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A Walk through the Cost Sharing Arrangement and Platform Contribution Rules

A Walk through the Cost Sharing Arrangement and Platform Contribution Rules

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 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.

Treas. 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 (or “RAB”) 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. In other words, a cost sharing arrangement is an arrangement by which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their reasonably RAB shares. An arrangement is a cost sharing agreement if and only if the requirements of Treasury Regulation Section 1.482-7(b)(ii) are satisfied.

According to Treasury Regulation Section 1.482-7(ii), all controlled participants must commit to, and in fact, engage in platform contributions transactions to the extent that there are platform contributions (or “PCTs”). In a PCT, each other controlled participant (or “PCT Payor”) is obligated to, and must in fact, make arm’s length payments (or “PCT Payments”) to each controlled participant (or “PCT Payee”) that provides a platform contribution.

A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible developed activity (whether prior to or during the course of the cost sharing agreement) that is reasonably anticipated to contribute to developing cost sharing intangibles. The determination whether a resource, capability, or right is reasonably anticipated to contribute to developing cost shared intangibles is ongoing and based on the best available information.

A platform contribution transaction payment is not the equivalent of a licensing fee. Treasury Regulation Section 1.482-7(c)(4) provides:

“Certain make-or-sell rights excluded- (i) In general. Any right to exploit an existing intangible without further development, such as the right to make, replicate, license or sell existing products, does not constitute a platform contribution to a cost sharing agreement, and the arm’s length compensation for such rights (make-or-sell rights) does not satisfy the compensation obligation under a PCT. By definition, a PCT payment is not the equivalent of a licensing fee for an existing intangible, because a platform contribution transaction requires “further development” of the intangible. If the payment were made solely for the use of the existing intangible, without any further modification, it would not qualify as a PCT.

Below, please see Illustration 1 through Illustration 3 which demonstrate examples of PCTs.

Illustration 1.

P and S, which are members of the same controlled group, execute a cost sharing agreement. Under the cost sharing agreement, P and S will bear their RAB shares of intangible development cost (“IDCs”) for developing the second generation of ABC, a computer 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 licensee) by which S may make and sell copies of the existing ABC. Such make-or-sell rights do not constitute a platform contribution to the cost sharing agreement.

The rules of Treasury Regulations Sections 1.482-1 and 1.482-4 through 1.482-6 must be applied to determine the arm’s length consideration in connection with the make-or-sell licensing arrangement. In certain circumstances, this determination of the arm’s length consideration may be done on an aggregate basis with the evaluation of compensation obligations pursuant to the PCTs entered into by P and S in connection with the cost sharing agreement.

Illustration 2.

P, a software company, has developed and currently exploits software program ABC. P and S enter into a cost sharing agreement to develop future generations 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. Concurrent with entering into the cost sharing agreement, 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 expected product life of three years. P and S enter into a contingent payment agreement to cover both the PCT Payments due from S to P’s platform contribution and payments due from S for the make-or-sell license. Based on the uncontrolled make-or-sell licenses, 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.

The make-or sell rights for the current version of ABC are not platform contributions, though paragraph Section 1.482-1(g)(2)(iv) of the regulations provides for the possibility 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 licenses may provide an arm’s length charge for the separate make-or-sell license between P and S, provided 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 includes the rights in the source code and future development rights in ABC.

Illustration 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 pharmaceutical compounds. The research tool, which is not itself such a compound, is used in the cost sharing agreement activity to develop such compounds. However, the cost sharing 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 research activity to develop cost shared intangibles relating to pharmaceutical compounds covered by the cost sharing agreement.

Development Costs and Reasonably Anticipated Benefits

Whenever parties enter into a cost sharing arrangement, the development costs should be carefully considered by the participants to a cost sharing arrangement. Treasury Regulation Section 1.482-7(d)(1) defines intangible development costs of a controlled participant as all of its costs related to the intangible development area, including operating expenses other than depreciation and amortization expenses, plus an arm’s length charge for intangible property made available to the cost sharing arrangement. Costs that may be shared include all costs associated with any research actually undertaken under the cost sharing arrangement. If a participant makes less payments in proportion to other participants, the IRS may adjust the pool of costs shared to properly reflect costs that relate to the intangible development area.

The participants must also consider the reasonable anticipated benefits of the cost sharing arrangement. Reasonably anticipated benefits are defined as additional income generated or cost saved by the use of covered intangibles. However, if the benefits received by a participant in a cost sharing arrangement is not in proportion to its contribution to the development costs, the IRS may make an adjustment to the taxable benefits derived from the cost sharing arrangement. Cost allocations that may be made by the IRS to make a controlled participant’s share of costs equal to its share of reasonably anticipated benefits are governed by Treasury Regulations Section 1.482-7. Anticipated benefits of uncontrolled participants will be excluded from anticipated benefits in calculating the benefits shares of controlled participants. A share of reasonably anticipated benefits will be determined using the most reliable estimate of benefits. The reliability of an estimate of RABs depends principally on two factors: the reliability of the basis for measuring benefits used and the reliability of the projections used. An allocation of costs or income may be made by the IRS if the participant did not use the most reliable estimate of benefits, which depends on the facts and circumstances of each case.

The measurement basis used for estimating a participant’s contribution and share of reasonably anticipated benefits must be consistent for all controlled participants. Benefits may be measured directly or indirectly, whichever produces the most reliable estimate, and it may be necessary to make adjustments to account for material differences in the activities that controlled participants perform in connection with exploitation of covered intangibles. Below are some of the methods that may be utilized to calculate the anticipated benefits and contributions to a cost sharing arrangement.

Arm’s-Length Calculation Using the Reasonable Anticipated Benefit Method

When determining RAB share, reasonable anticipated benefits must be estimated over the entire period, past and future, of exploitation of the cost sharing intangibles. A controlled participant’s RAB share is equal to its RAB divided by the sum of the RABs of all the controlled participants.

RAB’s 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 savings less any additional costs incurred), or on an indirect basis, by reference to certain measurements that reasonably can be assured to relate to benefits to be generated. Indirect basis for measuring anticipated benefits from participation in a cost sharing agreement include units used, produced, or sold; sales; or operating profits. See The Tax Advisor, Transfer Pricing: The New Temporary Cost-Sharing Regs, Jeffrey B. Kaufman (2009).

Income Method

Participants of a cost sharing arrangement may also use the income method to determine the reasonable anticipated benefits. Under income method, a cost sharing agreement between a platform contribution transaction payor and platform contribution payee, where the platform contribution transaction payor makes payments for its shares of the platform intangible contributed by the platform contribution transaction payee, the parties to the cost sharing agreement agree to share in the costs of the intellectual property development.

A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity (whether prior to or during the course of the cost sharing arrangement) that is reasonably anticipated to contribute to developing cost shared intangibles. The value of the platform contribution transaction is the present value of the stream of the reasonably anticipated residuals, over the duration of the cost sharing agreement activity, of divisional profits or losses, minus operating cost contributions, minus intangible cost contributions, minus platform contribution payments.

Market Capitalization Method

Under the market capitalization method, the arm’s length charge for a platform contribution covering resources, capabilities, and rights of the platform contribution payee is equal to the adjusted average market capitalization, as divided among the controlled participants according to their respective shares of the anticipated benefits. See The Tax Advisor, Transfer Pricing: The New Temporary Cost-Sharing Regs, Jeffrey B. Kaufman (2009).

Acquisition Price Method

The acquisition price method applies the comparable uncontrolled transaction or “CUT” method defined in Treasury Regulation Section 1.482-4 to evaluate reasonable anticipated benefits from a cost sharing arrangement. Under the CUT method, the arm’s length price is the price charged for comparable transactions between uncontrolled parties, adjusted for any material differences that exist between the controlled and uncontrolled transactions. The acquisition price method is ordinarily used where substantially all the target’s nonroutine contributions made to the platform contribution payee’s business activities are covered by a platform contribution transaction. Under this method, the arm’s length change for a platform contribution transaction is equal to the adjusted acquisition price, as divided among the controlled participants according to their respective reasonably anticipated benefits. Because information regarding comparable uncontrolled transactions is usually not available regarding intangible assets, this method usually is difficult to apply in practice.

Residual Profit Split Method

The residual profit split method evaluates whether the allocation of combined operating profit or loss attributable to one or more platform contributions subject to a platform contribution transaction is determined at arm’s length by reference to the relative value of each controlled participant’s contribution to that combined operating profit or loss. In other words, the division of profits must reflect the actual profit or loss between uncontrolled parties. To meet this requirement, the division or profit or loss must be adjusted annually to reflect any unanticipated changes in the income actually generated by the intangible.

Under the residual profit split method, the comparable profits method is used to estimate and allocate an arm’s length profit for contributions made by each controlled entity. Routine contributions ordinarily include contributions of tangible property, intangible property, and services. The residual profit not allocated on the basis of routine function is then allocated between the controlled entities on the basis of the relative value of the intangible property contributed by each controlled party. The difficulty in obtaining financial data may render this method difficult to apply in practice.

Comparable Uncontrolled Transaction Method

The comparable uncontrolled transaction method is the arm’s length total value for the platform contribution comparable to intangibles in transactions between uncontrolled parties, adjusted for any material differences that exist between the controlled and uncontrolled transactions. In order for the intangibles involved in the uncontrolled transaction to be considered comparable to the intangibles involved in the controlled transaction, both intangibles should be used in connection with similar products or processes within the same or similar industries.

“Best Method” for Determining the Arm’s Length Price

Treasury Regulation Section 1.482-7(g)(2) provides guidance on selecting the best method for purposes of evaluating a PCT, explaining that each method must be applied within the provisions of Treasury Regulation 1.482-1(c) (the best method rule), 1.482-1(d) (comparability analysis) and Section 1.482-1(e) (arm’s length range), unless modified in Treasury Regulation Section 1.482-7(g).

Under the best method, a method must be applied that provides the most reliable measure of an arm’s length result. The two primary factors are 1) degree of comparability and 2) the quality of the data and assumptions used in the analysis. Treasury Regulation Section 1.482-7(g)(2) provides other best method factors specific to PCTs including: 1) consistency with upfront contractual terms and risk allocation- the “investor model;” 2) consistency of evaluation with realistic alternatives; 3) aggregation; 4) discount rates; 5) financial projections; 6) accounting principles; and 7) valuation of subsequent PCTs. Based on these rules, it is extremely important to complete a detailed functional analysis to develop the relevant facts for purposes of determining the best method for the initial PCT transaction and show why other non-chosen methods are less reliable.

Foreign Transfer Pricing Considerations and Mutual Agreement Procedure Positions

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. This may result in double taxation. In some cases, a multinational corporation may mitigate potential double taxation and needless administrative burdens under treaty-based mutual agreement procedures or (“MAPs”). The standard MAP provision is set forth under Article 25 of the 2016 U.S. Model Income Tax Convention. A more detailed guidance for Maps is set forth in Rev. Proc. 2015-40, 2015-35, I.R.B. 236. The many intricacies and nuances of MAPs is beyond the scope of this article. The complexities of seeking relief under treaty-based mutual agreement procedures will be addressed in another article.

Other Considerations

Finally, it should be understood that cost sharing arrangements are not treated as partnerships for U.S. tax purposes. This means that a foreign controlled participant is not involved in a U.S. trade or business. This means that cost sharing payments technically do involve income that is subject to U.S. withholding taxes. In certain cases, cost sharing payments may also be exempt from withholding taxes in foreign countries.

Annual and Other Cost Sharing Filing

Participants to a cost sharing agreement have significant IRS filing requirements.
Each controlled participant must file with the IRS a “Statement of Controlled Participation to Treasury Regulation Section 1.482-7 Cost Sharing Arrangement” (CSA Statement) as described below. See Treas. Reg. Section 1.482-7(k)(4)(i).

The CSA Statement of each controlled participant must:

1. State that the participant is a controlled participant in a CSA;

2. Provide the controlled participant’s taxpayer identification number;

3. List the other controlled participants in the CSA, the country of organization of each of the participants, and the taxpayer identification number of each participant;

4. Specify the earliest date that any IDC occurred; and

5. Indicate the date on which the controlled participants (or revised) the CSA and, if different from the date, the date on which the controlled participants recorded the CSA (or any revision) contemporaneously.

Time for filing CSA Statement

Each controlled participant must file its original cost sharing agreement with the IRS Orden Campus no later than 90 days after the first occurrence of an IDC to which the newly formed cost sharing agreement applies or, for a participant that became a controlled participant after the formation of the cost sharing agreement, no later than 90 days after the participant became a controlled participant. A CSA Statement 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. The CSA Statement filed with the IRS Ogden Campus must be addressed as follows: “Attn: CSA Statements, Mail Stop 4912, Internal Revenue Service, 1973 North Rulon White Blvd., Ogden, Utah 84404-0040.

Annual return requirement

Each controlled participant must attach to its U.S. income tax return, for each year for the duration of the cost sharing agreement, a copy of the original CSA Statement that the controlled participant filed under the 90-day rule. In addition, the controlled participant must update the information reflected on the original CSA Statement annually by attaching a schedule that documents changes in the information over time.

If a controlled participant is not required to file a U.S. income tax return, 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 or any Form 8865 filed for that participant.

Below, please see Illustration 4 and Illustration 5 which demonstrate the annual CSA Statement filing requirements.

Illustration 4.

A and B, members of the same controlled group who file U.S. tax returns, agree to share the costs of developing a new chemical formula in a cost sharing arrangement under the regs. On Mar. 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 Mar. 1, Year 1. The first IDCs to which the CSA applies occurred on Mar. 15, Year 1. To comply with the filing requirement for CSA statements, A and B individually must file separate CSA Statements no later than 90 days after Mar. 15, Year 1 (i.e., June 13, Year 1). Also, to comply with the above annual requirement, A and B must attach copies of their respective CSA Statements to their respective Year 1 U.S. income tax returns.

Illustration 5.

The facts are the same in Illustration 2 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, A and B must each attach copies of their respective CSA Statements (as filed for Year 1) to their respective Year 2 income tax returns, along with a schedule update appropriately to reflect the changes in information described on the above list resulting from the addition of C to the CSA. To comply with both the 90-day rule and the annual filing requirement, C files a CSA Statement no later than 90 days after May 9, Year (Aug. 7, Year 2), and must attach a copy of the CSA Statement to its Year 2 income tax return.


In the current environment, multinational transfers of intellectual property is a 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.