The Internal Revenue Service has issued new regulations on cost-sharing arrangements for multinational companies that provide some extra flexibility in transfer pricing schemes.

The Treasury and the IRS filed the proposed and temporary cost-sharing regulations with the Federal Register on December 31. The regulations supersede proposed cost-sharing arrangement regulations issued by the IRS and the Treasury in August 2005. The new regulations go into effect as of the date of publication in the Federal Register, Jan. 5, 2009, and are generally applicable for cost-sharing arrangements commencing on or after that date, with transition rules for certain pre-existing arrangements. The cost-sharing arrangements apply to multinational companies and their foreign partners that share in the costs of developing intangible property such as patents and software code.

Congress first sanctioned the cost-sharing arrangements in 1986, and the IRS released regulations on them in 1995. In 2005 the IRS proposed tougher regulations to combat a perception that companies were abusing their valuation of intangible property, according to David Canale, Ernst & Young's director of transfer pricing controversy services. However many companies considered the 2005 regulations too restrictive and sent in a series of comments to the IRS asking for more flexibility in how to value the intangible property and in what can be included in the "buy-ins."

In the latest proposed regulations, the IRS has provided more flexibility, but still has not backed away from many of the 2005 restrictions. "The IRS in the 2005 proposed regulations was evaluating the intangible property very much in favor of the U.S., so there was a lot of criticism around that," said Canale. "They have a framework called the investor model. They provide more flexibility in how it is implemented versus how they described it in the 2005 regulations, but it's still a fairly restrictive interpretation of how you value this intellectual property. The IRS view is that this establishes an arm's-length price. They provide more guidance outlining methods that they consider provide more of an arm's-length approach."

The IRS has expanded the definition of what needs to be valued, including research teams, he noted. The new temporary proposed regulations are now effective and companies have to follow them, but they do have a three-year sunset period, and the IRS has three years to put them in final form. There will be another public hearing in which interested parties can provide further comments on the proposed regulations.

"They're not draconian now, but they are still very restrictive," said Canale. "A lot of the comments said that the [2005 proposed regulations] would have a chilling effect on taxpayers entering into cost-sharing arrangements. It has yet to be seen whether any of these modifications will un-chill them."

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