The qualified cost sharing regulations under Section 482 are an arrow in the IRS' quiver in its attempts to limit the ability of U.S. companies to develop an intangible, deduct the costs in the U.S., but then have a significant portion of the income earned in a non-U.S. entity that does not incur immediate U.S. tax. The regulations require that when a U.S. company and a foreign affiliate jointly develop an intangible, they must share costs in the same proportion that they expect to receive benefits from the intangible.
In sharing costs, the IRS regulations provide that compensatory stock options and other stock-based compensation should be included as a cost that must be borne proportionately between the companies engaged in a qualified cost sharing arrangement. The potential problem with this is that the Tax Court, in Xilinx v. Commissioner, 125 T.C. 37 (2005), albeit under a prior version of the Regulations, held that requiring such stock-based compensation to be a shared cost was improper, since arms-length arrangements between unrelated parties for the joint development of an intangible might not share such a cost.
The IRS has appealed the case to the 9th Circuit Court of Appeals. In a Coordinated Issue Paper, entitled "Cost Sharing Stock Based Compensation," LMSB-04-0208-005, UIL 482.11-13, the IRS has indicated it will continue to apply the Regulations as written. Further, it announced that even if it loses its appeal in Xilinx, it will continue to apply the Regulations except in the 9th Circuit. Further, since the 2003 cost sharing Regulations were issued after the tax years at issue in Xilinx, it appears that the IRS may still apply them in the 9th Circuit for tax years after the issuance of the 2003 Regulations regardless of the final outcome of Xilinx.