Final Regs. Adopt Differential Income Stream Method for Cost-Sharing Agreements

On Monday, the IRS issued regulations (T.D. 9630) that govern the application of the differential income stream approach to cost-sharing arrangements. The regulations finalized without change regulations proposed in 2012.

At the end of 2011, the IRS published final cost-sharing rules under Sec. 482. The goal of the new regulations was generally to ensure that cost-sharing arrangements are consistent with Sec. 482’s commensurate-with-income principle. Earlier, the IRS had introduced three new methods to ensure arm’s-length pricing in all cost-sharing transactions: the income method, the acquisition price method, and the market capitalization method.

The IRS contends that taxpayers were taking unreasonable positions in applying the income method by using low licensing discount rates and high cost-sharing discount rates without considering the relationship between the discount rates and financial projections. Believing that this resulted in material distortions and platform contribution transaction (PCT) payments (buy-in payments to cost-sharing arrangements) that were not at arm’s length, the IRS issued the 2012 proposed regulations (REG-145474-11) and now the final regulations to provide additional guidance on evaluating the results of an application of the income method and to provide a new specified application of the income method for directly determining the arm’s length charge for PCT payments. The IRS received comments in response to the proposed regulations, but chose not to incorporate the suggestions in the comments in the final regulations.

Part of the final rules will apply retroactively to tax years beginning on or after Dec. 19, 2011, and part will apply to tax years beginning on or after Aug. 27, the date the regulations will be published as final in the Federal Register.