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In 2009, corporate tax matters came to the forefront as the Obama administration made tax issues a top priority. While the Administration's tax proposals are still pending, a number of other tax regulations were passed last year. In this issue of Tax Insight, we will give an overview of major tax developments in 2009.
Introduced in 1995, cost-sharing agreements, or CSAs, have been controversial from the start. A CSA is a contractual agreement between companies in the same multinational group which allows the companies to share the costs and risks of developing, producing, or obtaining assets. Typically, companies with R & D or technology-related assets, such as pharmaceutical or software companies, have entered into this type of agreement.
In the past few years the IRS has expressed concern over what it perceives as abusive practices by taxpayers with regard to moving intellectual property to low tax jurisdictions. The IRS is particularly concerned with the methods used to value existing intangibles for purposes of determining the buy-in payments. The IRS believes that taxpayers have been undervaluing existing intangibles, thereby understating the buy-in payments due to the U.S. taxpayer.
To address the issue, in 2005, the U.S. Treasury released proposed regulations which included substantial revisions to the current Internal Revenue Code (IRC) Section 482 regulations governing CSAs. In 2009, the IRS issued revised rules in temporary and proposed form governing cost sharing agreements by businesses under common control.
One other significant development in the cost sharing area was the decision by the Tax Court in the Veritas case, which came out in December of 2009. This decision represented a significant victory for the taxpayer and concluded that the Comparable Uncontrolled Transaction (CUT) method, which the taxpayer had relied upon, was the best method to use in determining the buy-in payment under the cost sharing arrangement.
In a Chief Counsel Advice (CCA) issued in 2009, the IRS states that intangibles, such as trademarks and trade names, qualify as like-kind property under Internal Revenue Code (IRC) Sec. 1031 and can be valued separately and apart from goodwill.
The CCA was a reversal from the IRS prior long-standing position that intangibles such as trade-marks and customer-based intangibles could not qualify as like-kind property under Sec. 1031. While patents and copyrights have always been eligible for like-kind exchange treatment under Sec. 1031, the IRS now states in the CCA that trademarks, trade names, and mastheads are also eligible. It is important to note that not all of these intangibles are considered like-kind property. The property must meet the nature and character requirements detailed in Sec. 1031.
The CCA could result in tax savings opportunities for both buyers and sellers of businesses. Buyers and sellers should consider whether an allocation of residual purchase price to intangible assets other than goodwill could provide an opportunity for them to defer taxes in a like-kind exchange.
The IRS has issued final regulations regarding when and to what extent creditor interests in a target corporation will be treated as proprietary interests in applying the reorganization "continuity of interest" rules found in Sec. 1.368-1(e), which require that a substantial part of the value of proprietary interests be preserved in a reorganization in order to qualify for tax-free treatment. In a bankruptcy situation, often the creditor will take ownership interest in the company that owes them money. Previous rules concerning the "continuity of interest" requirement for reorganizations involving insolvent corporations did not clearly define the status of creditors who receive stock in a corporation acquiring a bankrupt corporation.
Under the final regs, stock received by creditors may qualify for continuity of interest purposes in a bankruptcy situation or in an instance where the amount of the target corporation's liabilities exceeds the fair market value of its assets prior to the potential reorganization. Generally, if creditors receive stock in the target corporation in exchange for their claim, then every claim from that class of creditors and every claim of all equal and junior classes of creditors would be a proprietary interest in the target immediately before the reorganization.
The provisions detail how to value junior and senior claims to determine if they meet the continuity of interest requirement. Valuation of a proprietary interest represented by a senior claim is determined by multiplying the fair market value of the creditor's claim by a fraction, the numerator being the fair market value of the proprietary interests in the issuing corporation that are received in the aggregate in exchange for the senior claims, and the denominator being the sum of the amount of money and the fair market value of all other consideration received collectively for such claims. Conversely, the value of a proprietary interest represented by a junior claim is the fair market value of the junior claim. If each senior claim is satisfied with the same ratio of stock to nonstock consideration and no junior claim is met with nonstock consideration, then there would be 100% continuity of interest.
The IRS issued final regulations, effective July 31, 2009, regarding the treatment of controlled services transactions under Sec. 482 and the allocation of income from intangible property, including contributions by a controlled party to the value of intangible property owned by another controlled party. The final regulations are generally consistent with the temporary regulations but do clarify and/or make certain changes. In light of the final regulations, it is important to review transfer pricing policies and, in particular, transfer pricing involving the provision of services related to intangible property. For more information, contact your VRC representative.