irst Adjustment Year in which a Periodic Trigger oc-
curred was Year 6, when the AERR of FS was de-
termined to be 2.73. Upon further investigation as to
w
hat may have caused the high return in FS’s mar-
ket, the Commissioner learns that, in Years 4 through
6, USP’s leading competitors experienced severe, un-
foreseen disruptions in their supply chains resulting
in a significant increase in USP’s and FS’s market
share for cell phones. Further analysis determines
that without this unforeseen occurrence the Periodic
Trigger would not have occurred. Based on para-
graph (i)(6)(vi)(A)(2) of this section, the Commis-
sioner determines to his satisfaction that no adjust-
ments are warranted.
Ex
ample 3. (i) USP, a U.S. corporation, and its
wholly-owned foreign subsidiaries FS1, FS2, and
FS3 enter into a CSA at the start of Year 1 to develop
v
ersion 2.0 of a computer program. USP makes a
platform contribution, version 1.0 of the program
(upon which version 2.0 will be based), for which
c
ompensation is due from FS1, FS2, and FS3. None
of the foreign subsidiaries makes any platform con-
tributions.
(
ii) In Year 6, the Commissioner audits Years 3
through 5 of the CSA and considers whether any pe-
riodic adjustments should be made. At the time of the
Determination Date, the Commissioner determines
that the first Adjustment Year in which a Periodic
Trigger occurred was Year 3, and further determines
that none of the exceptions to periodic adjustments
described in paragraph (i)(6)(vi) of this section ap-
pl
ies. The Commissioner exercises his discretion un-
der paragraph (i)(6)(i) of this section to make pe-
riodic adjustments using Year 3 as the Adjustment
Y
ear. Therefore, the arm’s length PCT Payments
from FS1, FS2, and FS3 to USP shall be determined
using the adjusted residual profit split method de-
s
cribed in paragraphs (g)(7)(v)(B) and (i)(6)(v)(B) of
this section. Periodic adjustments will be made for
each year to the extent the PCT Payments actually
made by FS1, FS2, and FS3 differ from the PCT Pay-
ment calculation under the adjusted residual profit
split method.
(iii) The periodic adjustments are calculated in
a series of steps set out in paragraph (i)(6)(v)(A) of
this section. First, a lump sum for the PCT Payments
is determined using the adjusted residual profit split
method. The following results are calculated (based
March 19, 20125472012–12 I.R.B.

on actual results for years for which actual results
are available and projected results for all years there-
after) in order to apply the adjusted residual profit
split method (it is determined that the cost shared in-
tangibles will be exploited through Year 7, so the re-
sults reported in the following table are cumulative
values through Year 7):
Participant
Divisional Profits (cumulative PV through
Year 7 as of the CSA Start Date)
Residual Profits (cumulative PV through Year
7 as of the CSA Start Date)
FS1
$667$314
FS2
$271$159
FS3
$592$295
Because only USP had nonroutine contributions,
under paragraph (g)(7)(iii)(C) of this section, the
entire nonroutine residual divisional profit consti-
tutes the PCT Payment owedto USP. Therefore, the
present values (as of the CSA Start Date) of the PCT
Payments owed are as follows:
PCT Payment owed from FS1 to USP: $314 million
PCT Payment owed from FS2 to USP: $159 million
PCT Payment owed from FS3 to USP: $295 million
Pursuant to paragraph (i)(6)(v)(A) of this section,
the steps in paragraphs (i)(6)(v)(A)(2) through (7)
of this section are performed separately for the PCT
Payments that are owed to USP by each of FS1, FS2,
and FS3.
(iv) First, the steps are performed with respect to
FS1. In step two, the first step result ($314 million)
is converted into a level royalty rate based on FS1’s
reasonably anticipated divisional profits or losses
through Year 7 (the PV of which is $667 million).
Consequently, the step two result is a level royalty
rate of 47.1% ($314/$667) of the divisional profits in
Years 1 through 7. In step three, the Commissioner
calculates the PCT Payments due through Year 3 (the
Adjustment Year) by applying the step two royalty
rate (47.1%) to FS1’s actual divisional profits for
each year up to and including Year 3 and then deter-
mining the aggregate PV of these PCT Payments as
of Year 3. In step four, the PCT Payments actually
made by FS1 to USP through Year 3 are similarly
converted to a PV as of Year 3 and subtracted from
the amount determined in step three. That difference
is the periodic adjustment in Year 3 with respect to the
PCT Payments made for Years 1 through 3 from FS1
to USP. Under step five, the royalties due from FS1 to
USP for Year 4 (the year after the Adjustment Year)
through Year 6 (the year including the Determination
Date) are determined. The periodic adjustment for
each of these years is calculated as the product of
the step two royalty rate and the divisional profit for
that year, minus any actual PCT Payment made by
FS1 to USP in that year. The periodic adjustment for
each such year is a PCT Payment due in addition to
the PCT Payment from FS1 to USP that was already
made under the CSA. Under step six, the periodic
adjustment for Year 7 (the only exploitation year
after the year containing the Determination Date)
will be determined by applying the step two royalty
rate to FS1’s divisional profit for that year. This
periodic adjustment for Year 7 is a PCT Payment
payable from FS1 to USP and is in lieu of any PCT
PaymentfromFS1toUSPotherwisedue.
(v) Next, the steps in paragraphs (i)(6)(v)(A)(2)
through (7) of this section are performed with re-
spect to FS2. In step two, the first step result ($159
million) is converted into a level royalty rate based
on FS2’s reasonably anticipated divisional profits or
losses through Year 7 (the PV of which is $271 mil-
lion). Consequently, the step two result is a level roy-
alty rate of 58.7% ($159/$271) of the divisional prof-
its in Years 1 through 7. In step three, the Commis-
sioner calculates the PCT Payments due through Year
3 (the Adjustment Year) by applying the step two roy-
alty rate (58.7%) to FS2’s actual divisional profits for
each year up to and including Year 3 and then deter-
mining the aggregate PV of these PCT Payments as
of Year 3. In step four, the PCT Payments actually
made by FS2 to USP through Year 3 are similarly
converted to a PV as of Year 3 and subtracted from
the amount determined in step three. That difference
is the periodic adjustment in Year 3 with respect to
the PCT Payments made for Years 1 through 3 from
FS2 to USP. Under step five, the royalties due from
FS2toUSPforYear4(theyearaftertheAdjustment
Year) through Year 6 (the year including the Determi-
nation Date) are determined. The periodic adjustment
for each of these years is calculated as the product of
the step two royalty rate and the divisional profit for
that year, minus any actual PCT Payment made by
FS2 to USP in that year. The periodic adjustment for
each such year is a PCT Payment due in addition to
the PCT Payment from FS2 to USP that was already
made under the CSA. Under step six, the periodic ad-
justment for Year 7 (the only exploitation year after
the year containing the Determination Date) will be
determined by applying the step two royalty rate to
FS2’s divisional profit for that year. This periodic ad-
justmentforYear7isaPCT Payment payable from
FS2toUSPandisinlieuofanyPCTPaymentfrom
FS2 to USP otherwise due.
(vi) Finally, the steps in paragraphs
(i)(6)(v)(A)(2) through (7) of this section are
performedwithrespecttoFS3.Insteptwo,thefirst
step result ($295 million) is converted into a level
royalty rate based on FS3’s reasonably anticipated
divisional profits or losses through Year 7 (the PV of
which is $592 million). Consequently, the step two
result is a level royalty rate of 49.8% ($295/$592)
of the divisional profits in Years 1 through 7. In
step three, the Commissioner calculates the PCT
Payments due through Year 3 (the Adjustment Year)
by applying the step two royalty rate (49.8%) to
FS3’s actual divisional profits for each year up to and
including Year 3 and then determining the aggregate
PV of these PCT Payments as of Year 3. In step four,
the PCT Payments actually made by FS3 to USP
through Year 3 are similarly converted to a PV as of
Year 3 and subtracted from the amount determined in
step three. That differenceis the periodic adjustment
in Year 3 with respect to the PCT Payments made
for Years 1 through 3 from FS3 to USP. Under step
five, the royalties due from FS3 to USP for Year 4
(the year after the Adjustment Year) through Year
6 (the year including the Determination Date) are
determined. The periodic adjustment for each of
these years is calculated as the product of the step
two royalty rate and the divisional profit for that
year, minus any actual PCT Payment made by FS3
to USP in that year. The periodic adjustment for
each such year is a PCT Payment due in addition to
the PCT Payment from FS3 to USP that was already
made under the CSA. Under step six, the periodic
adjustment for Year 7 (the only exploitation year
after the year containing the Determination Date)
will be determined by applying the step two royalty
rate to FS3’s divisional profit for that year. This
periodic adjustment for Year 7 is a PCT Payment
payable from FS3 to USP and is in lieu of any PCT
Payment from FS3 to USP otherwise due.
(j)Definitions and special rules—(1)Defini-
tions—(i)In general. For purposes of this section—
TermDefinitionMain Cross References
Acquisition price
§1.482–7(g)(5)(i)
2012–12 I.R.B.548March 19, 2012

TermDefinitionMain Cross References
Adjusted acquisition price
§1.482–7(g)(5)(iii)
Adjusted average market capitalization§1.482–7(g)(6)(iv)
Adjusted benefit shares§1.482–7(i)(2)(ii)(A)
Adjusted RPSM§1.482–7(i)(6)(v)(B)
Adjustment Year§1.482–7(i)(6)(i)
ADR
§1.482–7(i)(6)(iv)
AERR
§1.482–7(i)(6)(iii)
Applicable Method§1.482–7(g)(2)(ix)(A)
Average market capitalization§1.482–7(g)(6)(iii)
BenefitsBenefitsmean the sum of additional revenue
generated, plus cost savings, minus any cost
increases from exploiting cost shared intangibles.
§1.482–7(e)(1)(i)
Capability variation§1.482–7(f)(3)
Change in participation under a CSA§1.482–7(f)
Consolidated group§1.482–7(j)(2)(i)
Contingent payments§1.482–7(h)(2)(i)(B)
Controlled participantControlled participantmeans a controlled taxpayer,
as defined under §1.482–1(i)(5), that is a party to
the contractual agreement that underlies the CSA,
and that reasonably anticipates that it will derive
benefits, as defined in paragraph (e)(1)(i) of this
section, from exploiting one or more cost shared
intangibles.
§1.482–7(a)(1)
Controlled transfer of interests§1.482–7(f)(2)
Cost contribution§1.482–7(d)(4)
Cost shared intangibleCost shared intangiblemeans any intangible, within
the meaning of §1.482–4(b), that is developed by
the IDA, including any portion of such intangible
that reflects a platform contribution. Therefore, an
intangible developed by the IDA is a cost shared
intangible even though the intangible was not
always or was never a reasonably anticipated cost
shared intangible.
§1.482–7(b)
Cost sharing alternative§1.482–7(g)(4)(i)(B)
Cost sharing arrangement or CSA§1.482–7(a), (b)
Cost sharing transactions or CSTs§1.482–7(a)(1), (b)(1)(i)
Cross operating contributionsAcross operating contributionis any resource
or capability or right, other than a platform
contribution, that a controlled participant has
developed, maintained, or acquired prior to the CSA
Start Date, or subsequent to the CSA start date by
means other than operating cost contributions or
cost contributions, that is reasonably anticipated
to contribute to the CSA Activity within another
controlled participant’s division.
§1.482–7(a)(3)(iii), (g)(2)(iv)
CSA ActivityCSA Activityis the activity of developing and
exploiting cost shared intangibles.
§1.482–7(c)(2)(i)
CSA Start DateTheCSA Start Dateis the earlier of the date of
the CSA contract or the first occurrence of any
IDC to which the CSA applies, in accordance with
§1.482–7(k)(1)(iii).
§1.482–7(i)(6)(iii)(B) and (k)(1)(ii) and (iii)
CST Payments§1.482–7(b)(1)
Date of PCT§1.482–7(b)(3)
March 19, 20125492012–12 I.R.B.

TermDefinitionMain Cross References
Determination Date§1.482–7(i)(6)(i)
Differential income stream§1.482–7(g)(4)(vi)(F)(2)
DivisionDivisionmeans the territory or other division that
serves as the basis of the division of interests under
the CSA in the cost shared intangibles pursuant to
§1.482–7(b)(4).
See definitions of divisional profit or loss, operating
contribution, and operating cost contribution
Divisional interest§1.482–7(b)(1)(iii), (b)(4)
Divisional profit or lossDivisional profit or lossmeans the operating profit
or loss as separately earned by each controlled
participant in its division from the CSA Activity,
determined before any expense (including
amortization) on account of cost contributions,
operating cost contributions, routine platform and
operating contributions, nonroutine contributions
(including platform and operating contributions),
and tax.
§1.482–7(g)(4)(iii)
Fixed payments§1.482–7(h)(2)(i)(A)
Implied discount rate§1.482–7(g)(2)(v)(B)(2)
IDC share§1.482–7(d)(4)
Input parameters
§1.482–7(g)(2)(ix)(B)
Intangible development activity or IDA§1.482–7(d)(1)
Intangible development costs or IDCs§1.482–7(a)(1), (d)(1)
Licensing alternative§1.482–7(g)(4)(i)(C)
Licensing paymentsLicensing paymentsmeans payments pursuant to the
licensing obligations under the licensing alternative.
§1.482–7(g)(4)(iii)
Make-or-sell rights§1.482–7(c)(4), (g)(2)(iv)
Market-based input parameter§1.482–7(g)(2)(ix)(B)
Market returns for routine contributionsMarket returns for routine contributionsmeans
returns determined by reference to the returns
achieved by uncontrolled taxpayers engaged in
activities similar to the relevant business activity
in the controlled participant’s division, consistent
with the methods described in §§1.482–3, 1.482–4,
1.482–5, or §1.482–9(c).
§1.482–7(g)(4), (g)(7)
Method payment form§1.482–7(h)(3)
Nonroutine contributionsNonroutine contributionsmeans a controlled
participant’s contributions to the relevant business
activities that are not routine contributions.
Nonroutine contributions ordinarily include both
nonroutine platform contributions and nonroutine
operating contributions used by controlled
participants in the commercial exploitation of
their interests in the cost shared intangibles (for
example, marketing intangibles used by a controlled
participant in its division to sell products that are
based on the cost shared intangible).
§1.482–7(g)
Nonroutine residual divisional profit or loss§1.482–7(g)(7)(iii)
Operating contributionsAnoperating contributionis any resource
or capability or right, other than a platform
contribution, that a controlled participant has
developed, maintained, or acquired prior to the CSA
Start Date, or subsequent to the CSA Start Date by
means other than operating cost contributions or
cost contributions, that is reasonably anticipated to
contribute to the CSA Activity within the controlled
participant’s division.
§1.482–7(g)(2)(ii), (g)(4)(vi)(E), (g)(7)(iii)(A) and
(C)
2012–12 I.R.B.550March 19, 2012

TermDefinitionMain Cross References
Operating cost contributionsOperating cost contributionsmeansallcostsin
the ordinary course of business on or after the
CSA Start Date that, based on analysis of the
facts and circumstances, are directly identified
with, or are reasonably allocable to, developing
resources, capabilities, or rights (other than
reasonably anticipated cost shared intangibles) that
are reasonably anticipated to contribute to the CSA
Activity within the controlled participant’s division.
§1.482–7(g)(2)(ii), (g)(4)(iii), (g)(7)(iii)(B)
PCT Payee§1.482–7(b)(1)(ii)
PCT Payment§1.482–7(b)(1)(ii)
PCT Payor§1.482–7(b)(1)(ii), (i)(6)(i)
PCT Payor WACC§1.482–7(i)(6)(iv)(D)
Periodic adjustments§1.482–7(i)(6)(i)
Periodic Trigger§1.482–7(i)(6)(i)
Platform contribution transaction or PCT§1.482–7(a)(2), (b)(1)(ii)
Platform contributions§1.482–7(c)(1)
Post-tax income§1.482–7(g)(2)(v)(B)(4), (g)(4)(i)(G)
Pre-tax income§1.482–7(g)(2)(v)(B)(4), (g)(4)(i)(G)
Projected benefit shares§1.482–7(i)(2)(ii)(A)
PRRR
§1.482–7(i)(6)(ii)
PVI
§1.482–7(i)(6)(iii)(C)
PVTP
§1.482–7(i)(6)(iii)(B)
Reasonably anticipated benefitsA controlled participant’sreasonably anticipated
benefitsmean the benefits that reasonably may be
anticipated to be derived from exploiting cost shared
intangibles. For purposes of this definition, benefits
mean the sum of additional revenue generated,
plus cost savings, minus any cost increases from
exploiting cost shared intangibles.
§1.482–7(e)(1)
Reasonably anticipated benefits or RAB shares§1.482–7(a)(1), (e)(1)
Reasonably anticipated cost shared intangible§1.482–7(d)(1)(ii)
Relevant business activity§1.482–7(g)(7)(i)
Routine contributionsRoutine contributionsmeans a controlled
participant’s contributions to the relevant business
activities that are of the same or similar kind to
those made by uncontrolled taxpayers involved in
similar business activities for which it is possible
to identify market returns. Routine contributions
ordinarily include contributions of tangible property,
services and intangibles that are generally owned by
uncontrolled taxpayers engaged in similar activities.
A functional analysis is required to identify these
contributions according to the functionsperformed,
risksassumed,andresourcesemployedbyeachof
the controlled participants.
§1.482–7(g)(4), (g)(7)
Routine platform and operating contributions, and
net routine platform and operating contributions
§1.482–7(g)(4)(vii), 1.482–7(g)(7)(iii)(C)(4)
Specified payment form§1.482–7(h)(3)
Stock-based compensation§1.482–7(d)(3)
Stock options§1.482–7(d)(3)(i)
Subsequent PCT§1.482–7(g)(2)(viii)
Target
§1.482–7(g)(5)(i)
March 19, 20125512012–12 I.R.B.

TermDefinitionMain Cross References
Tax rate
Reasonably anticipated effective tax rate with
respect to the pre-tax income to which the tax
rate is being applied. For example, under the
income method, this rate would be the reasonably
anticipated effective tax rate of the PCT Payor or
PCT Payee under the cost sharing alternative or the
licensing alternative, as appropriate.
§1.482–7(g)(2)(v)(B)(4)(ii), (g)(4)(i)(G)
Trigger PCT§1.482–7(i)(6)(i)
Variable input parameter§1.482–7(g)(2)(ix)(C)
WACCWACCmeans weighted average cost of capital.§1.482–7(i)(6)(iv)(D)
(ii)Examples. The following examples
illustrate certain definitions in paragraph
(j)(1)(i) of this section:
Exampl
e1.Controlled participant. Foreign Par-
ent (FP) is a foreign corporation engaged in the ex-
traction of a natural resource. FP has a U.S. sub-
sidia
ry (USS) to which FP sells supplies of this re-
source for sale in the United States. FP enters into
a CSA with USS to develop a new machine to ex-
tract
the natural resource. The machine uses a new
extraction process that will be patented in the United
States and in other countries. The CSA provides that
USS w
ill receive the rights to exploit the machine in
the extraction of the natural resource in the United
States, and FP will receive the rights in the rest of the
worl
d. This resource does not, however, exist in the
United States. Despite the fact that USS has received
the right to exploit this process in the United States,
USS
is not a controlled participant because it will not
derive a benefit from exploiting the intangible devel-
oped under the CSA.
Exa
mple 2.Controlled participants. (i) U.S. Par-
ent (USP), one foreign subsidiary (FS), and a second
foreign subsidiary constituting the group’s research
arm
(R+D) enter into a CSA to develop manufactur-
ing intangibles for a new product line A. USP and FS
are assigned the exclusive rights to exploit the intan-
gi
bles 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 as-
si
gned 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 RAB shares of
U
SP 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
I
DCs incurred by R+D with respect to the new intan-
gible.
(ii) R+D does not qualify as a controlled partici-
p
ant within the meaning of paragraph (j)(1)(i) of this
section, because it will not derive any benefits from
exploiting cost shared 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 paragraph (a)(3) of this sec-
tion and §§1.482–4(f)(3)(iii) and (4), and 1.482–9,
as appropriate. Such consideration must be treated
as IDCs incurred by USP and FS in proportion to
their RAB shares (that is, 66
2
/3%and33
1
/3%, respec-
tively). R+D will not be considered to bear any share
of the IDCs under the arrangement.
Example 3.Cost shared intangible, reasonably
anticipated cost shared intangible.U.S.Parent
(USP) has developed and currently exploits an an-
tihist
amine, XY, which is manufactured in tablet
form. USP enters into a CSA with its wholly-owned
foreignsubsidiary(FS)todevelopXYZ,anewim-
prove
d version of XY that will be manufactured as
a nasal spray. Work under the CSA is fully devoted
to developing XYZ, and XYZ is developed. During
the de
velopment period, XYZ is a reasonably antic-
ipated cost shared intangible under the CSA. Once
developed, XYZ is a cost shared intangible under the
CSA.
Example 4.Cost shared intangible. The facts are
thesameasinExample 3, except that in the course of
deve
loping XYZ, the controlled participants by acci-
dent discover ABC, a cure for disease D. ABC is a
cost shared intangible under the CSA.
Exam
ple 5.Reasonably anticipated benefits.
Controlled parties A and B enter into a cost sharing
arrangement to develop product and process intan-
gib
les for an already existing Product P. Without
such intangibles, A and B would each reasonably
anticipate revenue, in present value terms, of $100M
fro
m sales of Product P until it became obsolete.
With the intangibles, A and B each reasonably antic-
ipate selling the same number of units each year, but
rea
sonably anticipate that the price will be higher.
Because the particular product intangible is more
highly regarded in A’s market, A reasonably antici-
pa
tes an increase of $20M in present value revenue
from the product intangible, while B reasonably
anticipates only an increase of $10M. Further, A
an
d B each reasonably anticipate spending an extra
$5M present value in production costs to include the
feature embodying the product intangible. Finally, A
a
nd B each reasonably anticipate saving $2M present
value in production costs by using the process in-
tangible. A and B reasonably anticipate no other
e
conomic effects from exploiting the cost shared
intangibles. A’s reasonably anticipated benefits from
exploiting the cost shared intangibles equal its rea-
sonably anticipated increase in revenue ($20M) plus
its reasonably anticipated cost savings ($2M) minus
its reasonably anticipated increased costs ($5M),
which equals $17M. Similarly, B’s reasonably an-
ticipated benefits from exploiting the cost shared
intangibles equal its reasonably anticipated increase
in revenue ($10M) plus its reasonably anticipated
cost savings ($2M) minus its reasonably anticipated
increased costs ($5M), which equals $7M. Thus A’s
reasonably anticipated benefits are $17M and B’s
reasonably anticipated benefits are $7M.
(2)Special rules—(i)Consolidated
group. For purposes of this section, all
members of the same consolidated group
shall be treated as one taxpayer. For these
purposes, the termconsolidated group
means all members of a group of con-
trolled entities created or organized within
a single country and subjected to an in-
come tax by such country on the basis of
their combined income.
(ii)Trade or business.Aparticipant
that is a foreign corporation or nonresi-
dent alien individual will not be treated
as engaged in a trade or business within
the United States solely by reason of its
participation in a CSA. See generally
§1.864–2(a).
(iii)Partnership. A CSA, or an arrange-
ment to which the Commissioner applies
the rules of this section, will not be treated
as a partnership to which the rules of sub-
chapter K of the Internal Revenue Code
apply. See §301.7701–1(c) of this chapter.
(3)Character—(i)CST Payments.CST
Payments generally will be considered the
payor’s costs of developing intangibles
at the location where such development
is conducted. For these purposes, IDCs
borne directly by a controlled participant
that are deductible are deemed to be re-
duced to the extent of any CST Payments
owed to it by other controlled participants
pursuant to the CSA. Each cost shar-
ing payment received by a payee will be
treated as comingpro ratafrom payments
made by all payors and will be appliedpro
rataagainst the deductions for the taxable
year that the payee is allowed in connec-
tion with the IDCs. Payments received in
excess of such deductions will be treated
as in consideration for use of the land and
tangible property furnished for purposes
of the CSA by the payee. For purposes of
the research credit determined under sec-
tion 41, CST Payments among controlled
participants will be treated as provided
for intra-group transactions in §1.41–6(i).
Any payment made or received by a tax-
2012–12 I.R.B.552March 19, 2012

payer pursuant to an arrangement that
the Commissioner determines not to be a
CSA will be subject to the provisions of
§§1.482–1 through 1.482–6 and 1.482–9.
Any payment that in substance constitutes
a cost sharing payment will be treated as
such for purposes of this section, regard-
less of its characterization under foreign
law.
(ii)PCT Payments. A PCT Payor’s pay-
ment required under paragraph (b)(1)(ii)
of this section is deemed to be reduced to
the extent of any payments owed to it un-
der such paragraph from other controlled
participants. Each PCT Payment received
by a PCT Payee will be treated as com-
ingpro rataout of payments made by all
PCT Payors. PCT Payments will be char-
acterized consistently with the designation
of the type of transaction pursuant to para-
graphs (c)(3) and (k)(2)(ii)(H) of this sec-
tion. Depending on such designation, such
payments will be treated as either consid-
eration for a transfer of an interest in intan-
gible property or for services.
(iii)Examples. The following examples
illustrate this paragraph (j)(3):
Example 1. U.S. Parent (USP) and its wholly
owned Foreign Subsidiary (FS) form a CSA to de-
velop a miniature widget, the Small R. Based on RAB
shares, USP agrees to bear 40% and FS to bear 60%
of the costs incurred during the term of the agreement.
The principal IDCs are operating costs incurred by FS
in Country Z of 100X annually, and costs incurred
by USP in the United States also of 100X annually.
Of the total costs of 200X, USP’s share is 80X and
FS’s share is 120X so thatFS must make a payment
to USP of 20X. The payment will be treated as a reim-
bursement of 20X of USP’s costs in the United States.
Accordingly, USP’s Form 1120 will reflect an 80X
deduction on account of activities performed in the
United States for purposes of allocation and appor-
tionment of the deduction to source. The Form 5471
“Information Return of U.S. Persons With Respect to
Certain Foreign Corporations” for FS will reflect a
100X deduction on account of activities performed
in Country Z and a 20X deduction on account of ac-
tivities performed in the United States.
Example 2.ThefactsarethesameasinExample
1, except that the 100X of costs borne by USP consist
of 5X of costs incurred by USP in the United States
and 95X of arm’s length rental charge, as described
in paragraph (d)(1)(iii) of this section, for the use of a
facility in the United States. The depreciation deduc-
tion attributable to the U.S. facility is 7X. The 20X
net payment by FS to USP will first be applied in re-
duction pro rata of the 5X deduction for costs and the
7X depreciation deduction attributable to the U.S. fa-
cility. The 8X remainder will be treated as rent for
the U.S. facility.
Example 3. (i) Four members (A, B, C, and D)
of a controlled group form a CSA to develop the next
generation technology for their business. Based on
RAB shares, the participants agree to bear shares of
the costs incurred during the term of the agreement in
the following percentages: A 40%; B 15%; C 25%;
and D 20%. The arm’s length values of the platform
contributions they respectively own are in the follow-
ing amounts for the taxable year: A 80X; B 40X; C
30X; and D 30X. The provisional (before offsets) and
final PCT Payments among A, B, C, and D are shown
in the table as follows:
(All amounts stated in X’s)
ABCD
Payments ..........................................
<40><21>
<37.5>
<30>
Receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4834
22.5
24
Final..............................................813
<15>
<6>
(ii) The first row/first column shows A’s provi-
sional PCT Payment equal to the product of 100X
(sum of 40X, 30X, and 30X) and A’s RAB share of
40%. The second row/first column shows A’s provi-
sional PCT receipts equal to the sum of the products
of 80X and B’s, C’s, and D’s RAB shares (15%, 25%,
and 20%, respectively). The other entries in the first
two rows of the table are similarly computed. The last
row shows the final PCT receipts/payments after off-
sets. Thus, for the taxable year, A and B are treated as
receiving the 8X and 13X, respectively,pro rataout
of payments by C and D of 15X and 6X, respectively.
(k)CSA administrative requirements.
A controlled participant meets the require-
ments of this paragraph if it substantially
complies, respectively, with the CSA
contractual, documentation, accounting,
and reporting requirements of paragraphs
(k)(1) through (4) of this section.
(1)CSA contractual requirements—(i)
In general. A CSA must be recorded in
writing in a contract that is contemporane-
ous with the formation (and any revision)
of the CSA and that includes the contrac-
tual provisions described in this paragraph
(k)(1).
(ii)Contractual provisions. The written
contract described in this paragraph (k)(1)
must include provisions that—
(A) List the controlled participants and
any other members of the controlled group
that are reasonably anticipated to benefit
from the use of the cost shared intangibles,
including the address of each domestic en-
tity and the country of organization of each
foreign entity;
(B) Describe the scope of the IDA to
be undertaken and each reasonably antic-
ipated cost shared intangible or class of
reasonably anticipated cost shared intangi-
bles;
(C) Specify the functions and risks that
each controlled participant will undertake
in connection with the CSA;
(D) Divide among the controlled partic-
ipants all divisional interests in cost shared
intangibles and specify each controlled
participant’s divisional interest in the cost
shared intangibles, as described in para-
graphs (b)(1)(iii) and (4) of this section,
that it will own and exploit without any
further obligation to compensate any other
controlled participant for such interest;
(E) Provide a method to calculate the
controlled participants’ RAB shares, based
on factors that can reasonably be expected
to reflect the participants’ shares of antici-
pated benefits, and require that such RAB
shares must be updated, as described in
paragraph (e)(1) of this section (see also
paragraph (k)(2)(ii)(F) of this section);
(F) Enumerate all categories of IDCs to
be shared under the CSA;
(G) Specify that the controlled par-
ticipant must use a consistent method of
accounting to determine IDCs and RAB
shares, as described in paragraphs (d) and
(e) of this section, respectively, and must
translate foreign currencies on a consistent
basis;
(H) Require the controlled participant
to enter into CSTs covering all IDCs, as
described in paragraph (b)(1)(i) of this sec-
tion, in connection with the CSA;
(I) Require the controlled participants
to enter into PCTs covering all platform
contributions, as described in paragraph
(b)(1)(ii) of this section, in connection with
the CSA;
(J) Specify the form of payment due un-
der each PCT (or group of PCTs) in exis-
tence at the formation (and any revision)
of the CSA, including information and ex-
planation that reasonably supports an anal-
March 19, 20125532012–12 I.R.B.

ysis of applicable provisions of paragraph
(h)ofthissection;and
(K) Specify the date on which the CSA
is entered into (CSA Start Date) and the
duration of the CSA, the conditions under
which the CSA may be modified or ter-
minated, and the consequences of a mod-
ification or termination (including conse-
quences described under the rules of para-
graph (f) of this section).
(iii)Meaning of contemporane-
ous—(A)In general. For purposes of this
paragraph (k)(1), a written contractual
agreement is contemporaneous with the
formation (or revision) of a CSA if, and
only if, the controlled participants record
the CSA, in its entirety, in a document
that they sign and date no later than 60
days after the first occurrence of any IDC
described in paragraph (d) of this section
to which such agreement (or revision) is
to apply.
(B)Example. The following example
illustrates the principles of this paragraph
(k)(1)(iii):
Example. Companies A and B, both of which are
members of the same controlled group, commence an
IDA on March 1, Year 1. Company A pays the first
IDCs in relation to the IDA, as cash salaries to A’s re-
search staff, for the staff’s work during the first week
of March, Year 1. A and B, however, do not sign
and date any written contractual agreement until Au-
gust 1, Year 1, whereupon they execute a “Cost Shar-
ing Agreement” that purports to be “effective as of”
March 1 of Year 1. The arrangement fails the require-
ment that the participants record their arrangement in
a written contractual agreement that is contempora-
neous with the formation of a CSA. The arrangement
has failed to meet the requirements set forth in para-
graph (b)(2) of this section and, pursuant to paragraph
(b) of this section, cannot be a CSA.
(iv)Interpretation of contractual pro-
visions—(A)In generalThe provisions
of a written contract described in this
paragraph (k)(1) and of the additional
documentation described in paragraph
(k)(2) of this section must be clear and
unambiguous. The provisions will be in-
terpreted by reference to the economic
substance of the transaction and the ac-
tual conduct of the controlled participants.
See §1.482–1(d)(3)(ii)(B) (Identifying
contractual terms). Accordingly, the
Commissioner may impute contractual
terms in a CSA consistent with the eco-
nomic substance of the CSA and may
disregard contractual terms that lack eco-
nomic substance. An allocation of risk
between controlled participants after the
outcome of such risk is known or reason-
ably knowable lacks economic substance.
See §1.482–1(d)(3)(iii)(B) (Identification
of taxpayer that bears risk). A contrac-
tual term that is disregarded due to a lack
of economic substance does not satisfy a
contractual requirement set forth in this
paragraph (k)(1) or documentation re-
quirement set forth in paragraph (k)(2) of
this section. See paragraph (b)(5) of this
section for the treatment of an arrange-
ment among controlled taxpayers that fails
to comply with the requirements of this
section.
(B)Examples. The following examples
illustrate the principles of this paragraph
(k)(1)(iv). In each example, it is assumed
that the Commissioner will exercise the
discretion granted pursuant to paragraph
(b)(5)(ii) of this section to apply the pro-
visions of this section to the arrangement
that purports to be a CSA.
Example 1. The contractual provisions recorded
upon formation of an arrangement that purports to be
a CSA provide that PCT Payments with respect to a
particular platform contribution will consist of pay-
ments contingent on sales. Contrary to the contrac-
tual provisions, the PCT Payments actually made are
contingent on profits. Because the controlled partic-
ipants’ actual conduct is different from the contrac-
tual terms, the Commissioner may determine, based
on the facts and circumstances, that—
(i) The actual payments have economic substance
and, therefore, impute payment terms in the CSA con-
sistent with the actual payments; or
(ii) The contract terms reflect the economic sub-
stance of the arrangement and, therefore, the actual
payments must be adjusted to conform to the terms.
Example 2. An arrangement that purports to be
a CSA provides that PCT Payments with respect to
a particular platform contribution shall be contingent
payments equal to 10% of sales of products that in-
corporate cost shared intangibles. The contract terms
further provide that the controlled participants must
adjust such contingent payments in accordance with
a formula set forth in the terms. During the first three
years of the arrangement, the controlled participants
fail to make the adjustments required by the terms
with respect to the PCT Payments. The Commis-
sioner may determine, based on the facts and circum-
stances, that—
(i) The contingent payment terms with respect to
the platform contribution do not have economic sub-
stance because the controlled participants did not act
in accordance with their upfront risk allocation; or
(ii) The contract terms reflect the economic sub-
stance of the arrangement and, therefore, the actual
payments must be adjusted to conform to the terms.
(2)CSA documentation require-
ments—(i)In general. The controlled
participants must timely update and main-
tain sufficient documentation to establish
that the participants have met the CSA
contractual requirements of paragraph
(k)(1) of this section and the additional
CSA documentation requirements of this
paragraph (k)(2).
(ii)Additional CSA documentation re-
quirements. The controlled participants to
a CSA must timely update and maintain
documentation sufficient to—
(A) Describe the current scope of the
IDA and identify—
(1) Any additions or subtractions from
the list of reasonably anticipated cost
shared intangibles reported pursuant to
paragraph (k)(1)(ii)(B) of this section;
(2) Any cost shared intangible, together
with each controlled participant’s interest
therein; and
(3) Any further development of intan-
gibles already developed under the CSA
or of specified applications of such intan-
gibles which has been removed from the
IDA (see paragraphs (d)(1)(ii) and (j)(1)(i)
of this section for the definitions of reason-
ably anticipated cost shared intangible and
cost shared intangible) and the steps (in-
cluding any accounting classifications and
allocations) taken to implement such re-
moval;
(B) Establish that each controlled par-
ticipant reasonably anticipates that it will
derive benefits from exploiting cost shared
intangibles;
(C) Describe the functions and risks that
each controlled participant has undertaken
during the term of the CSA;
(D) Provide an overview of each con-
trolled participant’s business segments, in-
cluding an analysis of the economic and le-
gal factors that affect CST and PCT pric-
ing;
(E) Establish the amount of each con-
trolled participant’s IDCs for each taxable
year under the CSA, including all IDCs
attributable to stock-based compensation,
as described in paragraph (d)(3) of this
section (including the method of measure-
ment and timing used in determining such
IDCs, and the data, as of the date of grant,
used to identify stock-based compensation
with the IDA);
(F) Describe the method used to es-
timate each controlled participant’s RAB
share for each year during the course of the
CSA, including—
(1) All projections used to estimate ben-
efits;
(2) All updates of the RAB shares in
accordance with paragraph (e)(1) of this
section; and
2012–12 I.R.B.554March 19, 2012

(3) An explanation of why that method
was selected and why the method provides
the most reliable measure for estimating
RAB shares;
(G) Describe all platform contributions;
(H) Designate the type of transaction
involved for each PCT or group of PCTs;
(I) Specify, within the time period pro-
vided in paragraph (h)(2)(iii) of this sec-
tion, the form of payment due under each
PCT or group of PCTs, including informa-
tion and explanation that reasonably sup-
ports an analysis of applicable provisions
of paragraph (h) of this section;
(J) Describe and explain the method se-
lected to determine the arm’s length pay-
ment due under each PCT, including—
(1) An explanation of why the method
selected constitutes the best method, as de-
scribed in §1.482–1(c)(2), for measuring
an arm’s length result;
(2) The economic analyses, data, and
projections relied upon in developing and
selecting the best method, including the
source of the data and projections used;
(3) Each alternative method that was
considered, and the reason or reasons that
the alternative method was not selected;
(4) Any data that the controlled partic-
ipant obtains, after the CSA takes effect,
that would help determine if the controlled
participant’s method selected has been ap-
plied in a reasonable manner;
(5) The discount rate or rates, where
applicable, used for purposes of evaluat-
ing PCT Payments, including information
and explanation that reasonably supports
an analysis of applicable provisions of
paragraph (g)(2)(v) of this section;
(6) The estimated arm’s length values of
any platform contributions as of the dates
of the relevant PCTs, in accordance with
paragraph (g)(2)(ii) of this section;
(7) A discussion, where applicable, of
why transactions were or were not aggre-
gated under the principles of paragraph
(g)(2)(iv) of this section;
(8) The method payment form and any
conversion made from the method pay-
ment form to the specified payment form,
as described in paragraph (h)(3) of this sec-
tion; and
(9) If applicable under paragraph
(i)(6)(iv) of this section, the WACC of
the parent of the controlled group that
includes the controlled participants.
(iii)Coordination rules and pro-
duction of documents—(A)Coordi-
nation with penalty regulations.See
§1.6662–6(d)(2)(iii)(D) regarding coordi-
nation of the rules of this paragraph (k)
with the documentation requirements for
purposes of the accuracy-related penalty
under section 6662(e) and (h).
(B)Production of documentation. Each
controlled participant must provide to the
Commissioner, within 30 days of a request,
the items described in this paragraph (k)(2)
and paragraph (k)(3) of this section. The
time for compliance described in this para-
graph (k)(2)(iii)(B) may be extended at the
discretion of the Commissioner.
(3)CSA accounting requirements—(i)
In general. The controlled participants
must maintain books and records (and re-
lated or underlying data and information)
that are sufficient to—
(A) Establish that the controlled partic-
ipants have used (and are using) a consis-
tent method of accounting to measure costs
and benefits;
(B) Permit verification that the amount
of any contingent PCT Payments due have
been (and are being) properly determined;
(C) Translate foreign currencies on a
consistent basis; and
(D) To the extent that the method of ac-
counting used materially differs from U.S.
generally accepted accounting principles,
explain any such material differences.
(ii)Reliance on financial accounting.
For purposes of this section, the controlled
participants may not rely solely upon fi-
nancial accounting to establish satisfaction
of the accounting requirements of this
paragraph (k)(3). Rather, the method of
accounting must clearly reflect income.
Thor Power Tools Co. v. Commissioner,
439 U.S. 522 (1979).
(4)CSA reporting requirements—(i)
CSA Statement. Each controlled partici-
pant must file with the Internal Revenue
Service, in the manner described in this
paragraph (k)(4), a “Statement of Con-
trolled Participant to §1.482–7 Cost Shar-
ing Arrangement” (CSA Statement) that
complies with the requirements of this
paragraph (k)(4).
(ii)Content of CSA Statement.The
CSA Statement of each controlled partic-
ipant must—
(A) State that the participant is a con-
trolled participant in a CSA;
(B) Provide the controlled participant’s
taxpayer identification number;
(C) List the other controlled partici-
pants in the CSA, the country of organ-
ization of each such participant, and the
taxpayer identification number of each
such participant;
(D) Specify the earliest date that any
IDC described in paragraph (d)(1) of this
section occurred; and
(E) Indicate the date on which the con-
trolled participants formed (or revised) the
CSA and, if different from such date, the
date on which the controlled participants
recorded the CSA (or any revision) con-
temporaneously in accordance with para-
graphs (k)(1)(i) and (iii) of this section.
(iii)Time for filing CSA Statement—(A)
90-day ruleEach controlled participant
must file its original CSA Statement with
the Internal Revenue Service Ogden Cam-
pus (addressed as follows: “Attn: CSA
Statements, Mail Stop 4912, Internal Rev-
enue Service, 1973 North Rulon White
Blvd., Ogden, Utah 84404–0040”), no
later than 90 days after the first occurrence
of an IDC to which the newly-formed
CSA applies, as described in paragraph
(k)(1)(iii)(A) of this section, or, in the case
of a taxpayer that became a controlled
participant after the formation of the CSA,
no later than 90 days after such taxpayer
became a controlled participant. A CSA
Statement filed in accordance with this
paragraph (k)(4)(iii)(A) must be dated and
signed, under penalties of perjury, by an
officer of the controlled participant who is
duly authorized (under local law) to sign
the statement on behalf of the controlled
participant.
(B)Annual return requirement—(1)In
general. Each controlled participant must
attach to its U.S. income tax return, for
each taxable year for the duration of the
CSA, a copy of the original CSA Statement
that the controlled participant filed in ac-
cordance with the 90-day rule of paragraph
(k)(4)(iii)(A) of this section. In addition,
the controlled participant must update the
information reflected on the original CSA
Statement annually by attaching a sched-
ule that documents changes in such infor-
mation over time.
(2)Special filing rule for annual return
requirement. If a controlled participant is
notrequiredtofileaU.S.incometaxre-
turn, the participant must ensure that the
copy or copies of the CSA Statement and
any updates are attached to Schedule M
of any Form 5471, any Form 5472 “Infor-
March 19, 20125552012–12 I.R.B.

mation Return of a Foreign Owned Cor-
poration,” or any Form 8865 “Return of
U.S. Persons With Respect to Certain For-
eign Partnerships,” filed with respect to
that participant.
(iv)Examples. The following examples
illustrate this paragraph (k)(4). In each
example, Companies A and B are members
of the same controlled group.
Example 1. AandB,bothofwhichfileU.S.
tax returns, agree to share the costs of developing a
new chemical formula in accordance with the provi-
sions of this section. On March 30, Year 1, A and
B record their agreement in a written contract styled,
“Cost Sharing Agreement.” The contract applies by
its terms to IDCs occurring after March 1, Year 1.
The first IDCs to which the CSA applies occurred
on March 15, Year 1. To comply with paragraph
(k)(4)(iii)(A) of this section, A and B individually
must file separate CSA Statements no later than 90
days after March 15, Year 1 (June 13, Year 1). Fur-
ther, to comply with paragraph (k)(4)(iii)(B) of this
section, A and B must attach copies of their respec-
tive CSA Statements to their respective Year 1 U.S.
income tax returns.
Example 2. ThefactsarethesameasinExam-
ple 1, except that a year has passed and C, which
files a U.S. tax return, joined the CSA on May 9,
Year 2. To comply with the annual filing requirement
described in paragraph (k)(4)(iii)(B) of this section,
A and B must each attach copies of their respective
CSA Statements (as filed for Year 1) to their respec-
tive Year 2 income tax returns, along with a schedule
updated appropriately to reflect the changes in infor-
mation described in paragraph (k)(4)(ii) of this sec-
tion resulting from the addition of C to the CSA. To
comply with both the 90-day rule described in para-
graph (k)(4)(iii)(A) of this section and the annual fil-
ing requirement described in paragraph (k)(4)(iii)(B)
of this section, C must file a CSA Statement no later
than 90 days after May 9, Year 2 (August 7, Year 2),
and must attach a copy of such CSA Statement to its
Year 2 income tax return.
(l)Effective/applicability date.This
section applies on December 16, 2011.
(m)Transition rule—(1)In general.
An arrangement in existence on January 5,
2009, will be considered a CSA, as
described under paragraph (b) of this
section, if, prior to such date, it was a
qualified cost sharing arrangement under
the provisions of §1.482–7 (as contained
in the 26 CFR part 1 edition revised as of
January 1, 1996, hereafter referred to as
“former §1.482–7”), but only if the written
contract, as described in paragraph (k)(1)
of this section, is amended, if necessary,
to conform with, and only if the activities
of the controlled participants substantially
comply with, the provisions of this section,
as modified by paragraphs (m)(2) and
(m)(3) of this section, by July 6, 2009.
(2)Transitional modification of appli-
cable provisions. For purposes of this
paragraph (m), conformity and substantial
compliance with the provisions of this sec-
tion shall be determined with the following
modifications:
(i) CSTs and PCTs occurring prior to
January 5, 2009, shall be subject to the
provisions of former §1.482–7 rather than
this section.
(ii) Except to the extent provided in
paragraph (m)(3) of this section, PCTs
that occur under a CSA that was a qual-
ified cost sharing arrangement under the
provisions of former §1.482–7 and re-
mained in effect on January 5, 2009, shall
be subject to the periodic adjustment rules
of §1.482–4(f)(2) rather than the rules of
paragraph (i)(6) of this section.
(iii) Paragraphs (b)(1)(iii) and (b)(4) of
this section shall not apply.
(iv) Paragraph (k)(1)(ii)(D) of this sec-
tion shall not apply.
(v) Paragraphs (k)(1)(ii)(H) and (I) of
this section shall be construed as applying
only to transactions entered into on or after
January 5, 2009.
(vi) The deadline for recordation of the
revised written contractual agreement pur-
suant to paragraph (k)(1)(iii) of this section
shall be no later than July 6, 2009.
(vii) Paragraphs (k)(2)(ii)(G) through
(J) of this section shall be construed as ap-
plying only with reference to PCTs entered
into on or after January 5, 2009.
(viii) Paragraph (k)(4)(iii)(A) of this
section shall be construed as requiring a
CSA Statement with respect to the revised
written contractual agreement described
in paragraph (m)(2)(vi) of this section no
later than September 2, 2009.
(ix) Paragraph (k)(4)(iii)(B) of this sec-
tion shall be construed as only applying
for taxable years ending after the filing of
the CSA Statement described in paragraph
(m)(2)(viii) of this section.
(3)Special rule for certain periodic ad-
justments. The periodic adjustment rules
in paragraph (i)(6) of this section (rather
than the rules of §1.482–4(f)(2)) shall ap-
ply to PCTs that occur on or after the date
of a material change in the scope of the
CSA from its scope as of January 5, 2009.
A material change in scope would include
a material expansion of the activities un-
dertaken beyond the scope of the intangi-
ble development area, as described in for-
mer §1.482–7(b)(4)(iv). For this purpose,
a contraction of the scope of a CSA, ab-
sent a material expansion into one or more
lines of research and development beyond
the scope of the intangible development
area, does not constitute a material change
in scope of the CSA. Whether a mate-
rial change in scope has occurred is deter-
mined on a cumulative basis. Therefore,
a series of expansions, any one of which is
not a material expansion by itself, may col-
lectively constitute a material expansion.
§1.482–7T [Removed]
Par. 14. Section 1.482–7T is removed.
Par. 15. Section 1.482–8 is amended
by:
1. RevisingExamples 13through18at
the end of paragraph (b).
2. Revising paragraph (c)(1).
The additions and revision reads as fol-
lows:
§1.482–8 Examples of the best method
rule.
*****
(b) * * *
Example 13.Preference for acquisition price
method. (i) USP develops, manufacturers, and
distributes pharmaceutical products. USP and FS,
USP’s wholly-owned subsidiary, enter into a CSA
to develop a new oncological drug, Oncol. Immedi-
ately prior to entering into the CSA, USP acquires
Company X, an unrelated U.S. pharmaceutical com-
pany. Company X is solely engaged in oncological
pharmaceutical research, and its only significant
resources and capabilities are its workforce and its
sole patent, which is associated with Compound X,
a promising molecular compound derived from a
rare plant, which USP reasonably anticipates will
contribute to developing Oncol. All of Company X
researchers will be engaged solely in research that
is reasonably anticipated to contribute to developing
Oncol as well. The rights in the Compound X and
the commitment of Company X’s researchers to the
development of Oncol are platform contributions for
which compensation is due from FS as part of a PCT.
(ii) In this case, the acquisition price method,
based on the lump sum price paid by USP for
Company X, is likely to provide a more reliable
measure of an arm’s length PCT Payment due to
USP than the application of any other method. See
§§1.482–4(c)(2) and 1.482–7(g)(5)(iv)(A).
Example 14.Preference for market capitaliza-
tion method. (i) Company X is a publicly traded U.S.
company solely engaged in oncological pharmaceuti-
cal research and its only significant resources and ca-
pabilities are its workforce and its sole patent, which
is associated with Compound Y, a promising molecu-
lar compound derived from a rare plant. Company X
has no marketable products. Company X enters into
a CSA with FS, a newly-formed foreign subsidiary,
to develop a new oncological drug, Oncol, derived
2012–12 I.R.B.556March 19, 2012

from Compound Y. Compound Y is reasonably antic-
ipated to contribute to developing Oncol. All of Com-
pany X researchers will be engaged solely in research
that is reasonably anticipated to contribute to devel-
oping Oncol under the CSA. The rights in Compound
Y and the commitment of Company X’s researchers
are platform contributions for which compensation is
due from FS as part of a PCT.
(ii) In this case, given that Company X’s platform
contributions covered by PCTs relate to its entire eco-
nomic value, the application of the market capital-
ization method, based on the market capitalization of
Company X, provides a reliable measure of an arm’s
length result for Company X’s PCTs to the CSA. See
§§1.482–4(c)(2) and 1.482–7(g)(6)(v)(A).
Example 15.Preference for market capitaliza-
tion method. (i) MicroDent, Inc. (MDI) is a publicly
traded company that developed a new dental surgi-
cal microscope ScopeX–1, which drastically shortens
many surgical procedures. On January 1 of Year 1,
MDI entered into a CSA with a wholly-owned foreign
subsidiary (FS) to develop ScopeX–2, the next gener-
ation of ScopeX–1. In the CSA, divisional interests
are divided on a territorial basis. The rights associ-
ated with ScopeX–1, as well as MDI’s research capa-
bilities are reasonably anticipated to contribute to the
development of ScopeX–2 and are therefore platform
contributions for which compensation is due from FS
as part of a PCT. At the time of the PCT, MDI’s only
product was the ScopeX-I microscope, although MDI
was in the process of developing ScopeX–2. Concur-
rent with the CSA, MDI separately transfers exclu-
sive and perpetual exploitation rights associated with
ScopeX–1 to FS in the same territory as assigned to
FS in the CSA.
(ii) Although the transactions between MDI and
FS under the CSA are distinct from the transactions
between MDI and FS relating to the exploitation
rights for ScopeX–1, it is likely to be more reliable
to evaluate the combined effect of the transactions
than to evaluate them in isolation. This is because
the combined transactions between MDI and FS
relate to all of the economic value of MDI (that is,
the exploitation rights and research rights associated
with ScopeX–1, as well as the research capabilities
of MDI). In this case, application of the market cap-
italization method, basedon the enterprise value of
MDI on January 1 of Year 1, is likely to provides a
reliable measure of an arm’s length payment for the
aggregated transactions. See §§1.482–4(c)(2) and
1.482–7(g)(6)(v)(A).
(iii) Notwithstanding that the market capitaliza-
tion method provides the most reliable measure of
the aggregated transactions between MDI and FS,
see §1.482–7(g)(2)(iv) for further considerations of
when further analysis may be required to distinguish
between the remuneration to MDI associated with
PCTs under the CSA (for research rights and capa-
bilities associated with ScopeX–1) and the remunera-
tion to MDI for the exploitation rights associated with
ScopeX–1.
Example 16.Income method (applied using
CPM) preferred to acquisition price method.The
facts are the same as inExample 13, except that the
acquisition occurred significantly in advance of for-
mation of the CSA, and reliable adjustments cannot
be made for this time difference. In addition, Com-
pany X has other valuable molecular patents and as-
sociated research capabilities, apart from Compound
X, that are not reasonably anticipated to contribute to
the development of Oncol and that cannot be reliably
valued. The CSA divides divisional interests on a
territorial basis. Under the terms of the CSA, USP
will undertake all R&D (consisting of laboratory
research and clinical testing) and manufacturing
associated with Oncol, as well as the distribution
activities for its territory (the United States). FS will
distribute Oncol in its territory (the rest of the world).
FS’s distribution activities are routine in nature, and
the profitability from its activities may be reliably
determined from third-party comparables. FS does
not furnish any platform contributions. At the time
of the PCT, reliable (ex ante) financial projections
associated with the development of Oncol and its
separate exploitation in each of USP’s and FSub’s
assigned geographical territories are undertaken. In
this case, application of the income method using
CPMislikelytoprovideamorereliablemeasureof
an arm’s length result than application of the acquisi-
tion price method based on the price paid by USP for
Company X. See §1.482–7(g)(4)(vi) and (5)(iv)(C).
Example 17.Evaluation of alternative methods.
(i) The facts are the same as inExample 13, except
that the acquisition occurred sometime prior to the
CSA, and Company X has some areas of promising
research that are not reasonably anticipated to con-
tribute to developing Oncol. For purposes of this ex-
ample, the CSA is assumed to divide divisional in-
terests on a territorial basis. In general, the Com-
missioner determines that the acquisition price data
is useful in informing the arm’s length price, but not
necessarily determinative. Under the terms of the
CSA, USP will undertake all R&D (consisting of lab-
oratory research and clinicaltesting) and manufactur-
ing associated with Oncol, as well as the distribution
activities for its territory (the United States). FS will
distribute Oncol in its territory (the rest of the world).
FS’s distribution activities are routine in nature, and
the profitability from its activities may be reliably de-
termined from third-party comparables. At the time
of the PCT, financial projections associated with the
development of Oncol and its separate exploitation in
each of USP’s and FSub’s assigned geographical ter-
ritories are undertaken.
(ii) Under the facts, it is possible that the acquisi-
tion price method or the income method using CPM
might reasonably be applied. Whether the acquisi-
tion price method or the income method provides the
most reliable evidence of the arm’s length price of
USP’s contributions depends on a number of factors,
including the reliability of the financial projections,
the reliability of the discount rate chosen, and the ex-
tent to which the acquisition price of Company X can
be reliably adjusted to account for changes in value
over the time period between the acquisition and the
formation of the CSA and to account for the value of
the in-process research done by Company X that does
not constitute platform contributions to the CSA. See
§1.482–7(g)(4)(vi) and (5)(iv)(A) and (C).
Example 18.Evaluation of alternative methods.
(i) The facts are the same as inExample 17, except
that FS has a patent on Compound Y, which the par-
ties reasonably anticipate will be useful in mitigating
potential side effects associated with Compound X
and thereby contribute to the development of Oncol.
The rights in Compound Y constitute a platform con-
tribution for which compensation is due from USP as
part of a PCT. The value of FS’s platform contribution
cannot be reliably measured by market benchmarks.
(ii) Under the facts, it is possible that either the
acquisition price method and the income method to-
gether or the residual profit split method might rea-
sonably be applied to determine the arm’s length PCT
Payments due between USP and FS. Under the first
option the PCT Payment for the platform contribu-
tions related to Company X’s workforce and Com-
pound X would be determined using the acquisition
price method referring to the lump sum price paid by
USP for Company X. Because the value of these plat-
form contributions can be determined by reference
to a market benchmark, they are considered routine
platform contributions. Accordingly, under this op-
tion, the platform contribution related to Compound
Y would be the only nonroutine platform contribution
and the relevant PCT Payment is determined using
the income method. Under the second option, rather
than looking to the acquisition price for Company X,
all the platform contributions are considered nonrou-
tine and the RPSM is applied to determine the PCT
Payments for each platform contribution. Under ei-
ther option, the PCT Payments will be netted against
each other.
(iii) Whether the acquisition price method to-
gether with the income method or the residual profit
split method provides the most reliable evidence of
the arm’s length price of the platform contributions of
USP and FS depends on a number of factors, includ-
ing the reliability of the determination of the relative
values of the platform contributions for purposes of
the RPSM, and the extent to which the acquisition
price of Company X can be reliably adjusted to
account for changes in value over the time period
between the acquisition and the formation of the
CSA and to account for the value of the rights in the
in-process research doneby Company X that does
not constitute platform contributions to the CSA. In
these circumstances, it is also relevant to consider
whether the results of each method are consistent
with each other, or whether one or both methods are
consistent with other potential methods that could be
applied. See §1.482–7(g)(4)(vi), (5)(iv), and (7)(iv).
(c)Effective/applicability date—(1)In
general. Paragraphs (a) and (b)Examples
10through12of this section are generally
applicable for taxable years beginning af-
ter December 31, 2006. Paragraph (b)Ex-
amples 13through18of this section are
generally applicable on January 5, 2009.
*****
§1.482–8T [Removed].
Par. 16. Section 1.482–8T is removed.
Par. 17. Section 1.482–9 is amended
by revising paragraph (m)(3) to read as
follows:
§1.482–9 Methods to determine taxable
income in connection with a controlled
services transaction.
*****
March 19, 20125572012–12 I.R.B.

(m) * * *
(3)Coordination with rules govern-
ing cost sharing arrangements. Section
1.482–7 provides the specific methods to
be used to determine arm’s length results
of controlled transactions in connection
with a cost sharing arrangement. This sec-
tion provides the specific methods to be
used to determine arm’s length results of
a controlled service transaction, including
in an arrangement for sharing the costs
and risks of developing intangibles other
than a cost sharing arrangement covered
by §1.482–7. In the case of such an ar-
rangement, consideration of the principles,
methods, comparability, and reliability
considerations set forth in §1.482–7 is
relevant in determining the best method,
including an unspecified method, under
this section, as appropriately adjusted in
light of the differences in the facts and
circumstances between such arrangement
and a cost sharing arrangement.
*****
§1.482–9T [Removed].
Par. 18. Section 1.482–9T is removed.
Par. 19. Section 1.861–17 is amended
by revising paragraph (c)(3)(iv) to read as
follows:
§1.861–17 Allocation and apportionment
of research and experimental expenditures.
*****
(c) * * *
(3) * * *
(iv)Effect of cost sharing arrange-
ments. If the corporation controlled by
the taxpayer has entered into a cost shar-
ing 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.
*****
Par. 20. Section 1.6662–6 is amended
by revising paragraph (d)(2)(iii)(D) to read
as follows:
§1.6662–6 Transaction between persons
described in section 482 and net section
482 transfer price adjustments.
*****
(d) * * *
(2) * * *
(iii) * * *
(D) Satisfaction of the documentation
requirements described in §1.482–7(k)(2)
for the purpose of complying with the
rules for CSAs under §1.482–7 also satis-
fies all of the documentation requirements
listed in paragraph (d)(2)(iii)(B) of this
section, except the requirements listed
in paragraphs (d)(2)(iii)(B)(2)and(10)
of this section, with respect to CSTs and
PCTs described in §1.482–7(b)(1)(i) and
(ii), provided that the documentation also
satisfies the requirements of paragraph
(d)(2)(iii)(A) of this section.
*****
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 21. The authority citation for part
301 continues to read in part as follows:
Authority: 26 U.S.C. 7805* * *
Par. 22. Section 301.7701–1 is
amended by revising paragraph (c) to read
as follows:
§301.7701–1 Classification of
organizations for Federal tax purposes.
*****
(c)Cost sharing arrangements.Acost
sharing arrangement that is described in
§1.482–7 of this chapter, including any ar-
rangement that the Commissioner treats as
a CSA under §1.482–7(b)(5) of this chap-
ter, is not recognized as a separate entity
for purposes of the Internal Revenue Code.
See §1.482–7 of this chapter for the rules
regarding CSAs.
*****
PART 602—OMB CONTROL
NUMBER UNDER THE PAPERWORK
REDUCTION ACT
Par. 23. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805
Par. 24. In §602.101, paragraph (b) is
amended as follows:
1. The following entry to the table is
removed:
§602.101 OMB Control numbers.
*****
(b) * * *
CFR part or section where
Identified and described
Current OMB
Control No.
**********
1.482–7T...........................................................
1545–1364
**********
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
Approved December 8, 2011.
Emily S. McMahon,
Acting Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 16,
2011, 2:00 p.m., and published in the issue of the Federal
Register for December 22,2011, 76 F.R. 80082)
2012–12 I.R.B.558March 19, 2012

Section 501.—Exemption
From Tax on Corporations,
Certain Trus
ts, Etc.
26 CFR 1.501(
c)(29)–1T: CO-OP health insurance
issuers (tem
porary).
T.D. 9574
DEPARTMENT O
FTHE
TREASURY
Internal Re
venue Service
26 CFR Part 1
Applicati
on for Recognition as
a 501(c)(2
9) Organization
AGENCY: In
ternal Revenue Service
(IRS), Tre
asury.
ACTION: Te
mporary regulations.
SUMMARY: T
his document contains tem-
porary re
gulations authorizing the IRS to
prescrib
e the procedures by which certain
entities
may apply to the IRS for recog-
nition of
exemption from Federal income
tax. Thes
e regulations affect qualified
nonprof
it health insurance issuers, par-
ticipat
ing in the Consumer Operated and
Oriente
d Plan program established by the
Centers
for Medicare and Medicaid Ser-
vices, t
hat seek exemption from Federal
income
tax under the Internal Revenue
Code. T
he text of the temporary regula-
tions a
lso serves as the text of the proposed
regula
tions (REG–135071–11) set forth in
the no
tice of proposed rulemaking on this
subje
ct in this issue of the Bulletin.
DATES
:Effective Date:These regulations
are ef
fective on February 7, 2012.
Appli
cability Date: For date of applica-
bilit
y, see §1.501(c)(29)–1T(c).
FOR FU
RTHER INFORMATION
CONTA
CT: Amy Franklin or Martin
Schäf
fer, (202) 622–6070 (not a toll-free
numbe
r).
SUPPL
EMENTARY INFORMATION:
Backg
round
Secti
on 501(c)(29) of the Internal Rev-
enue
Code (Code) provides requirements
for t
ax exemption under section 501(a)
for q
ualified nonprofit health insurance is-
suer
s (QNHIIs). Section 501(c)(29) was
adde
d to the Code by section 1322(h)(1)
of the Patient Protection and Affordable
Care Act (Affordable Care Act), Public
Law 111–148 (March 23, 2010).
Section 1322 of the Affordable Care
Act directs the Centers for Medicare and
Medicaid Services (CMS) to establish the
Consumer Operated and Oriented Plan
(CO-OP) program. The purpose of the
CO-OP program is to foster the creation
of member-governed QNHIIs that will
operate with a strong consumer focus and
offer qualified health plans in the individ-
ual and small group markets. CMS will
provide loans and repayable grants (col-
lectively, loans) to organizations applying
to become QNHIIs, to help cover start-up
costs and meet any solvency requirements
in States in which the organization is li-
censed to issue qualified health plans.
A Funding Opportunity Announcement
for the CO-OP program (CFDA Num-
ber 93.545), published by CMS on July
28, 2011 (and amended on September
16, 2011), provides that for each loan the
appropriate CMS official will issue a No-
tice of Award and Loan Agreement to the
QNHII. In addition, the Chief Executive
Officer of the QNHII, or an officer of the
QNHII’s Board of Directors, must sign
and return the Loan Agreement to CMS.
On December 13, 2011, CMS issued final
regulations implementing the CO-OP pro-
gram at 76 FR 77392.
The CMS final regulations define a
QNHII as an entity that, within specified
time frames, satisfies or can reasonably be
expected to satisfy the standards in section
1322(c) of the Affordable Care Act and
in the CMS final regulations. The entity
will constitute a QNHII until such time
as CMS determines the entity does not
satisfy or cannot reasonably be expected
to satisfy these standards. Section 1322(c)
of the Affordable Care Act imposes a
number of requirements, including that
a QNHII be organized as a nonprofit
member corporation under State law and
that substantially all its activities consist
of the issuance of qualified health plans in
the individual and small group markets in
each State in which it is licensed to issue
such plans.
Section 501(c)(29)(A) of the Code pro-
vides that a QNHII (within the meaning
of section 1322(c) of the Affordable Care
Act) which has received a loan or grant
under the CO-OP program may be rec-
ognized as exempt from taxation under
section 501(a), but only for periods for
which the organization is in compliance
with the requirements of section 1322 of
the Affordable Care Act and of any loan
or grant agreement with the Secretary
of Health and Human Services. Section
501(c)(29)(B) provides that a QNHII will
not qualify for tax-exemption unless it
meets four additional requirements. First,
the QNHII must give notice to the Secre-
tary of the Treasury, in such manner as the
Secretary may by regulations prescribe,
that it is applying for recognition of ex-
emption as an organization described in
section 501(c)(29). Second, no part of
the QNHII’s net earnings may inure to the
benefit of any private shareholder or indi-
vidual, except to the extent permitted by
section 1322(c)(4) of the Affordable Care
Act (which requires that any profits be
used to lower premiums, to improve bene-
fits, or for other programs intended to im-
prove the quality of health care delivered
to the organization’s members). Third, no
substantial part of the QNHII’s activities
may consist of carrying on propaganda,
or otherwise attempting, to influence
legislation. Finally, the QNHII may not
participate in or intervene in (including the
publishing or distributing of statements)
any political campaign on behalf of
(or in opposition to) any candidate for
public office. As required by section
1322(b)(2)(C)(iii) of the Affordable Care
Act, CMS must notify the IRS of any
determination of a failure to comply with
the CO-OP program standards, including
any loan agreement, that may affect a
QNHII’s tax-exempt status under section
501(c)(29) of the Code.
The IRS issued Notice 2011–23,
2011–13 I.R.B. 588 (March 10, 2011)
(see §601.601(d)(2)(ii)(b) of this chap-
ter), which addresses the requirements for
tax exemption for QNHIIs described in
section 501(c)(29). The Notice provides
guidance on the annual filing require-
ment for QNHIIs that intend to apply for
recognition of exempt status under section
501(c)(29). The Noticealso states that the
Treasury Department and the IRS intend
to recognize a QNHII that has received a
loan or grant under the CO-OP program
as exempt effective from the later of the
date of its formation or March 23, 2010,
provided that the organization’s purposes
and activities have been consistent with
the requirements forexemption since that
March 19, 20125592012–12 I.R.B.

date. In addition, the Notice states that the
IRS intends to issue a revenue procedure
explaining how and when a QNHII may
apply for recognition of exempt status
as an organization described in section
501(c)(29).
Under the authority provided by these
temporary regulations, the Treasury De-
partment and the IRS are issuing a revenue
procedure regarding the application for
recognition of exemption as an organi-
zation described in section 501(c)(29).
The revenue procedure will provide that
a substantially completed application for
recognition of exemption under section
501(c)(29) must include a copy of both
theNoticeofAwardissuedbyCMSand
the fully executed Loan Agreement with
CMS.
Explanation of Provisions
Section 501(c)(29)(B)(i) provides that a
QNHII which has received a loan through
the CO-OP program may be recognized
as exempt from taxation under section
501(a) only if, among other things, the
QNHII gives notice to the IRS, in such
manner as the Secretary may by regu-
lations prescribe, that it is applying for
recognition as an organization described
in section 501(c)(29). These temporary
regulations provide that the Commissioner
has the authority to prescribe the applica-
tion procedures that a QNHII seeking such
recognition must follow. These temporary
regulations expressly authorize the Com-
missioner to recognize a QNHII as exempt
effective as of a date prior to the date of its
application, provided that the application
is submitted in the manner and within the
time prescribed by the Commissioner and
the QNHII’s prior purposes and activities
were consistent with the requirements for
exempt status under section 501(c)(29).
Special Analyses
It has been determined that this Trea-
sury Decision is not asignificant regula-
tory action as defined in Executive Order
12866, as supplemented by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
5) does not apply. For the applicability of
the Regulatory Flexibility Act (5 U.S.C.
chapter 6), refer to the Special Analyses
section of the preamble to the cross-refer-
enced notice of proposed rulemaking pub-
lished in this issue of the Bulletin. Pur-
suant to section 7805(f) of the Code, this
regulation has been submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comments regard-
ing its impact on small businesses.
Drafting Information
The principal authors of these
regulations are Amy Franklin and
Martin Schäffer of the Office of Division
Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities),
although other persons in the IRS and the
Treasury Department participated in their
development.
*****
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.501(c)(29)–1T also issued
under 26 U.S.C. 501(c)(29)(B)(i). * * *
Par. 2. Section 1.501(c)(29)–1T is
added to read as follows:
§1.501(c)(29)–1T CO-OP Health
Insurance Issuers (temporary).
(a)Organizations must notify the Com-
missioner that they are applying for recog-
nition of section 501(c)(29) status.Anor-
ganization will not be treated as described
in section 501(c)(29) unless the organiza-
tion has given notice to the Commissioner
that it is applying for recognition as an or-
ganization described in section 501(c)(29)
in the manner prescribed by the Commis-
sioner in published guidance.
(b)Effective date of recognition of sec-
tion 501(c)(29) status. An organization
may be recognized as an organization de-
scribed in section 501(c)(29) as of a date
prior to the date of the notice required by
paragraph (a) of this section if the notice
isgiveninthemannerandwithinthetime
prescribed by the Commissioner and the
organization’s purposes and activities prior
to giving such notice were consistent with
the requirements for exempt status under
section 501(c)(29). However, an organi-
zation may not be recognized as an organ-
ization described in section 501(c)(29) be-
fore the later of its formation or March 23,
2010.
(c)Effective/applicability date. Para-
graphs (a) and (b) of this section are effec-
tive on February 7, 2012.
(d)Expiration date. The applicability
of this section expires on February 6, 2015.
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
Approved January 26, 2012.
Emily S. McMahon,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on February 6,
2012, 8:45 a.m., and published in the issue of the Federal
Register for February 7, 2012, 77 F.R. 6005)
2012–12 I.R.B.560March 19, 2012

Part IV. Items o
fGeneralInterest
Noti
ce of Proposed
Rul
emaking by
Cro
ss-Reference to
Te
mporary Regulations
Ap
plication for Recognition as
a5
01(c)(29) Organization
REG–135071–11
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
by cross-reference to temporary regula-
tions.
SUMMARY: In this issue of the Bulletin
are temporary regulations (T.D. 9574) au-
thorizing the IRS to prescribe the proce-
dures by which a qualified nonprofit health
insurance issuer participating in the Con-
sumer Operated and Oriented Plan pro-
gram, established by the Centers for Medi-
care and Medicaid Services, may apply for
recognition as a tax-exempt organization
under the Internal Revenue Code. The text
of those regulations also serves as the text
of these proposed regulations.
DATES: Written or electronic comments
and requests for a public hearing must be
received by April 9, 2012.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR(REG–135071–11),
Room 5203, Internal Revenue Ser-
vice, P.O. Box 7604, Ben Franklin Sta-
tion, Washington, DC 20044. Submis-
sions may be hand-delivered Monday
through Friday between the hours of 8
a.m. and 4 p.m. to CC:PA:LPD:PR
(REG–135071–11), Courier’s Desk, Inter-
nal Revenue Service, 1111 Constitution
Avenue, NW, Washington, DC, or sent
electronically via the Federal eRulemak-
ing Portal atwww.regulations.gov(IRS
REG–135071–11).
FOR FURTHER INFORMATION
CONTACT: Concerning the proposed reg-
ulations, Amy Franklin or Martin Schäffer
at (202) 622–6070; concerning submission
of comments and request for hearing,
Oluwafunmilayo Taylor at (202)
622–7180 (not toll-free numbers).
SUPP
LEMENTARY INFORMATION:
Background and Explanation of
Provisions
The temporary regulations in this issue
of the Bulletin make additions to the In-
come Tax Regulations (26 CFR part 1) re-
lating to section 501(c)(29) of the Inter-
nal Revenue Code (Code). The temporary
regulations provide that the Commissioner
has the authority to prescribe the proce-
dures under which a qualified nonprofit
health insurance issuer (within the mean-
ing of section 1322(c) of the Patient Pro-
tection and Affordable Care Act, Public
Law 111–148 (March 23, 2010)) which has
received a loan or grant from the Centers
for Medicare and Medicaid Services under
the Consumer Operated and Oriented Plan
program may request to be recognized as
tax-exempt under section 501(a) as an or-
ganization described in section 501(c)(29).
The temporary regulations expressly au-
thorize the Commissioner to recognize a
qualified nonprofit health insurance issuer
as exempt effective as of a date prior to
thedateofitsapplication, provided that
the application is submitted in the manner
and within the time prescribed by the Com-
missioner and the organization’s prior pur-
poses and activities were consistent with
the requirements for exempt status under
section 501(c)(29). The text of the tempo-
rary regulations alsoserves as the text of
these proposed regulations. The preamble
to the temporary regulations explains the
additions.
S
pecial Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866, as supplemented by Execu-
tive Order 13563. Therefore, a regulatory
assessment is not required. It also has been
determined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. chap-
ter 5) does not apply, and because no col-
lection of information is imposed on small
entities, the provisions of the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not
apply. Pursuant to section 7805(f) of the
Code, the proposed regulation has been
submitted to the Chief Counsel for Advo-
cacy
of the Small Business Administration
for
comments on its impact on small busi-
nes
ses.
Com
ments and Requests for a Public
Hea
ring
Bef
ore these proposed regulations are
ado
pted as final regulations, consideration
wil
l be given to any comments that are sub-
mi
tted timely to the IRS as prescribed in
th
is preamble under the “Addresses” head-
in
g. The IRS and the Treasury Department
re
quest comments on the proposed regula-
ti
ons, including how they might be made
e
asier to understand. All comments will be
a
vailable atwww.regulations.govor upon
r
equest. A public hearing will be sched-
u
led if requested in writing by any person
t
hat timely submits written comments. If
a public hearing is scheduled, notice of the
date, time, and place for the public hearing
will be published in theFederal Register.
Drafting Information
The principal authors of these
regulations are Amy Franklin and
Martin Schäffer of the Office of Division
Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities),
although other persons in the IRS and the
Treasury Department participated in their
development.
*****
Proposed Amendment to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.501(c)(29)–1 also issued un-
der 26 U.S.C. 501(c)(29)(B)(i). * * *
Par. 2. Section 1.501(c)(29)–1 is added
to read as follows:
§1.501(c)(29)–1 CO-OP Health Insurance
Issuers.
[The text of proposed amendment to
§1.501(c)(29)–1 is the same as the text for
March 19, 20125612012–12 I.R.B.

§1.501(c)(29)–1T(a) through (c) published
elsewhere in this issue of the Bulletin].
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on February 6,
2012, 8:45 a.m., and published in the issue of the Federal
Register for February 7, 2012, 77 F.R. 6027)
Procedures for Certain
Trusts that Qualify as Type
III Supporting Organizations,
Announcement 2010–19
Obsolete
Announcement 2012–12
Announcement 2010–19, 2010–14
I.R.B. 529 (April 5, 2010), described pro-
cedures for certain charitable trusts that
classified themselves as private founda-
tions after August 16, 2007, to be reclassi-
fied as Type III supporting organizations.
These procedures applied to trusts that
met the requirements to be classified as a
Type III supporting organization through
the end of the 2008 taxable year (including
by meeting the significant voice respon-
siveness test for periods after August 16,
2007), but erroneously filed Form 990–PF
and paid Internal Revenue Code § 4940
tax for the 2008 taxable year. Announce-
ment 2010–19 explained, among other
things, how such a trust could request a
ruling that it was, and continued to be, a
Type III supporting organization described
in § 509(a)(3).
Since Announcement 2010–19 was is-
sued, the IRS has updated its procedures
for an organization to obtain a determina-
tion regarding its foundation status.See
Rev. Proc. 2012–10, 2012–2 I.R.B. 273.
In addition, in June 2011 the IRS released
Form 8940,Request for Miscellaneous De-
terminations Under Section 507, 509(a),
4940, 4942, 4945, and 6033 of the In-
ternal Revenue Code, referenced in Rev.
Proc. 2012–10, which describes the de-
tailed procedures for a “[c]hange in Type
(or initial determination of Type) of a sec-
tion 509(a)(3) organization” (Part II, box
8f) and a “Reclassification of foundation
status, . . .” (Part II, box 8g). A user fee
applies to these determinations.
Accordingly, Announcement 2010–19
is hereby declared to be obsolete.
For further information regarding this
announcement, contact Mike Repass of
the Exempt Organizations, Tax Exempt
and Government Entities Division at (202)
283–8924 (not a toll-free call).
2012–12 I.R.B.562March 19, 2012

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
withamplifiedandclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is self
contained. In this case, the previously pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names in
subsequent rulings. After the original rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of cases
in litigation, or the outcome of a Service
study.
Abbreviations
The fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
DC—Dummy Corporation.
DE—Donee.
Del. Order
—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
March 19, 2012i2012–12 I.R.B.

Numerical Finding List
1
Bulletins 2012–1 through 2012–12
Announcements:
2012-1, 2012-1 I.R.B.249
2012-2, 2012-2 I.R.B.285
2012-3, 2012-4 I.R.B.335
2012-4, 2012-4 I.R.B.335
2012-5, 2012-5 I.R.B.348
2012-6, 2012-6 I.R.B.366
2012-7, 2012-6 I.R.B.367
2012-8, 2012-7 I.R.B.373
2012-9, 2012-7 I.R.B.377
2012-12, 2012-12 I.R.B.562
Notices:
2012-1, 2012-2 I.R.B.260
2012-3, 2012-3 I.R.B.289
2012-4, 2012-3 I.R.B.290
2012-5, 2012-3 I.R.B.291
2012-6, 2012-3 I.R.B.293
2012-7, 2012-4 I.R.B.308
2012-8, 2012-4 I.R.B.309
2012-9, 2012-4 I.R.B.315
2012-10, 2012-5 I.R.B.343
2012-11, 2012-5 I.R.B.346
2012-12, 2012-6 I.R.B.365
2012-13, 2012-9 I.R.B.421
2012-14, 2012-8 I.R.B.411
2012-15, 2012-9 I.R.B.424
2012-16, 2012-9 I.R.B.427
2012-17, 2012-9 I.R.B.430
2012-18, 2012-10 I.R.B.438
2012-19, 2012-10 I.R.B.440
2012-21, 2012-10 I.R.B.450
2012-23, 2012-11 I.R.B.483
Proposed Regulations:
REG-109369-10, 2012-9 I.R.B.434
REG-113903-10, 2012-11 I.R.B.486
REG-120282-10, 2012-11 I.R.B.487
REG-130302-10, 2012-8 I.R.B.412
REG-149625-10, 2012-2 I.R.B.279
REG-102988-11, 2012-4 I.R.B.326
REG-124627-11, 2012-8 I.R.B.417
REG-130777-11, 2012-5 I.R.B.347
REG-135071-11, 2012-12 I.R.B.561
REG-145474-11, 2012-11 I.R.B.495
Revenue Procedures:
2012-1, 2012-1 I.R.B.1
2012-2, 2012-1 I.R.B.92
2012-3, 2012-1 I.R.B.113
2012-4, 2012-1 I.R.B.125
2012-5, 2012-1 I.R.B.169
Revenue Procedures— Continued:
2012-6, 2012-1 I.R.B.197
2012-7, 2012-1 I.R.B.232
2012-8, 2012-1 I.R.B.235
2012-9, 2012-2 I.R.B.261
2012-10, 2012-2 I.R.B.273
2012-11, 2012-7 I.R.B.368
2012-12, 2012-2 I.R.B.275
2012-13, 2012-3 I.R.B.295
2012-14, 2012-3 I.R.B.296
2012-15, 2012-7 I.R.B.369
2012-16, 2012-10 I.R.B.452
2012-17, 2012-10 I.R.B.453
2012-18, 2012-10 I.R.B.455
2012-21, 2012-11 I.R.B.484
Revenue Rulings:
2012-1, 2012-2 I.R.B.255
2012-2, 2012-3 I.R.B.286
2012-3, 2012-8 I.R.B.383
2012-4, 2012-8 I.R.B.386
2012-5, 2012-5 I.R.B.337
2012-6, 2012-6 I.R.B.349
2012-7, 2012-6 I.R.B.362
2012-9, 2012-11 I.R.B.475
Treasury Decisions:
9559, 2012-2 I.R.B.252
9560, 2012-4 I.R.B.299
9561, 2012-5 I.R.B.341
9562, 2012-5 I.R.B.339
9563, 2012-6 I.R.B.354
9565, 2012-8 I.R.B.378
9566, 2012-8 I.R.B.389
9567, 2012-8 I.R.B.395
9568, 2012-12 I.R.B.499
9569, 2012-11 I.R.B.465
9570, 2012-11 I.R.B.477
9571, 2012-11 I.R.B.468
9572, 2012-11 I.R.B.471
9573, 2012-12 I.R.B.498
9574, 2012-12 I.R.B.559
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2011–27 through 2011–52 is in Internal Revenue Bulletin
2011–52, dated December 27, 2011.
2012–12 I.R.B.iiMarch 19, 2012

Finding List of Current Actions on
Previously Published Items
1
Bulletins 2012–1 through 2012–12
Announcements:
2002-44
Supplemented by
Notice 2012-13, 2012-9 I.R.B.421
2010-19
Obsoleted by
Ann. 2012-12, 2012-12 I.R.B.562
2011-63
Corrected by
Ann. 2012-9, 2012-7 I.R.B.377
Notices:
2006-87
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2007-25
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2007-77
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2008-107
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2010-27
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2010-88
As modified by Ann. 2011-40, is superseded by
Notice 2012-1, 2012-2 I.R.B.260
2011-8
Superseded by
Notice 2012-19, 2012-10 I.R.B.440
2011-28
Superseded by
Notice 2012-9, 2012-4 I.R.B.315
Revenue Procedures:
2000-43
Amplified, modified and superseded by
Rev. Proc. 2012-18, 2012-10 I.R.B.455
2003-61
Superseded by
Notice 2012-8, 2012-4 I.R.B.309
2007-44
Modified by
Ann. 2012-3, 2012-4 I.R.B.335
Revenue Procedures— Continued:
2011-1
Superseded by
Rev. Proc. 2012-1, 2012-1 I.R.B.1
2011-2
Superseded by
Rev. Proc. 2012-2, 2012-1 I.R.B.92
2011-3
Superseded by
Rev. Proc. 2012-3, 2012-1 I.R.B.113
2011-4
Superseded by
Rev. Proc. 2012-4, 2012-1 I.R.B.125
2011-5
Superseded by
Rev. Proc. 2012-5, 2012-1 I.R.B.169
2011-6
Superseded by
Rev. Proc. 2012-6, 2012-1 I.R.B.197
2011-7
Superseded by
Rev. Proc. 2012-7, 2012-1 I.R.B.232
2011-8
Superseded by
Rev. Proc. 2012-8, 2012-1 I.R.B.235
2011-9
Superseded by
Rev. Proc. 2012-9, 2012-2 I.R.B.261
2011-10
Superseded by
Rev. Proc. 2012-10, 2012-2 I.R.B.273
2011-37
Obsoleted in part by
Rev. Proc. 2012-16, 2012-10 I.R.B.452
2011-40
Corrected by
Ann. 2012-6, 2012-6 I.R.B.366
2011-49
Modified by
Ann. 2012-3, 2012-4 I.R.B.335
2011-50
Corrected by
Ann. 2012-6, 2012-6 I.R.B.366
2011-51
Corrected by
Ann. 2012-6, 2012-6 I.R.B.366
2012-8
Corrected by
Ann. 2012-7, 2012-6 I.R.B.367
Revenue Rulings:
92-19
Supplemented in part by
Rev. Rul. 2012-6, 2012-6 I.R.B.349
2008-40
Modified by
Notice 2012-6, 2012-3 I.R.B.293
2011-1
Modified by
Notice 2012-6, 2012-3 I.R.B.293
Treasury Decision:
9517
Corrected by
Ann. 2012-4, 2012-4 I.R.B.335
Ann. 2012-5, 2012-5 I.R.B.348
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2011–27 through 2011–52 is in Internal Revenue Bulletin 2011–52, dated December 27,
2011.
March 19, 2012iii2012–12 I.R.B.

Internal Revenue Service
W
ashington,DC20224
Official Business
Penalty for Private Use, $300
INTERNAL REVENUE BULLETIN
The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue
Bulletin is sold on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superin-
tendent of Documents when their subscriptions must be renewed.
CUMULATIVE BULLETINS
The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
sold on a single copy basis andare notincluded as part of the subscription to the Internal Revenue Bulletin. Subscribers to the weekly
Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the
Superintendent of Documents.
ACCESS THE INTERNAL REVENUE BULLETIN ON THE INTERNET
You may view the Internal Revenue Bulletin on the Internet at www.irs.gov. Select Businesses. Under Businesses Topics, select
More Topics. Then select Internal Revenue Bulletins.
INTERNAL REVENUE BULLETINS ON CD-ROM
Internal Revenue Bulletins are available annually as part ofPublication 1796 (Tax Products CD-ROM). The CD-ROM can be
purchased from National Technical Information Service (NTIS) on the Internet at www.irs.gov/cdorders (discount for online orders)
or by calling 1-877-233-6767. The first release is available in mid-December and the final release is available in late January.
HOW TO ORDER
Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,
detach entire page, and mail to the Superintendent of Documents, P.O. Box 979050, St. Louis, MO 63197–9000. Please allow two to
six weeks, plus mailing time, for delivery.
WE WELCOME COMMENTS ABOUT THE INTERNAL
REVENUE BU
LLETIN
If you have
comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be p
leased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page (www.irs.gov)
or write t
o the IRS Bulletin Unit, SE:W:CAR:MP:T:T:SP, Washington, DC 20224.