New Cross-Licensing Guidance

International Tax Alert
02.16.07

On February 14, 2007, the IRS provided favorable guidance related to certain patent cross-licensing arrangements. New Rev. Proc. 2007-23, which was issued in response to comments and requests for guidance in connection with Notice 2006-34 (see Alert regarding Notice 2006-34), permits taxpayers to use the Net Consideration Method described therein for qualified patent cross licensing arrangements (QPCLAs) entered into on and after February 14, 2007. For QPCLAs entered into prior to that date, the IRS will not raise the use of the Net Consideration Method and will not further pursue the use of that method if it is currently an issue under consideration. The IRS is requesting comments on the definition of a QPCLA and whether the Net Consideration Method should be extended to other types of cross-licensing arrangements (CLAs).

Commentators to Notice 2006-34 urged that only cash transferred under a CLA be taken into account and subject to withholding. Based on these comments, Treasury and the IRS determined that taxpayers are not required to take into account amounts other than the “net consideration” for QPCLAs.

A QPCLA is a nonexclusive, nontransferable patent cross-licensing arrangement among uncontrolled parties, the subject matter of which is limited to the parties’ present or future patent rights, as specified in the arrangement, with no more than de minimis licensing or other transfer of other intangible property. The determination of whether the licensing or other transfer of other intangible property is de minimis is determined under all the facts and circumstances.

Under the Net Consideration Method, only the “net consideration” transferred between the parties to a QPCLA during a taxable year will be taken into account for withholding purposes. The Net Consideration Method applies whether the QPCLA is entered into in advance of, during, or after a patent dispute. In addition, under the Net Consideration Method, only the “net consideration” transferred between the parties to a QPCLA during a taxable year will be taken into account for capitalization purposes under Code sections 263(a) or 263A.

“Net consideration” is defined as the amount of consideration other than license rights and de minimis other intangible property received in the taxable year by a party pursuant to the arrangement, reduced by the amount of consideration other than license rights and de minimis other intangible property paid in the taxable year by the party pursuant to the arrangement.

The Net Consideration Method may be used for a QPCLA by any taxpayer without regard to whether the taxpayer has made a payment of income subject to withholding with respect to the QPCLA. However, a taxpayer may not use the Net Consideration Method for a QPCLA unless the taxpayer takes into account only the “net consideration” for such arrangement on its audited financial statements or other similar foreign corporation statements (if any) for all years that the net consideration method is used for tax purposes. The use of the Net Consideration Method will be presumed to clearly reflect a taxpayer’s income.

For further information, please contact any of the following lawyers:

Marc Gerson, mgerson@milchev.com, 202-626-1475

Rocco Femia, rfemia@milchev.com, 202-626-5823

Kimberly Majure

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