Transfer Pricing Developments – Cost Sharing Arrangements: IRS Finalizes Cost Sharing Regulations & Issues Supplemental Guidance on the Application of the Income Method

Sullivan & Cromwell LLP - December 28, 2011

On December 16, 2011, the Internal Revenue Service (the “IRS”) and the Treasury Department finalized regulations (the “Final Regulations”) under Section 482 of the Internal Revenue Code of 1986, as amended (the “Code”), relating to cost sharing arrangements with respect to the development of intangibles. On December 19, 2011, the IRS and the Treasury Department released proposed and temporary regulations (the “Income Method Regulations”) that provide additional guidance regarding the application of the income method for valuing platform contributions to a cost sharing arrangement (i.e., contributions of resources, rights or capabilities that are reasonably expected to benefit the development of the cost shared intangibles and for which a buy-in payment is required).

The Final Regulations replace temporary and proposed regulations (the “Temporary Regulations”) issued in 2009. The Final Regulations contain several changes and clarifications to the Temporary Regulations, and the preamble to the Final Regulations (the “Preamble”) provides insight into the IRS’s overall approach to cost sharing, particularly with respect to valuing platform contributions. The language in the Preamble suggests that the IRS is committed to using the aggregation approach and the income method in many cases, despite the IRS’s loss on this issue under older regulations in the 2009 Tax Court decision Veritas v. Commissioner.

The issuance of the Final Regulations is set against a backdrop of increased IRS attention to transfer pricing in general and to cost sharing arrangements and platform contributions in particular.