On January 15, 2025, the Internal Revenue Service (IRS) Office of Chief Counsel issued Advice Memorandum (AM) 2025-001, which updated and clarified its position with respect to the interaction of the periodic adjustment rules in the section 482 regulations and generally applicable principles in those regulations. In general, the AM concludes that taxpayers may not overcome the application of the periodic adjustment rules by invoking generally applicable principles, such as the arm's length standard or the best method rule, notwithstanding prior guidance in AM 2007-007. Issuance of the memo alone is noteworthy, indicating that the IRS is considering the application of the periodic adjustment rules in active examinations. Taxpayers that have undertaken or are considering transfers of high-value intangibles, particularly in the context of cost sharing arrangements (CSAs), should review their policies and positions in light of the IRS position. 

The memo analyzes the periodic adjustment rules in the context of an intercompany license of intangible property subject to Treas. Reg. § 1.482-4 (Scenario 1) and a platform contribution, including of intangible property, under a CSA subject to Treas. Reg. § 1.482-7 (Scenario 2). In Scenario 1, the taxpayer determined the amount of the royalty by applying the comparable uncontrolled transaction (CUT) method, which the memo acknowledges would be the best method for pricing the license under the section 482 regulations. In Scenario 2, the taxpayer priced the platform contribution transaction using the income method provided for in the cost sharing section 482 regulations based on projected future profits from the cost shared intangibles reasonably anticipated to be developed under the CSA. Under both scenarios, the memo assumes that by year 6, the product subject to the intercompany license or CSA experiences significantly more success in terms of market share or actual profits. In its examination of years 6 and 7, the IRS uses actual profits as the basis for a periodic adjustment under the periodic adjustment regulations, which permit the IRS to use hindsight to adjust prices established at the start of an arrangement where certain mechanical thresholds are met. See Treas. Reg. §§ 1.482-4(f)(2)(i), -7(i)(6). The taxpayers challenge the periodic adjustment as inappropriate under the arm's length standard of Treas. Reg. § 1.482-1(b) and because the taxpayers selected and applied a transfer pricing method that meets the best method rule of Treas. Reg. § 1.482-1(c). The memo assumes that the taxpayers did not establish that any of the enumerated exceptions in the periodic adjustment rules themselves applied in their circumstances.

The memo concludes that a taxpayer cannot rely on the arm's length standard or application of a method consistent with the best method rule to overcome the IRS's assertion of the ability to make a periodic adjustment under the regulations. It provides that a taxpayer may rebut the application of the periodic adjustment rules only by demonstrating that the taxpayer meets one of the enumerated exceptions in the periodic adjustment rules themselves, for example in cases where the results were not anticipated and were outside the control of the taxpayer. The memo leans heavily on the commensurate with income standard in section 482, and the legislative history thereto, to support its conclusion.

The AM is noteworthy in several respects. It walks back the guidance provided in AM 2007-007 that the periodic adjustment rules establish a presumption that taxpayers may rebut. It cites the Organisation for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines as providing corroborating guidance in rules analogous to the periodic adjustment rules, representing the second such reference to the Guidelines in transfer pricing advice memoranda in recent years. It reiterates the view of the IRS that any adjustment pursuant to section 482 is at the discretion of the IRS, suggesting that the IRS can choose in its discretion to forego asserting a periodic adjustment even in cases where the regulations would permit such an adjustment. And it does not engage fully with the interaction between the commensurate with income standard and the arm's length standard, in particular, the legislative history suggesting that Congress viewed the commensurate with income standard as a neutral standard to ensure arm's length results. 

The memo leaves open technical and administrative questions regarding the application of the periodic adjustment rules, and the interaction between the commensurate with income standard and the arm's length standard is at issue in pending litigation. Stay tuned for further developments in this area.

For more information, please contact:

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

Lisandra Ortiz, lortiz@milchev.com, 202-626-5841

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