IRS consents to a new method for counting stock-based compensation under a cost sharing arrangement

Plain-English summary

A domestic corporation and its foreign subsidiary share the costs of developing intangible property under a cost sharing arrangement governed by IRC § 482. The corporation asked to change how it measures, times, and identifies stock-based compensation that must be included as an intangible development cost. It wanted to replace the default tax-deduction method and grant-date identification with the elective financial-statement method in Treas. Reg. § 1.482-7(d)(3)(iii)(B) and the period-by-period method in Notice 2005-99. The IRS granted prospective consent based on the corporation's representations, including its promise to correct earlier failures to include stock-based compensation. The written elections had to be added to the cost sharing arrangement within 60 days of the letter. The ruling did not approve any other aspect of the arrangement.

Ruling snapshot

• Question: May the corporation prospectively use the elective method and period-by-period identification for stock-based compensation under its cost sharing arrangement?
• Outcome: Approved (consent granted 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: 202110017                                               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-122220-20
                                                                 Date:
                                                                 December 15, 2020



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


Legend

Taxpayer = -------------
Year 1 =    -------
Year 2 =   ---------
Year 3 =    -------
Year 4 =    -------
Year 5 =    -------
Date 1 =    --------------------------
Company Z = ----------------------------


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

This responds to correspondence dated October 2, 2020 and December 11, 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 5 and
subsequent tax years.

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
PLR-122220-20                             2

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 formed in Year 1. Effective Date 1, Taxpayer
and its foreign subsidiary, Company Z, entered into an agreement that they intended
would qualify as a CSA within the meaning of Treas. Reg. § 1.482-7(b).
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, employees of its affiliates, directors and other service providers.
In Year 3, Taxpayer had an initial public offering and its ---------- common stock has
been publicly traded on an established U.S. securities market at all times since that
date.
For certain years prior to Year 4, Taxpayer and the foreign controlled participant under
the CSA did not include SBC as IDCs under the CSA. Beginning in Year 4, however,
Taxpayer and the foreign controlled participant 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). 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 4.
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 (with
respect to its publicly-traded common stock) 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 respect to its publicly-traded common stock) 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
      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 that is the subject of this ruling request is publicly traded stock within
      the meaning of Treas. Reg. § 1.482-7(d)(3)(iii)(B)(2).
PLR-122220-20                            3

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

  5) 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 continue to use the method of measurement and timing provided in
     Treas. Reg. § 1.482-7(d)(3)(iii)(A), as well as their existing method for
     identification, until all Legacy SBC has been exercised or lapsed.

  6) 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:

         a. 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.

         b. 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.

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

  8) 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 stock options; nonvested 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) (“FAS 123R”); or Share-Based Payments within the meaning
            of FAS 123R’s successor, ASC 718; and

         b. Are not subject to market conditions or significant post-vesting restrictions
            within the meaning of ASC 718,
PLR-122220-20                             4

       Taxpayer and all controlled participants to the CSA will use the method of
       measurement provided in Treas. Reg. § 1.482-7(d)(3)(iii)(B)(1) and as expanded
       by Notice 2005-99.
                                           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:
       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
PLR-122220-20                                    5

        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).
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-

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-122220-20                            6

       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
       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
PLR-122220-20                             7

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.
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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