Follow-up comments on cost-sharing regulations.

The following comments were filed with the U.S. Department of the Treasury and the Internal Revenue Service on October 20, 2006. They were prepared under the aegis of TEI's International Tax Committee, whose chair is Janice L. Lucchesi of Akzo Nobel Inc.

This letter follows up on our August 4, 2006, meeting at which Tax Executives Institute committed to provide additional comments on the proposed cost sharing regulations, supplementing the Institute's November 28, 2005, submission. As always, TEI appreciates the government's continuing willingness to work with taxpayers to make the cost sharing rules more administrable.

We address specific issues discussed on August 4th, including additional examples on the use of a discount rate, alternatives to the geographic exclusivity requirement, proposed changes to the example of a workforce-in-place, and exceptions to the periodic adjustment requirement. In addition, TEI's position on other issues--transition rule changes, an additional example of the use of make-or-sell rights, a possible range of discount rates, and the development of a possible "angel" list of routine cost sharing agreements--is still being developed.

Use of a Project-Specific Discount Rate

In determining the discount rate to be used to test whether a Periodic Adjustment is required, the proposed regulations demonstrate a preference for using the overall weighted average cost of capital (WACC) of the company if it is publicly traded. Prop. Reg. [section] 1.482-7(i)(6) provides that the applicable discount rate (ADR) will be the WACC of the PCT Payor if it (or its consolidated group parent) is publicly traded in the United States, unless the Commissioner determines (or the participants establish to the Commissioner's satisfaction) that another discount rate better reflects the degree of risk of the CSA activity.

During our meeting, the IRS stated that the use of the ADR for publicly traded companies is intended to prompt the IRS examination team to scrutinize a transaction; it is not intended to require that an adjustment be automatically made. The government invited TEI to submit examples of the use of other discount rates to clarify this intent.

The following examples--which demonstrate the use of risk-adjusted hurdle rates and cash flows--should be added to the regulations:

Example (1) [use of risk-adjusted hurdle rate]. USPharm, a publicly traded U.S. pharmaceutical company, enters into a CSA with FPharm, its wholly owned foreign subsidiary. USPharm and its affiliates, including FPharm, are engaged in the development, manufacture, and sale of many pharmaceutical products, both commercialized and in the R&D pipeline stage. USPharm had been developing a specific drug compound called T. Under the agreement, both controlled participants agree to share future research costs of developing T. USPharm's consistent practice has been to use a risk-adjusted hurdle rate to evaluate its potential R&D projects (including the development of T) and determine which will receive funding. This risk-adjusted hurdle rate is considerably higher than USPharm's WACC, representing the higher risk of developing a single drug compared with the aggregate risk of a diversified portfolio of development, manufacturing, sales, marketing, and other activities. In other words, because the WACC compensates only certain types of risk (most notably, "systematic risk"), it would not compensate FPharm for the risk of failure of T if it were not "probabilistically adjusted" to account for well-documented and quantifiable failure risks in FPharm's industry.

FPharm is a PCT Payor and meets the definition of a publicly traded company under Prop. Reg. [section] 1.482-7(i)(6)(iv)(B). The use of USPharm's WACC results in a Periodic Trigger. The use of USPharm's WACC, however, does not properly reflect the degree of risk of the CSA activity because the WACC does not incorporate the "non-systematic" risks--such as product failure risks --that a third-party investor would clearly account for when investing in a project such as the development of T. If USPharm's risk-adjusted hurdle rate had been used instead of its WACC, no Periodic Trigger would have occurred. The Commissioner therefore determines that under all the relevant facts and circumstances, no Periodic Adjustment occurs because such an adjustment does not reasonably reflect an arm's-length result.

Example (2) [use of risk-adjusted cash flows]. The facts are the same as in Example (1), except that instead of using a risk-adjusted hurdle rate, USPharm uses risk-adjusted cash flows in conjunction with its WACC as a discount rate to determine the net present value (NPV) of each of its R&D projects. Therefore, the [intangible development costs] IDCs incurred by FPharm must be similarly probabilistically adjusted for the risk of failure that is borne by FPharm. The Commissioner determines that the use of risk-adjusted cash flows and a WACC discount rate will generate the same NPV as the application of a risk-adjusted hurdle rate to non-risk-adjusted cash flows. Based on this methodology, no Periodic Trigger would have occurred. The Commissioner therefore determines that a Periodic Adjustment will not be made because the outcome of such an adjustment does not reasonably reflect an arm's-length result under all the relevant facts and circumstances.

Example (3) [use of risk-adjusted cash flows in clinical trials]. The facts are the same as in Example (1), except that instead of using a risk-adjusted hurdle rate, USPharm uses risk-adjusted cash flows in conjunction with its WACC as a discount rate to determine the net present value (NPV) of each of its R&D projects. T is in phase I of clinical trials. USPharm has determined that in its industry, phase I clinical trials generally have a 50-percent probability of success; phase II trials, a 60-percent probability of success; and phase III, an 80-percent probability of success. The cumulative probability of success--taking into account all three phases of the clinical trials--is 50% x 60% x 80% = 24%.

To obtain risk-adjusted cash flows, USPharm applies this 24-percent cumulative probability of success against the cash flows projected to result if T were successful. USPharm then discounts these risk-adjusted cash flows using its WACC.

The Commissioner determines that the use of risk-adjusted cash flows and a WACC discount rate will generate the same NPV as the application of a risk-adjusted hurdle rate to non-risk-adjusted cash flows. Based on this methodology, no Periodic Trigger would have occurred. The Commissioner therefore determines that a Periodic Adjustment will not be made because the outcome of such an adjustment does not reasonably reflect an arm's-length result under all the relevant facts and circumstances.

TEI believes that the inclusion of these examples is consistent with the following statement in the preamble: "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. 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." 2005-40 I.R.B. 625, 627.

Unsuccessful R&D

By allocating the residual profit to the contributor of previously developed intangible property (and therefore limiting the profit to be allocated by the non-contributing CSA participants), the proposed regulations presume that all R&D projects result in a successful product or that, conversely, all R&D failures are necessary failures and the market is willing to pay for such failures. Often, however, businesses abandon projects without producing a viable product and some R&D failures have no value in the market. To illustrate this business reality, TEI recommends that the regulations include the following example:

Example (1). USCo has a non-U.S, subsidiary that operates an R&D center in Asia. Over the past 10 years, R&DSub has spent a total of $6 million to develop product X and $4 million to develop product Y, both of which are based on technology Z. R&DSub has discontinued the R&D project for product Y, but continues to work on product X. None of the learning acquired from the Product Y project is relevant in developing product X. R&DSub determines that the current value of product X is $3 million based on reasonably available alternatives, e.g., the amount a third-party would be willing to pay to acquire or license rights to product X. R&DSub contributes product X to a cost sharing arrangement with USCo, the goal of which is to complete the development of product X. R&DSub's contribution is valued at $3 million. The $6 million spent to date on product X and the $4 million spent on product Y are irrelevant.

Alternatives to Geographic Exclusivity

Prop. Reg. [section] 1.482-7(b)(4)(i) requires the participants in a CSA to divide the world into two or more non-overlapping, geographic territories. Each controlled participant must then be assigned the exclusive right to exploit developed intangibles in at least one of the pre-determined territories.

Requiring CSA participants to partition the world into exclusive territories to exploit their interests in cost-shared intangibles is unnecessary to ensure that each participant pays its fair share of the associated development costs. If the relative benefits derived by the participants from selling those products do not correspond to each participant's share of the costs incurred to develop those products, then the current cost sharing regulations provide an effective and efficient way for the participants to true up the costs with the benefits.

TEI suggests that a new subsection be added to section 1.482-7(b)(4)(i) to permit a division of rights other than on a territorial basis:

Prop. Reg. [section] 1.482-7(b)(4)(iii)--Other permissible methods to measure the expected benefits from a CSA--In lieu of a division of interests under a CSA on a territorial basis, the CSA may provide that in determining the RAB [reasonably anticipated benefit] share of each participant under Reg. [section] 1.482-7(e) and in valuing a PCT under Reg. [section] 1.4827(g), projections of expected benefits that are reliable and capable of being measured against actual results may be used. The entire amount of expected benefit from the CSA must be accounted for in the projections.

Prop. Reg. [section] 1.482-7(b)(4)(iv)--Examples. The following examples illustrate the principles of this paragraph (b)(4)(iii):

Example (1) Field of use. USPharma and its foreign subsidiary FPharma enter into a CSA to develop a new drug compound Y. Y has potential applications in the field of both heart disease and cancer. Under the CSA, USPharma receives exclusive worldwide rights for Y in the field of heart disease; FPharma receives exclusive worldwide rights for Y in the field of cancer. Each field of use is capable of being valued independently of the other. The value of both fields of use together constitute 100 percent of USPharma and FPharma's expected future profits from Y. Although neither USPharma nor FPharma has exclusive rights within a given geographic territory, each has exclusive rights within its applicable field of use. Accordingly, USPharma and FPharma have satisfied the requirements of Reg. [section] 1.482-7(b)(4).

Example (2) Manufacturing projections. USP and its foreign subsidiaries, $1 and $2, each own and operate a manufacturing facility for the production of product X. Together, these three facilities account for the entire worldwide production of X by USP and its affiliates. The output of USP's facility is intended primarily for the U.S. market; S1's facility, primarily for the European market; and S2's facility, primarily for the Asian market. USP, S1, and S2 do not, however, have exclusive geographic rights. In the event of a workforce strike, supply chain emergency, or similar event, each plant has the flexibility to ship products, as needed, outside of its home territory.

Each year as part of its standard process, USP, S1, and S2 forecast the sales and manufacturing costs for the quantity of X projected to be made by each facility over the next three years. This forecast reflects 100 percent of the expected output of X by USP, S1, and S2 for the next three years, based on information available at the time.

USP, S1, and S2 enter into a CSA with goal of reducing the cost of manufacturing X. Although USP, S1, and S2 do not have exclusive rights within a given geographic territory, the forecast provides a quantifiable basis for measuring their expected contributions and benefits under cost sharing. In valuing each party's expected contributions and benefits, no discount is taken for the nonexclusive nature of each party's rights. As a result, the sum of the contributions of USP, S1, and S2 equals 100 percent of the value of all contributions to cost-sharing, and the sum of USP, S1, and S2's benefits equals 100 percent of the value of all benefits under cost-sharing. Accordingly, USP, S1, and S2 have satisfied the requirements of Reg. [section] 1.482-7(b)(4).

Workforce-In-Place

Prop. Reg. [section] 1.482-7(b)(3)(viii), Example 2, provides an example of a team of experienced researchers in place as the proper subject of a PCT:

Example (2). Company P and Company S execute a CSA under which they will share the IDCs for developing Vaccine Z. Company P will commit its research team that has successfully developed a number of other vaccines to the project. The expertise and existing integration of the research team are unique resources or capabilities of Company P which are reasonably anticipated to contribute to the development of Vaccine Z, and therefore the RT Rights in the research team constitute an external contribution for which compensation is due from Company S as part of a PCT. The applicable method and determination of the arm's length compensation due pursuant to the PCT will be based on the RT. The controlled parties designate the RT as a provision of services that would otherwise be governed by [section] 1.482-2(b)(3)(first sentence) if entered into by controlled parties. Accordingly, pursuant to paragraph (a)(2) of this section, the applicable method for determining the arm's length value of the compensation obligation under the PCT between Company P and Company S will be governed by [section] 1.482-2(b)(3)(first sentence) as supplemented by paragraph (g) of this section. The RT in this case is the perpetual and exclusive provision of the benefits by Company P of its research team to the development of Vaccine Z by the uncontrolled party. Because the IDCs include the ongoing compensation of the researchers, the compensation obligation under the PCT is only for the value of the commitment of the research team by Company P to the CSA's development efforts net of such researcher compensation. Though Company P and Company S are not required to actually enter into the transaction described by the RT, the value of the compensation obligation of Company S for the PCT will reflect the full value of provision of services described in the RT, as limited by Company S's RAB share.

By suggesting that the inclusion of experienced research teams is a proper subject of an external contribution, the regulations signal that PCTs are no longer to be confined to items of legally protectable intangible property, at least in terms traditionally used in the context of section 482 and other Code provisions. This example does not mirror business reality because companies frequently change their research strategy and personnel. In addition, transactions between unrelated parties are rarely, if ever, structured in a manner that is comparable to this example. We continue to believe that the example in the proposed regulations unreasonably eliminates perhaps the single greatest benefit of CSAs since their introduction in the 1968 regulations: their use as a vehicle for true shared ownership of intangibles through joint investment.

We recognize that the government takes issue with our analysis, in part, related to section 367 implications, and, in part, the appearance of potential abuse. To address TEI's concern about the example's potential for double-counting the value of the research team, the government invited the Institute to submit an example that demonstrates that--if the value of the future technology to be developed by the research team has already been properly reflected in the valuation--it will not be counted twice.

TEI therefore recommends that the following sentence be added at the end of Prop. Reg. [section] 1.482-7(b)(3)(viii), Example (2):

   To prevent double-counting in determining
   the RAB share of each of P and
   S, however, the value of the commitment
   of the research team will not be
   taken into account to the extent that
   the value of the results expected to be
   generated by the research team in the
   future has already been incorporated
   in the valuation of Vaccine Z and the
   computation of P and S's RAB shares.

In addition, TEI recommends that a new Example 5 be added to the proposed regulations:

   The facts are the same as in Example 2,
   except that in addition to committing
   its research team to the CSA, Company
   P contributes Vaccine Z, which it has
   already developed with the intent of
   developing into new Vaccine Z1. To
   prevent double-counting in determining
   both the RAB share of each of P and
   S and the PCT payment due from S to P,
   however, the value of the commitment
   of the research team is not taken into
   account to the extent that the value of
   the results expected to be generated by
   the research team in the future has already
   been incorporated into the valuation
   of Vaccine Z and the computation
   of P's and S's RAB shares.

Use of a Cumulative Basis to Determine RAB Shares

Prop. Reg. [section] 1.482-7(i) permits the IRS to make adjustments in connection with a CSA to ensure that the results are consistent with the arm's-length standard. Except with regard to allocations relating to PCTs, the regulations describe three types of potential allocations: (i) cost sharing transaction (CST) allocations, (ii) allocations regarding changes in participation under a CSA, and (iii) allocations when CSTs are consistently and materially disproportionate to RAB shares. An example within the subsection considers the use of projected benefits to determine RAB shares and concludes that because the differences between the parent's and foreign subsidiary's adjusted and projected benefit shares are less than 20 percent of their projected benefit shares, the projection of future benefits is reliable. (1)

TEI suggests that an additional example be added to Prop. Reg. [section] 1.4827(i)(2)(ii)(D):

Example (2). The facts are the same as in Example 1, except that in Year 1, USP and FS project that their sales in Years 1 through 3 will be equal, and they divide costs accordingly. In Year 3, the Commissioner examines the controlled participants' method for dividing costs. USP and FS actually accounted for 42 percent and 58 percent of total sales on a cumulative basis for Years 1 through 3. The Commissioner agrees that sales during the first three years provide a reliable basis for estimating benefit shares. Because the differences between USP's and FS's adjusted and projected benefit shares are less than 20 percent of their projected benefit shares, the projection of future benefits for Years 1-3 is reliable.

Royalty Streams

(1) Declining Royalties. Prop. Reg. [section] 1.4827(g)(2)(viii) provides that the valuation of the amount charged in a PCT must be consistent with the assumption that a contributed intangible maintains a constant value throughout the period in which that intangible is used in developing and exploiting the cost-shared intangibles. Example (1) in the proposed regulation describes a company (P) that has developed and currently markets Version 1.0 of a new software application XYZ. The company enters into a cost sharing arrangement with Company S under which they will share the intangible development costs (IDCs) for developing future versions of XYZ. Because Version 1.0 is reasonably anticipated to contribute to the development of future versions of the software, the RT Rights in Version 1.0 constitute P's external contribution for which compensation is due. The reference transaction (RT) in this case is the perpetual and exclusive provision of the benefit of all rights in Version 1.0, other than make-or-sell rights, including the exclusive right to use Version 1.0 for purposes of research and to exploit any products that incorporated the platform technology of Version 1.0, and would cover a term extending as long as the uncontrolled taxpayer were to continue to exploit future versions of XYZ or any other product based on the Version 1.0 platform. Although Company P and Company S are not required to actually enter into the transaction described by the RT, the value of the compensation obligation of Company S for the PCT will reflect the full value of the external contribution defined by the RT, as limited by Company S's RAB share.

TEI recommends that section 1.4827(g)(2) be revised to recognize that the value of research and development may depreciate over time and be replaced by subsequent discoveries. As a consequence, a platform or knowledge may become obsolete. As a rule of administrative convenience, the life of an external contribution should be limited to a finite period. In the case of any patent subject to the PCT, the period should be the life of the patent; for non-patented external contributions, the period should not exceed 10 years. Prop. Reg. [section] 1.482-7(g)(2)(viii)(A) should be revised to read, as follows (proposed changes in italics):

In general.--The valuation of the amount charged in a PCT must be consistent with the assumption that, as of the date of the PCT, each controlled participant's aggregate net investment in developing cost shared intangibles pursuant to the CSA, attributable to both external contributions and cost contributions, is reasonably anticipated to earn a rate of return equal to the appropriate discount rate, determined following the principles set forth in paragraph (g)(2)(vi) of this section, over the entire period of developing and exploiting the cost shared intangibles. If the cost shared intangibles themselves are reasonably anticipated to contribute to developing other intangibles, then the period of the preceding sentence includes the period of developing and exploiting such indirectly benefited intangibles. The valuation of the amount charged in a PCT must be consistent with the assumption that, as of the date of the PCT, each controlled participant's aggregate net investment in developing cost shared intangibles pursuant to the CSA attributable to an external contribution shall cease to have value after the close of the tenth year following the first year of substantial exploitation of cost shared intangibles that were developed with the use of such external contribution, in the case of non-patented external contributions, or the life of the patent, in case of patented external contributions.

TEI also recommends that a second example be added to Prop. Reg. [section] 1.4827(g)(2)(viii)(B), as follows (other examples would need to be conformed):

Example 2. The facts are the same as example 1, except that it is anticipated that GHI or newer generations of technology utilizing the DEF platform will be exploited indefinitely. Notwithstanding this circumstance, the PCT with respect to the external contribution of DEF (non-patented technology) is deemed to cease to have value after the end of Year 10, the tenth year following the first substantial exploitation of GHI.

(2) Limited Duration Royalty Stream as PCT Payment. TEI notes that a buy-in or PCT Payment may take the form of a royalty stream over a limited time period, as long as the expected net present value of the royalty stream accounts for the entire projected value of the contributed technology during the lesser of the anticipated period of exploitation or the first 10 years of substantial exploitation based on the contributed technology. Thus, the Institute suggests adding the following sentence to the end of Example (1):

   The compensation obligation of Company
   S for the PCT may, but is not required
   to, take the form of a royalty
   stream based on sales of any products
   incorporating the platform technology
   of Version 1.0 for a limited duration
   (for example, for the first 5 years following
   the inception of cost sharing),
   provided the net present value of the
   expected royalty stream reflects the
   full value of the external contribution
   for the first 10 years of exploitation
   defined by the RT, as limited by Company
   S's RAB share.

Exceptions to Periodic Adjustments

(1) Review of the CSA by the IRS. Prop. Reg. [section] 1.482-7(i)(1) provides that the Commissioner may make allocations to adjust the results of a controlled transaction in connection with a CSA to ensure consistency with the arm's-length standard. Subparagraph (i)(6)(vi) sets forth exceptions to the periodic adjustment rules. Participants in the Compliance Assurance Process or taxpayers who have received an Advance Pricing Agreement or been the subject of a Competent Authority review have demonstrated their willingness to comply with the cost sharing requirements. Because their CSAs have already been reviewed and affirmed by government authorities, TEI recommends that taxpayers in these situations be exempted from the periodic adjustment rules. The Institute suggests that the following language be added to the regulations:

(G) PCT has been reviewed in CAP, APA, or CA. If the PCT has been reviewed and approved by the Service as part of a Compliance Assurance Process (CAP) audit, or as part of an Advance Pricing Agreement (APA) or Competent Authority (CA) proceeding, then the Commissioner shall not make a subsequent periodic adjustment with respect to such PCT.

(H) PCT has been reviewed through audit. If the PCT has been reviewed and approved as part of an income tax audit by the Service of the company's tax return of either the year that the PCT was made or the year in which the NPV of the PCT was determined for purposes of defining a royalty stream, then the Commissioner shall not make a subsequent periodic adjustment with respect to such PCT.

(2) Determination on a Cumulative Basis. Prop. Reg. [section] 1.482-7(i)(6)(vi)(E) provides that if the actually experienced return ratio (AERR) determined is within the periodic return ratio range (PRRR) for each year of the 10-year period beginning with the first taxable year in which there is substantial exploitation of cost shared intangibles resulting from the CSA, then no periodic adjustment in a subsequent year will be made. TEI recommends that this test be performed on a cumulative basis, rather than annually.

Compliance Issues

Prop. Reg. [section] 1.482-7(k) contains the contractual, documentation, accounting, and reporting requirements that a CSA must meet initially and on an annual basis. Under Prop. Reg. [section] 1.482-7(k)(1)(i), a CSA must be recorded in writing in a contract that is contemporaneous with the formation (and any revision) of the CSA. Under subparagraph (iii), a written agreement is contemporaneous if the controlled participants record the CSA in a signed document no later than 60 days after the first occurrence of any IDC.

Under Prop. Reg. [section] 1.482-7(k)(4), each participant must file a "CSA Statement" with the IRS setting forth the participants and the date of formation of the CSA within 90 days after the first occurrence of an IDC or, if the participant joins the CSA after its formation, within 90 days of joining. In addition, each participant must annually file the CSA Statement with its U.S. tax return (or if no return is required to be filed, as an attachment to Form 5471, 5472, or 8865 filed with respect to a participant). Finally, 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.

These requirements impose significant burdens on taxpayers; we commend your willingness to consider other options.

First, TEI recommends that the time to sign the CSA agreement be changed to be within 90 days (rather than the current 60) of the occurrence of the first IDC.

Second, the requirement in Prop. Reg. [section] 1.482-7(k)(4)(iii)(A) to file an original CSA Statement with IRS no later than 90 days after first joining CSA should be eliminated. Instead, the CSA Statement should be filed with the tax return for the applicable year. In addition, the requirement that an officer of the controlled participant sign the CSA Statement should be amended to permit an officer of a controlled participant that is filing the U.S. income tax return to sign the statement. To reflect these proposed changes, the regulations should be amended to read, as follows:

(A) Time for filing CSA statement--Each controlled participant must file its original CSA Statement with its U.S. income tax return for the year in which it becomes a participant in the CSA. A CSA Statement filed in accordance with this paragraph (k)(4)(iii)(A) must be dated and signed, under penalties of perjury, by an officer of one of the controlled participants that is filing the U.S. income tax return.

Prop. Reg. [section] 1.482-7(k)(1)(iii)(B) also requires that each participant must attach to its U.S. tax return (or Form 5471 or 5472, if no return is filed) a copy of the original CSA statement and any changes to the statement. TEI suggests that this requirement be amended to require that the CSA Statement be filed only in the year in which a participant joins CSA; subsequently, the participants need only file a statement that lists the participants for that year. Thus, this subparagraph should be amended, as follows:

(B) Annual return requirement--(1) In general. For each year subsequent to the filing of the original CSA Statement, each controlled participant must attach to its U.S. income tax return a CSA Statement that incorporates any changes from the original CSA Statement. (2) Special filing rule for original CSA Statement and annual return requirements. 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 with respect to that participant. (2)

Finally, an example should be added to the administrative rules to demonstrate when a CSA will be deemed to be in substantial compliance with the reporting rules. TEI recommends the addition of new section 1.482-7(k)(v) to address this issue:

   A CSA will be deemed to be in substantial
   compliance with the reporting
   rules required by [Prop.] Reg. [section] 1.4827(b)(1)(vii),
   if its participants make a
   good faith effort to comply with such
   rules. Inadvertent failure of a participant
   to comply with the reporting
   rules will not deem the CSA to fail to
   be in substantial compliance.

Example: U.S. Co. forms a CSA with 50 non-U.S, controlled participants in Year 1. In Year 1, U.S. Co. includes the original CSA Statement with its tax return and the Forms 5471 of 49 of the controlled participants. A statement, however, is inadvertently omitted for one of the 50 controlled participants. The CSA is deemed to be in substantial compliance with the reporting rules of Prop. Reg. [section] 1.482-7(b)(1)(vii).

Conclusion

Tax Executives Institute thanks the U.S. Department of Treasury and the Internal Revenue Service for their willingness to consider changes to the proposed cost sharing regulations. We appreciated the opportunity to meet with you and to present our views on the proposed regulations. We will continue to develop comments on the remaining issues.

In the meantime, if you have any questions, please do not hesitate to call Janice L. Lucchesi, chair of TEI's International Tax Committee, at 312.544.7023; [e-mail]; or Mary L. Fahey of the Institute's professional staff at 202.638.5601; [e-mail].

1. Example (1) provides: "U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a CSA to develop new food products, dividing costs on the basis of projected sales two years in the future. In Year 1, USP and FS project that their sales in Year 3 will be equal, and they divide costs accordingly. In Year 3, the Commissioner examines the controlled participants' method for dividing costs. USP and FS actually accounted for 42% and 58% of total sales, respectively. The Commissioner agrees that sales two years in the future provide a reliable basis for estimating benefit shares. Because the differences between USP's and FS's adjusted and projected benefit shares are less than 20% of their projected benefit shares, the projection of future benefits for Year 3 is reliable."

2. Please note that the examples in subparagraph (iv) should also be amended to reflect these changes.