Industry Director Directive #1 on Transfer of Intangibles Offshore/ §482 Cost Sharing Buy-in Payment
LMSB Control No: LMSB-04-0307-027
Impacted IRM 4.51.5
April 5, 2007
MEMORANDUM FOR INDUSTRY DIRECTORS
DIRECTOR, FIELD SPECIALISTS
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE
DIRECTOR, INTERNATIONAL COMPLIANCE STRATEGY
FROM: Patricia C. Chaback /s/ Patricia C. Chaback
Communications, Technology, and Media
SUBJECT: Tier I - Transfer of Intangibles Offshore / § 482 Cost Sharing
Buy-in Payment Issue Directive #1
This memorandum provides the Field direction on the Tier I Issue, Transfer of Intangibles Offshore / § 482 Cost Sharing Buy-in Payment.
Background / Strategic Importance
Transfer of Intangibles Offshore / § 482 Cost Sharing has been identified as a Tier I issue and is one of the most significant compliance challenges facing LMSB. Cost Sharing Arrangements (CSAs)1 are often used by taxpayers inappropriately to transfer intangible assets and associated profits offshore to related foreign affiliates for inadequate consideration. LMSB Compliance estimates that inadequate consideration has resulted in material underreporting of taxable income by U.S. Corporations.
The issue spans all industries but controversy is most prevalent in the High Technology industry. Examination spends considerable resources auditing these arrangements and often must hire industry and economist experts to support adjustments.
The primary issue in § 482 cost sharing involves external contributions for which arm’s length consideration (buy-in payment) must be provided. 2 A buy-in payment is required to the extent that one party (typically the U.S. taxpayer) makes pre-existing 3 intangibles (“initial buy-in”), or intangibles acquired during the CSA (“acquisition buy-in”), available for further development within the CSA. 4 In this case, the other party (typically the foreign participant) must make a buy-in payment as consideration for a deemed transfer of interest in the intangible property abroad.
Disputes with taxpayers surrounding the buy-in payment include: up-front valuation of intangibles; definition and scope of intangibles made available (e.g. technology, goodwill, workforce in place, etc.); useful life of pre-existing intangibles; application of the “commensurate with income” standard; form of payment (royalty, lump sum, or installment); timing of payment; best method rule; rights to further development in research versus manufacturing and selling (“make-sell”) rights; marketing rights versus technology rights; core technology; in-process R&D; fully developed technology and products; third party acquisition buy-in--(stock or asset purchase of a company) or license of intangibles from third party; and documentation requirements.
In recognition of the strategic importance of cost sharing buy-in issues, an Issue Management Team (IMT) has been formed to identify, develop, resolve, and improve Service-wide coordination of § 482 cost sharing buy-in issues. A primary purpose of the IMT is to ensure that when these issues are identified for audit, they are examined fairly and consistently for all taxpayers.
1 Pursuant to Treas. Reg. § 1.482-7
2 Treas. Reg. § 1.482-7(g)
3 Intangibles developed before entering into the CSA.
4 The importance of the buy-in payment was recognized in the legislative history of the Tax Reform Act of 1986: “In addition, to the extent, if any, that one party is actually contributing funds toward research and development at a significantly earlier point in time than the other, or is otherwise effectively putting its funds at risk to a greater extent than the other, it would be expected that an appropriate return would be provided to such party to reflect its investment.” H.R. Conf. Rep. No. 99-841 at II-638 (1986).
This issue should be tracked using the following Uniform Issue List Codes (UILCs):
482.11-10 Cost Sharing Buy-in Payments 5;
482.11-11 Cost Sharing Arrangements: Buy-in Payment for Pre-Existing Intangibles; or
482.11-12 Cost Sharing Arrangements: Buy-in Payment for Post Formation Acquisition Intangibles.
5 UIL 482.11-10 should be used only where there is a project or case that involves both buy-in payment for pre-existing intangibles and buy-in payment for post formation acquisitions. Otherwise, the more specific UILs 482.11-11 and 482.11-12 should be used.
Planning and Examination Guidance
The § 482 cost sharing buy-in issue is identified by a statement which must be attached to the U.S. income tax return, Form 5471 (Schedule M), or Form 5472, every year as required by Treas. Reg. § 1.482-7(c)(1)(iii) and the administrative requirements of Treas. Reg. § 1.482-7(j)(3).
Planning and Examination Risk Analysis
In accordance with prior transfer pricing directives as they relate to all multinational enterprises, an IDR should be issued early in the examination planning process requesting all transfer pricing documentation, (studies) pursuant to § 6662(e). 6 As a Tier I issue, subject to a documented risk and materiality analysis, the § 482 "cost sharing buy-in issue" should be raised and fully developed by examiners. It is imperative that the risk assessment be performed early in the planning process in order to allow for an in-depth examination of the transfer pricing buy-in issues.
Audit Evaluation and Issue Development
For assistance with audit evaluation and issue development, examiners should contact International Technical Advisors, Jon Tamaki or Matthew Hartman; or High Tech Industry Counsel, Michelle Korbas through local counsel.
An Audit Checklist for Cost Sharing Arrangements dated August 9, 2005, provides guidance in identifying and examining cost sharing buy-in payment issues.
The cost sharing IMT is developing a Coordinated Issue Paper (CIP) on §482 buy-in adjustments which will address certain key issues pertaining to calculation of the buy-in and increase the uniformity of examination of the issues.
Under the Outside Expert Program (OEP), which complements the in-house expertise of the IRS Economist program, the Service has retained several independent experts to serve on an ad hoc basis as consultants on cost sharing cases.
The Office of Chief Counsel provides support to improve compliance with § 482. Within the Office of Chief Counsel, the Associate Chief Counsel International (ACCI) Branch 6 has subject matter jurisdiction over technical issues under § 482. The Advance Pricing Agreement (APA) Program, also located within ACCI negotiates and executes APAs with taxpayers on § 482 issues, including cost sharing buy-in payments.
LMSB Counsel has designated International Field Counsels (IFCs) who have substantial expertise on transfer pricing issues, including cost sharing buy-in payments. These attorneys and others in LMSB provide front-line assistance to LMSB Examination, and also act as liaisons for coordination of technical issues with attorneys in ACCI.
The majority of § 482 cost sharing buy-in disputes are resolved in Examination or in Appeals. Only one docketed case involving buy-in payments is currently pending in U.S. Tax Court: Veritas Software Corp. v. Commissioner, Docket No. 12075-06.
On August 29, 2005, proposed regulations were issued to address the recurring buy-in payment issues. 7 The proposed § 482 cost sharing regulations provide a comprehensive rewrite of the 1996 regulations and clarify how the arm’s length principle is properly applied to CSAs. The proposed regulations adopt as a fundamental concept an “investor model” for addressing the relationships and contributions of controlled participants in a CSA. Specific methods for determining the arm’s length compensation for external contributions (i.e., the buy-in) are derived from the investor model. The proposed regulations also enunciate general principles governing all methods, specified and unspecified. Final regulations are expected mid-2007.
Effect on Other Guidance
This directive has no effect on previous guidance.
Any questions regarding this directive may be directed to International Technical Advisor, Jon Tamaki or High Tech Industry Counsel, Michelle Korbas.
This Directive is not an official pronouncement of law, and cannot be used, cited, or relied upon as such.
cc: Commissioner, LMSB
Deputy Commissioner, Operations
Deputy Commissioner, International
Division Counsel, LMSB
Directors, Field Operations
Director, Performance, Quality and Audit Assistance