§ 1.482-4(f)(6)(iii) Example.

Posted on | By Internal Revenue Service
Category: US IRC Section 482 on Transfer Pricing, § 1.482-4 Methods to determine taxable income in connection with a transfer of intangible property | Tag: , , , , , , ,
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Calculation of the equivalent royalty amount. (i) FSub is the foreign subsidiary of USP, a U.S. company. USP licenses FSub the right to produce and sell the whopperchopper, a patented new kitchen appliance, for the foreign market. The license is for a period of five years, and payment takes the form of a single lump-sum charge of $500,000 that is paid at the beginning of the period.

(ii) The equivalent royalty amount for this license is determined by deriving an equivalent royalty rate equal to the lump-sum payment divided by the present discounted value of FSub’s projected sales of whopperchoppers over the life of the license. Based on the riskiness of the whopperchopper business, an appropriate discount rate is determined to be 10 percent. Projected sales of whopperchoppers for each year of the license are as follows:

Year Projected sales
1 $2,500,000
2 2,600,000
3 2,700,000
4 2,700,000
5 2,750,000

(iii) Based on this information, the present discounted value of the projected whopperchopper sales is approximately $10 million, yielding an equivalent royalty rate of approximately 5%. Thus, the equivalent royalty amounts for each year are as follows:

Year Projected sales Equivalent royalty amount
1 $2,500,000 $125,000
2 2,600,000 130,000
3 2,700,000 135,000
4 2,700,000 135,000
5 2,750,000 137,500

(iv) If in any of the five taxable years the equivalent royalty amount is determined not to be an arm’s length amount, a periodic adjustment may be made pursuant to § 1.482-4(f)(2)(i). The adjustment in such case would be equal to the difference between the equivalent royalty amount and the arm’s length royalty in that taxable year.

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