U.S. Proposes New Tax Regulations for Valuation of Intangibles
on August 25, 2005.The proposals would limit cost-sharing arrangements that allow companies to undervalue patents, licenses, trademarks and other intellectual property rights that are transferred to a subsidiary company. According to WebCPA, "The changes could mean a big difference to the bottom lines of companies whose main asset is their intellectual property."
Under such cost sharing arrangements, related parties will agree to share the costs and risks of intangible development in proportion to their reasonable expectations of benefit from the separate exploitation of the developed intangibles. The second sentence of 26 U.S.C. Section 482 enunciates a "commensurate with income" standard for transfer or licensing of the developed intangible property and requires that the income from the agreement be commensurate with the income attributable to the intangible. The proposed regulations are intended to provide further guidance under the "arms-length standard" in 26 CFR §1.482-1(b)(1) regarding “the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.”
U.S. tax authorities have now proposed an "investor model" in which each controlled participant may be viewed as making an aggregate investment, attributable to both cost contributions
(ongoing share of intangible development costs) and external contributions (the preexisting advantages which the parties bring into the arrangement), in order to achieve an anticipated return appropriate to the risks of the arrangement. Valuations are not appropriate if an investor would not undertake to invest in the arrangement because its total anticipated return is less than the total anticipated return that could have been achieved through an alternative investment. The appropriate “price” of undertaking a risky investment is typically determined
at the time the investment is undertaken, based on the ex ante expectations of the investors. According to the proposal:
Given the uncertainty about whether and to what extent intangibles will be successfully developed under a cost sharing arrangement, ex post interpretations of ex ante expectations are inherently unreliable and susceptible to abuse. Accordingly, an important implication of determining the arm’s length result under the investor model, reflected in the methods, is that compensation for external contributions is analyzed and valued ex ante. The ex ante perspective is fundamental to achieving arm’s length results.
Under-priced transfer agreements for intangible assets such as intellectual property have long been a target of tax collectors for allowing companies to stash income in overseas tax havens while still providing their U.S. parent companies with deductions for research and development expenses. For example, Ireland has a corporate tax rate of 12.5 percent, while the U.S. has a 35 percent federal rate plus additional amounts charged by states. According to the American Shareholders Association, this year's one-time discount for such tax liabilities under the Invest
in USA Act has repatriated about $200 billion from multinational corprations at an effective
U.S. tax rate of about 5.25 percent.
"This Treasury development makes it even more clear that patent holders must have a strategy for managing their intellectual property that includes a mechanism for measuring value, says Bill Black, a CPA and valuation consultant in Atlanta. "Like FAS 141/142, which required IP valuation in acquisitions, this means that you need to be able to segregate the prospective cash flows from the various components of your intangible assets, and be
prepared to defend the methodology you use to measure that which cannot be seen, touched, or
Written or electronic comments must be received on or before November 28, 2005. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for November 16, 2005, at 10:00 a.m. must be received by October 26, 2005.
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