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Cross-Border Intercompany Transfers of Intangible Property and Cost Sharing Arrangement Considerations for Multinationals

Cross-Border Intercompany Transfers of Intangible Property and Cost Sharing Arrangement Considerations for Multinationals

By Anthony Diosdi

Multinational corporations usually engage in a variety of cross-border intercompany transactions. A common arrangement is for a U.S. parent corporation to license its intangibles to a foreign subsidiary for exploitation abroad. When such a transfer takes place, a “transfer price” must be computed in order to satisfy various financial reporting, tax, and other regulatory requirements. Internal Revenue Code Section 482 governs the transfer pricing rules and provides that multinational corporations must allocate their worldwide profits among the various countries in which they operate. To this end, Section 482 and its regulations adopt an arm’s-length standard for evaluating the appropriateness of a transfer price. To arrive at an arm’s-length result, a multinational corporation must select and apply the method that provides the most reliable estimate of an arm’s-length price.

Under Section 482 of the Internal Revenue Code, the Internal Revenue Service (“IRS”) is empowered to reallocate income, deductions, credits and allowances among business enterprises controlled directly or indirectly by the same interests as may be necessary clearly to reflect the income of each such enterprise. In effect, the IRS is empowered to shift income, deductions and credits in order to produce the tax results that would have been obtained if the related parties had been dealing as independent parties at arm’s length. The Section 482 arm’s length standard applies to all transfers of intangible property. For transfer pricing purposes, an “intangible” includes any of the following items:

1) patents, inventions, formulae, processes, designs, patterns, or know-how;

2) copyrights and literary, musical, or artistic compositions;

3) trademarks, trade names, or brand names;

4) franchises, licenses, or contracts;

5) Workforce, goodwill, and customer relations;

6) methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data, and;

7) other similar items.

Transfers of Intangible Property

The starting point under the regulations of Section 482 is to identify the owner of the intangible property. The owner of intangible property is typically the entity that owns a legally protected right to exploit the intangible. The owner of intangible property that is not legally protected will generally be the entity that bore the greatest part of the development costs. Because in theory the owner and a related party may enjoy the rights of intangibles through consolidated groups (e.g., one by the other or both by a common owner), the regulations to Section 482 refer to the owner as the controlled owner and the party using rights to the intangible as the controlled person.

The general rule is that when a controlled corporation pays inadequate consideration for the right to exploit an intangible, and the transfer retains a substantial interest in the intangible, the arm’s length consideration should be in the form of a taxable royalty. That is, unless under the circumstances a different classification of the payment is more appropriate. There are a number of methods for estimating an arm’s-length charge for transfers of intangibles. A multinational must select and apply the method which provides the most reliable estimate of an arm’s length price.

Cost Sharing Arrangements

The Section 482 regulations contain an important exception to the general rule that an arm’s length royalty or other consideration must be paid by a related enterprise when intangibles are transferred to it by an enterprise controlled by the same interest. Intangles may be shared between two or more related enterprises under an arrangement that provides for the sharing of the costs and risks of developing intangible property in return for an interest in the intangible property that may be produced. Under a qualified cost sharing arrangement, the related person receiving an interest in intangible property is not required to pay an arm’s length royalty for its use; it need only bear or pay an appropriate share of the cost of the research and development concerned.

For example, a U.S. parent parent corporation and a foreign subsidiary may agree to equally share the costs of developing a new software program. Under such an agreement, the parent might own the rights to engineer and market an English language program in the United States, while the subsidiary may own the rights to develop and market the English language program abroad. The advantage of a cost-sharing arrangement is that the foreign subsidiary’s ownership of the foreign rights to the software program negates the need to have that subsidiary pay a royalty to the U.S. parent corporation.

Tres. Reg. Section 1.482-7(a)(1) defines a cost sharing arrangement as an agreement for sharing costs of development of one or more intangibles in proportion to the participants’ shares of reasonably anticipated benefits from their exploitation of interests in any intangibles that are developed. If a “qualified cost sharing arrangement” exists, no Section 482 allocation of arm’s length royalties or equivalent payments can be made by the IRS. The IRS can only adjust the cost sharing payments to make each controlled participant’s share of the relevant intangibles development costs equal to its share of reasonably anticipated benefits from use of the intangibles developed. To be treated as a qualified cost sharing arrangement and thus insulated from risk of royalty allocations, the arrangement must satisfy the following four requirements:

1) Include two or more participants;

2) Provide a method to calculate each controlled participant’s share of intangible development costs, based on factors that can reasonably be expected to reflect the participant’s share of anticipated benefits;

3) Provide for adjustment to the controlled participant’s shares of intangible development costs to account for changes in economic conditions, the business operations and practices of the participants and the ongoing development of intangibles under the arrangements; and

4) Be recorded in a document that is contemporaneous that includes:

i) A list of the arrangement’s participants, and any other member of the controlled group that will benefit from the use of intangibles developed under the cost sharing arrangement;

ii) The information described in paragraphs (2) and (3) above;

iii) A description of the scope of the research and development to be undertaken, including the intangible or class of intangibles intended to be developed;

iv) A description of each participant’s interest in any covered intangibles;

v) The duration of the arrangement; and

vi) The conditions under which the arrangement may be modified or terminated and the consequences of such modification or termination, such as the interest that such participants will receive in any covered intangibles.

Development Costs and Reasonably Anticipated Benefits

The costs that may be shared to develop intangible property include all costs of any research actually undertaken under the cost sharing arrangement. These costs include cost sharing payments a participant makes to the other participant or participants less such payments it receives from other participants. Over the years, issues have surfaced concerning whether operating expenses include stock-based compensation provided by a controlled participant, often in the form of stock options. Treasury Regulation Section 1.482-7(d)(2) was issued by the Department of Treasury which takes the position that operating expenses include any stock-based compensation provided to an employee or independent contractor, including for example, restricted stock, stock options, and stock appreciation rights. Under Treasury Regulation Section 1.482-7(d)(2)(ii), the determination of whether stock-based compensation is related to the development of an intangible is to be made as of the date the stock-based compensation is granted. The regulation deals in detail with permissible methods for measuring the cost associated with stock-based compensation. A word of warning to any multinational corporation having cost-sharing arrangements with foreign affiliates which involves stock-based compensation arrangements to develop intangible assets, this area is full of minefields. This is particularly the case after the United States Supreme Court announced that it was denying the petition for certiorari for Altera Corporation & Subsidiaries v. Commissioner, 926 F.3d. 1061 (2019). By way of background, in Altera Corp. v. Commissioner, Altera prevailed in a suit before the United States Tax Court. The Tax Court invalidated a requirement that related parties allocate stock-based compensation costs when entering into cost-sharing arrangements to develop intangible assets. On appeal, the Ninth Circuit Court of Appeals reversed the Tax Court and upheld the regulation. The Supreme Court’s denial of Altera’s petition for certiorari basically affirmed the Ninth Circuit Court of Appeal’s decision.

Foreign Transfer Pricing Considerations

Many foreign countries have developed their own transfer pricing rules. The methodology and transfer price that the IRS may accept, may or may not be acceptable to a foreign country’s taxing agencies. Any multinational corporation that is involved in the cross-border transfer of intangible property should develop a plan that takes into consideration the regulations of Section 482 and the substantive internal law of the applicable foreign jurisdiction or jurisdictions. In some cases, a multinational corporation may mitigate potential double taxation and needless administrative burdens under treaty-based mutual agreement procedures of “MAPs.” If possible, the use of a MAP relevant to a bilateral tax treaty should be closely reviewed for potential application.


In the current environment, multinational transfers of intellectual property is transfer pricing strategy driven to a great extent. Consequently, it is extremely important to develop an effective transfer strategy well in advance to avoid costly adjustments by the IRS or a foreign taxing agency.

We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in foreign tax planning and compliance. We have also  provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.