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The authors illustrate how two of the new methods for valuing buy-in payments under the 2008 cost sharing regulations produce different results.
The temporary cost sharing regulations issued in December 2008 introduce two new pricing methods for determining the value of the platform contribution transaction (PCT) payment, or buy-in, for contributions to a qualified cost sharing agreement:
* the acquisition price method, which determines the value of the PCT payment as the amount paid to acquire a target company less its tangible assets and other assets that are not contributed to the arrangement; and
* the income method, which determines the value of a PCT payment as the present value of residual profits associated with the transferred rights.
The regulations indicate that the acquisition price method generally is the preferred approach for acquisitions in which the target company does not have substantial ongoing business operations, and whose income and assets are limited to essentially those contributed to the cost sharing arrangement. Conceptually, if the income method is applied in a way that captures residual/excess profits into perpetuity, the acquisition price method and the income method should give fairly similar economic answers, since the price paid in an acquisition is generally linked fairly closely to the present value of cash flows that are expected by the buyer. However, in actual practice, the application of these two methods may give substantially different answers because the income method respects the functions and ownership rights of different legal entities while the acquisition price method effectively ignores such functions and rights.
Example
ParentCo is a U.S. taxpayer that has a cost sharing arrangement covering the development of technology with CFC 1 (a controlled foreign corporation) . Under the arrangement, ParentCo has the rights to the U.S. market and CFC 1 has rights to the market for the rest of the world (ROW). The cost sharing arrangement is longstanding, and all prior buy-in issues have been resolved. In addition, ParentCo owns Trademark X, which it licenses to CFCl at a royalty rate of 5 percent of sales.
TargetCo owns Patent Y and has two employees. TargetCo currently licenses Patent Y to unrelated third parties for a royalty rate of 6 percent of sales.
ParentCo believes that the use of...