US Treasury Clamps Down On Export Of Intellectual Property

by Mike Godfrey, Tax-News.com, New York

30 July 2002

On Friday the Treasury Department announced that it had changed its rules for the tax treatment of the cost of stock options when companies transfer intellectual property to subsidiaries abroad, a type of transaction which is popular with Silicon Valley companies. The proposed new regulations affect the related party transfer pricing rules governing cost-sharing arrangements.

"The proposed regulations address a significant international tax issue - the treatment of compensatory stock options as a cost to be taken into account by related taxpayers participating in a cost-sharing arrangement for the joint development of intangible assets," stated Acting Assistant Secretary (Tax Policy) Pamela Olson. "The rules governing cost sharing arrangements are critically important. The proposed regulations represent a first step in ensuring that the rules regarding the treatment of cost-sharing arrangements reach appropriate results."

Participants in cost sharing arrangements are required to share all costs related to the development of intangibles in the same proportion as they share the reasonably anticipated benefits attributable to the intangible development. The proposed regulations clarify that compensatory stock options, like other compensation, are taken into account in determining the costs of a participant. The proposed regulations also provide rules for measuring the cost associated with stock-based compensation, generally allowing taxpayers a choice of measuring the cost based on the stock price at the date of exercise or the "fair value", as noted in financial statements, at the date of grant.

Although industry commentators were taken by surprise, and blamed the current political opposition to companies which 'expatriate', the Treasury said that the measure had been in the works for a long time.

The increasing migration of patents, trademarks and other intangible property to overseas affiliates, promoted as a tax strategy by some top accounting firms, was the subject of an article in The Wall Street Journal last month. Technology is transferred abroad through so-called cost-sharing arrangements between a US company's domestic and foreign branches. Even though most of the actual research may be done in the US, if a foreign subsidiary shares in the costs, it can develop part ownership of an innovation and thus avoid or reduce US taxes on income flows representing its portion of the intellectual property asset. Until now, research-heavy companies in the Valley have been able to ignore the substantial costs of stock options for their US staff when calculating the proportion of assets that can be treated in this way.

Technology companies say that options are impossible to value accurately, and in any case never would be included in the costs of a joint venture between two independent entities. "We're well aware of the position that taxpayers have taken and the arguments they've made about it, but they just don't hold a lot of water," said Pam Olson, "If you're going to allow a cost-sharing arrangement, the cost-sharing arrangement has to reflect all the costs."

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