IRS releases PLR, granting consent to taxpayer’s request regarding cost-sharing arrangement and intangible development costs
Granting consent to a taxpayer and other controlled participants to use the methods described in Reg. section 1.482-7(d)(3)(iii)(B) and Notice 2005-99
Cost-sharing arrangement and intangible development costs
The IRS today publicly released a private letter ruling* that grants consent to a taxpayer and other controlled participants to use the methods described in Reg. section 1.482-7(d)(3)(iii)(B) and Notice 2005-99 for measuring, timing, and identifying employee stock options, restricted shares, and restricted share units for purposes of determining the amount that the taxpayer must include in its cost-sharing arrangement (CSA) as intangible development costs (IDCs).
Read PLR 202227006 [PDF 94 KB] (release date of July 8, 2022, and dated April 12, 2022)
* A private letter ruling (PLR) is a taxpayer-specific ruling furnished by the IRS Office of Chief Counsel in response to requests made by taxpayers and can only be relied upon by the taxpayer to whom issued. Pursuant to section 6110(k)(3), written determinations such as private letter rulings are not intended to be relied upon by third parties and may not be cited as precedent. These written determinations may, however, offer an indication of the IRS’s position on the issues addressed.
The purpose of this report is to provide text of the PLR. The facts presented in the PLR are as follows:
- Company Z, a public domestic corporation, was incorporated in Year 1.
- Company W, a domestic entity, was incorporated in Year 2 and acquired by Company Z in Month 1.
- Company W is currently a limited liability company and a disregarded domestic entity wholly owned by Company Z.
- On Date 1, prior to the acquisition of Company W by Company Z, Company W and Company X entered into an agreement that they intended would qualify as a CSA within the meaning of Reg. section 1.482-7(b). The CSA was subsequently amended, and Company X was replaced as a controlled participant.
- As of Date 2, Company Y was the only foreign controlled participant to the CSA.
- At the time of entering into the CSA (i.e., on Date 1), Company W was a private company and was required to use the method provided in Reg. section 1.482-7(d)(3)(iii)(A) (the “default method”) for measurement and timing for including stock-based compensation (SBC) in IDCs, and the method provided in Reg. section 1.482-7(d)(3)(ii) (“grant date identification”) for identifying SBC as related to intangible development activity (IDA).
- For certain years prior to Year 3, the controlled participants to the CSA did not include SBC as IDCs under the CSA. Beginning in Year 3, the controlled participants under the CSA have included SBC as IDCs using the default method and grant-date identification.
- Company W stated that it will correct any and all noncompliance with Reg. section 1.482-7(d)(1)(iii) (i.e., failing to include SBC as IDCs) for all years since the inception of the CSA to the date when inclusion began in Year 3.
Company W filed this request for IRS consent to prospectively change the method for measuring and timing of SBC that must be included as IDCs from the default method to the method described in Reg. section 1.482-7(d)(3)(iii)(B), which was extended to certain restricted shares and restricted share units by Notice 2005-99 (the “elective method”). Company W also requested consent to prospectively change the method for identifying SBC with the IDA from grant-date identification as provided in Reg. section 1.482-7(d)(3)(ii) to period-by-period identification as provided in Notice 2005-99.
Company W made the following representations:
- With regard to the CSA, Company W will remain in compliance with all record keeping requirements of Code and the regulations, including Reg. section 1.482-7(k)(2)(ii). Upon request, Company W will timely provide to the IRS records kept pursuant to such requirements.
- The SBC that is the subject of this ruling request is Company Z’s publicly traded stock within the meaning of Reg. section 1.482-7(d)(3)(iii)(B)(2).
- Under the terms of the SBC plan, the service and performance vesting restrictions of the SBC to which this election will apply will not have a substantial effect on the fair value of the SBC under GAAP and will not result in unreasonably long vesting periods within the meaning of Financial Accounting Standards Codification Topic No. 718, “Compensation-Stock Based Compensation,” Financial Accounting Standards Board (rev. 2016) (ASC 718).
- SBC granted prior to the term of the CSA is excluded from IDCs.
- For all SBC granted before the first day of the first tax year following receipt of IRS consent (“Legacy SBC”), all controlled participants to the CSA will continue to use the method of measurement and timing provided in Reg. section 1.482-7(d)(3)(iii)(A), as well as their existing method for identification, until all Legacy SBC has been exercised or lapsed.
- If the IRS grants consent for Company W to adopt the period-by-period identification method described in Notice 2005-99, and Company W then makes an election to adopt such method, then:
- Any SBC, the fair value of which is not reflected as a charge against income in audited financial statements, will be identified for purposes of Reg. section 1.482-7 as if the fair value of such compensation were reflected as a charge against income in audited financial statements.
- SBC granted, but not vested during the term of the CSA, must be treated as vesting immediately before expiration or termination of the CSA for purposes of Reg. section 1.482-7.
- All controlled participants to the CSA will apply the identification method consistently as required under the principles of Reg. section 1.482-7(d)(3)(iii)(C).
- For all SBC issued with respect to publicly traded stock within the meaning of Reg. section 1.482-7(d)(3)(iii)(B)(2) granted on or after the first day of the first tax year following receipt of IRS consent that satisfy the following conditions, all controlled participants to the CSA will use the method of measurement and timing provided in Reg. section 1.482-7(d)(3)(iii)(B)(1) and as expanded by Notice 2005-99:
- Are stock options; non-vested equity shares or non-vested equity share units within the meaning of Statement of Financial Accounting Standards No. 123, “Share-Based Payment,” Financial Accounting Standards Board (rev. 2004) (FAS 123R); or Share-Based Payments within the meaning of FAS 123R’s successor, ASC 718; and
- Are not subject to market conditions or significant post-vesting restrictions within the meaning of ASC 718.
The PLR concludes that based on these facts, the IRS grants Company W and the other controlled participants prospective consent to change to the elective method and period-by-period identification for SBC covered by Reg. section 1.482-7(d)(3)(iii)(B) and Notice 2005-99. The IRS added that this consent is effective for 60 days from the date of this letter ruling. Therefore, if Company W chooses to adopt the elective method and period-by-period identification, it must make the written election within 60 days from the date of this letter ruling.
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