IRS approves a prospective switch in cost-sharing treatment of stock-based compensation

Plain-English summary

A publicly traded domestic corporation shares intangible-development costs with foreign participants under a cost sharing arrangement governed by IRC § 482. It asked to change the measurement, timing, and identification of stock-based compensation included in those costs. The company wanted to replace the default tax-deduction method and grant-date identification with the elective financial-statement method under Treas. Reg. § 1.482-7(d)(3)(iii)(B) and period-by-period identification under Notice 2005-99. The IRS granted prospective consent based on the company's representations, including that it would correct earlier years in which stock-based compensation had not been included. The company had 60 days from the letter date to make the written elections in its cost sharing arrangement, and the ruling did not approve any other part of that arrangement.

Ruling snapshot

• Question: May the company prospectively change to the elective method and period-by-period identification for stock-based compensation included in its cost sharing arrangement?
• Outcome: Approved (consent effective for 60 days)
• Key authorities: IRC § 482; Treas. Reg. § 1.482-7(d)(3)(ii), (iii)(A), (B), and (C); Notice 2005-99

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202110011                                              Third Party Communication: None
 Release Date: 3/12/2021                                        Date of Communication: Not Applicable
 Index Number: 482.11-13
                                                                Person To Contact:
 --------------------------------                               ---------------------------, ID No. ---------------
 ------------------------------------------------------------   -----------------
 ---------------------------------------                        Telephone Number:
 ---------------------------------------                        --------------------
 ----------------------------------------                       Refer Reply To:
                                                                CC:INTL:B06
                                                                PLR-115345-20
                                                                Date:
                                                                December 15, 2020

------------

Legend

Taxpayer =                 --------------------------------
Country A =                ----------------
Foreign Entity A =         ------------------------------
Foreign Entity B =         --------------
Foreign Entity C =         ----------------------
Year 1 =                   -------
Year 2 =                   -------
Year 3 =                   -------
Year 4 =                   -------
Date 1 =                   ------------------
Month 1 =                  -------------


Dear ------------------:

This responds to correspondence dated July 7, 2020 and December 9, 2020, submitted
by your representatives. The correspondence requests that the Internal Revenue
Service (“Service”) grant Taxpayer consent to use the methods described in Treas.
Reg. § 1.482-7(d)(3)(iii)(B) and Notice 2005-99, 2005-2 C.B. 1214, for measuring,
timing, and identifying employee stock options, restricted shares, restricted share units,
and stock appreciation rights as related to intangible development activity (“IDA”) for
purposes of determining the amount Taxpayer must include in its cost sharing
arrangement (“CSA”) as intangible development costs (“IDCs”) for Year 4 and
subsequent tax years.
PLR-115345-20                                  2

The consent granted by this letter is based on facts and representations submitted by
Taxpayer and its representatives and accompanied by a penalties of perjury statement
executed by an appropriate party. This office has not verified any of the material
submitted in support of the request for rulings. Verification of the factual information,
representations, and other data may be required as part of the audit process.


                                           FACTS
Taxpayer, a domestic corporation, was incorporated in Year 1. Effective Date 1,
Taxpayer and Foreign Entity A entered into an agreement that they intended would
qualify as a CSA within the meaning of Treas. Reg. § 1.482-7(b). Taxpayer has
subsequently restructured its operations a number of times since Date 1. At the time of
Taxpayer’s submission of this request, Foreign Entity B and Foreign Entity C had
replaced Foreign Entity A as controlled participants in the CSA.
Since Year 2, Taxpayer has followed a stock-based compensation (“SBC”) plan,
pursuant to which it issues equity awards with respect to shares of Taxpayer’s common
stock to its employees and employees of its affiliates. In Month 1, Taxpayer closed its
initial public offering and became publicly traded on an established U.S. securities
market.
For certain years prior to Year 3, Taxpayer and the foreign controlled participant(s)
under the CSA did not include SBC as IDCs under the CSA. Beginning in Year 3,
however, Taxpayer and the foreign controlled participant(s) under the CSA have
included SBC as IDCs, using the method for measurement and timing of SBC provided
in Treas. Reg. § 1.482-7(d)(3)(iii)(A) (the “default method”) and the method for
identifying SBC as related to IDA provided in Treas. Reg. § 1.482-7(d)(3)(ii) (“grant-date
identification”). Taxpayer has stated that it will correct any and all noncompliance with
Treas. Reg. § 1.482-7(d)(1)(iii) (i.e., failing to include SBC as IDCs) for all years prior to
Year 3.
Taxpayer filed this request for the Commissioner’s consent to prospectively change its
method for measurement and timing for purposes of taking into account SBC that
Taxpayer must include as IDCs from the default method to the method described in
Treas. Reg. § 1.482-7(d)(3)(iii)(B), which was extended to certain restricted shares and
restricted share units by Notice 2005-99 (“elective method”). Taxpayer also requested
consent to prospectively change its method for identifying SBC with the IDA from grant
date identification as provided in Treas. Reg. § 1.482-7(d)(3)(ii) to period-by-period
identification as provided in Notice 2005-99.
Taxpayer has made the following representations, as stated in its submissions:
   1) With regard to its CSA, Taxpayer will remain in compliance with all record-
      keeping requirements of the Internal Revenue Code of 1986, as amended, and
PLR-115345-20                                3

     the regulations thereunder, including Treas. Reg. § 1.482-7(k)(2)(ii). Upon
     request, Taxpayer will timely provide to the Commissioner records kept pursuant
     to such requirements.

  2) The SBC for which Taxpayer requests to use the method of measurement and
     timing and period-by-period identification provided in Treas. Reg. § 1.482-
     7(d)(3)(iii)(B)(1) and Notice 2005-99 is publicly traded stock within the meaning of
     Treas. Reg. § 1.482-7(d)(3)(iii)(B)(2).

  3) 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 U.S. generally accepted accounting
     principles (“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”).

  4) For all SBC granted before the first day of the first taxable year following receipt
     of Service’s consent (“Legacy SBC”), Taxpayer and all controlled participants to
     the CSA will use the method of measurement and timing provided in Treas. Reg.
     § 1.482-7(d)(3)(iii)(A) and grant date identification provided in Treas. Reg. §
     1.482-7(d)(3)(ii) until all Legacy SBC has been exercised or lapsed.

  5) For all SBC issued with respect to publicly traded stock within the meaning of
     Treas. Reg. § 1.482-7(d)(3)(iii)(B)(2) granted on or after the first day of the first
     taxable year following receipt of Service’s consent, Taxpayer and all controlled
     participants to the CSA will use the method of measurement and timing provided
     in Treas. Reg. § 1.482-7(d)(3)(iii)(B)(1) (and as expanded by Part A of Notice
     2005-99).

  6) For all SBC issued with respect to publicly traded stock within the meaning of
     Treas. Reg. § 1.482-7(d)(3)(iii)(B)(2) granted on or after the first day of the first
     taxable year following receipt of Service’s consent that satisfy the following:

         a. Are nonvested equity shares or nonvested equity share units within the
            meaning of ASC 718; and

         b. Are not subject to market conditions or significant post-vesting restrictions
            within the meaning of ASC 718,

     Taxpayer and all controlled participants to the CSA will use the method of
     measurement and timing provided in Treas. Reg. § 1.482-7(d)(3)(iii)(B)(1) (and
     as expanded by Notice 2005-99).
PLR-115345-20                                4


   7) If the Commissioner grants consent for Taxpayer to adopt the period-by-period
      identification method described in Notice 2005-99, and Taxpayer then makes an
      election to adopt such method, then the Taxpayer additionally represents the
      following:

          1. Taxpayer will apply the identification method consistently as required
             under the principles of Treas. Reg. § 1.482-7(d)(3)(iii)(C).

          2. 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
             Treas. Reg. § 1.482-7 as if the fair value of such compensation were
             reflected as a charge against income in audited financial statements.

          3. As under the grant-date identification rule, under this elective period-by-
             period identification rule, SBC granted prior to the term of its CSAs will be
             excluded from the participants’ IDCs.


          4. 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 Treas. Reg. § 1.482-7.

   8) SBC granted prior to the term of its CSA is excluded from its IDCs.



                                          LAW
Measurement and Timing of SBC Related to Intangible Development
Treas. Reg. § 1.482-7(d)(3)(iii)(A) provides the default method for measurement and
timing of SBC IDCs as follows:
      Except as otherwise provided in this paragraph (d)(3)(iii), the cost
      attributable to stock-based compensation is equal to the amount allowable
      to the controlled participant as a deduction for federal income tax purposes
      with respect to that stock-based compensation (for example, under section
      83(h)) and is taken into account as an IDC under this section for the taxable
      year for which the deduction is allowable.
Treas. Reg. § 1.482-7(d)(3)(iii)(B)(1) provides the alternative elective method for
measurement and timing of SBC IDCs with respect to options on publicly traded stock
as follows:
PLR-115345-20                                         5

        With respect to stock-based compensation in the form of options on publicly
        traded stock, the controlled participants in a CSA may elect to take into
        account all IDCs attributable to those stock options in the same amount,
        and as of the same time, as the fair value of the stock options reflected as
        a charge against income in audited financial statements or disclosed in
        footnotes to such financial statements, provided that such statements are
        prepared in accordance with United States generally accepted accounting
        principles by or on behalf of the company issuing the publicly traded stock.
Treas. Reg. § 1.482-7(d)(3)(iii)(B)(4) provides for the time and manner of making the
election, in relevant part, as follows:
        The election described in this paragraph (d)(3)(iii)(B) is made by an explicit
        reference to the election in the written contract required by paragraph (k)(1)
        of this section or in a written amendment to the CSA entered into with the
        consent of the Commissioner pursuant to paragraph (d)(3)(iii)(C) of this
        section.
Treas. Reg. § 1.482-7(d)(3)(iii)(C) provides, in relevant part:
        [I]f controlled participants already have granted stock options that have
        been or will be taken into account under the general rule of paragraph
        (d)(3)(iii)(A) of this section, then except in cases specified in the last
        sentence of paragraph (d)(3)(iii)(B)(4) of this section, the controlled
        participants may make the election described in paragraph (d)(3)(iii)(B) of
        this section only with the consent of the Commissioner, and the consent will
        apply only to stock options granted in taxable years subsequent to the
        taxable year in which consent is obtained.
Notice 2005-991 extended the elective method to
        [N]onvested equity shares or nonvested equity share units within the
        meaning of Statement of Financial Accounting Standards No. 123, “Share-
        Based Payment,” Financial Accounting Standards Board (rev. 2004) (SFAS
        123R), provided that those shares or share units: (i) constitute or are issued
        with respect to publicly traded stock within the meaning of § 1.482-
        7(d)(2)(iii)(B)(2); and (ii) are not subject to market conditions or significant
        post-vesting restrictions within the meaning of SFAS 123R.2
We refer to such shares and share units as “restricted shares and share units.” An
election to apply the elective method to restricted shares or share units is generally
made in the time and manner set forth in Treas. Reg. § 1.482-7(d)(3)(iii)(B)(4).

1 Notice 2005-99 refers to the SBC rules contained in Treas. Reg. § 1.482-7(d)(2) (2003), the materially

similar predecessor of the rules in Treas. Reg. § 1.482-7(d)(3) that are applicable in the present case.
2 FAS 123R was amended after the publication of Notice 2005-99 by ASC 718.
PLR-115345-20                                6

However, the consent of the Commissioner is not required to elect the elective method
for restricted shares and share units if the election is made by a written amendment to
the CSA not later than the latest due date (with regard to extensions) of a Federal
income tax return of any controlled participant for the first taxable year beginning after
December 8, 2005.
Identifying SBC Related to Intangible Development
Treas. Reg. § 1.482-7(d)(3)(ii) provides the rule for identification of SBC with the IDA
(“grant date identification”), in relevant part, as follows:
       The determination of whether stock-based compensation is directly
       identified with, or reasonably allocable to, the IDA is made as of the date
       that the stock-based compensation is granted. Accordingly, all stock-based
       compensation that is granted during the term of the CSA and, at date of
       grant, is directly identified with, or reasonably allocable to, the IDA is
       included as an IDC under paragraph (d)(1) of this section.
Notice 2005-99 provides that a taxpayer may choose to determine whether SBC
measured by the elective method is related to the IDA by analyzing the activities of the
employee recipients of the SBC by reference to financial reporting periods, identifying
the related compensation on a period-by-period basis (“period-by-period identification”),
rather than using grant date identification. Notice 2005-99 further provides:
       Taxpayers’ implementation of this identification method based on financial
       reporting periods must meet four requirements. First, the identification
       methodology must be applied consistently (under the principles of § 1.482-
       7(d)(2)(iii)(C)). Second, any stock-based compensation the fair value of
       which is not reflected as a charge against income in audited financial
       statements (for example, as in the case of certain stock options the fair
       value of which was disclosed in footnotes prior to the effective date of SFAS
       123R) must be identified for purposes of § 1.482-7 as if the fair value of
       such compensation were reflected as a charge against income in audited
       financial statements. Third, as under the grant-date identification rule,
       controlled participants using this identification methodology must exclude
       stock-based compensation granted prior to the term of the QCSA. Fourth
       and finally, stock-based compensation granted but not vested during the
       term of the QCSA must be treated as vesting immediately before expiration
       or termination of the QCSA for purposes of § 1.482-7. Under this final
       requirement, if costs attributable to stock-based compensation granted
       during the term of the QCSA are allocable under U.S. GAAP to reporting
       periods subsequent to the term of the QCSA, the determination of whether
       these costs must be taken into account as intangible development costs
       must be based on the employee’s activities as of the financial reporting
PLR-115345-20                                7

       period during which the date of the expiration or termination of the QCSA
       occurs.
Generally, pursuant to Treas. Reg. § 1.482-7(d)(3)(iii)(C) and (B)(4), a change of
identification method may be made only by a written amendment to the CSA entered
into with the consent of the Commissioner. However, Notice 2005-99 further provides
that the consent of the Commissioner is not required to change from grant date
identification to period-by-period identification if such written amendment is “made no
later than the latest due date (with regard to extensions) of a Federal income tax return
of any controlled participant for the first taxable year beginning after December 8, 2005.”
In applying period-by-period identification, Notice 2005-99 provides:
       [A]ctivities within the intangible development area are not necessarily
       coextensive with those activities classified as “research and development”
       for financial reporting purposes. Consequently, nothing in this notice should
       be interpreted as eliminating the requirement to take into account all stock-
       based compensation costs related to the intangible development area.
       Controlled participants must identify the stock-based compensation that is
       related to the intangible development area, notwithstanding that the
       activities conducted to develop intangibles covered by the QCSA may differ
       from the activities classified as “research and development” for U.S. GAAP
       purposes.
                                       ANALYSIS
Based on the facts and representations Taxpayer has made, the Service grants
Taxpayer prospective consent to change to the elective method and period-by-period
identification for SBC covered by Treas. Reg. § 1.482-7(d)(3)(iii)(B) and Notice 2005-99.
This consent is effective for 60 days from the date of this letter. Therefore, if Taxpayer
chooses to adopt the elective method and period-by-period identification, it must make
the written elections in its CSA within 60 days from the date of this letter.
The sole purpose of this private letter ruling is to grant consent for Taxpayer to use the
elective method and period-by-period identification for purposes of including SBC as an
IDC that Taxpayer must share for purposes of its CSA. Except as expressly provided
herein, no opinion is expressed or implied concerning the tax consequences of any
aspect of any transaction or item discussed or referenced in this letter, including the
CSA, or concerning the validity of any provisions within the CSA.
This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.
PLR-115345-20                                  8

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.


                                       Sincerely,



                                       Robert Z. Kelley
                                       Senior Counsel, Branch 6
                                       (International)




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