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Treasury And IRS Propose Changes To The Treatment Of Compensatory Stock Options In Cost Sharing Arrangements

July 29, 2002

The Treasury Department and the IRS have issued proposed regulations [pdf] on the tax treatment of compensatory stock options under the related party transfer pricing rules governing cost-sharing arrangements.

"The proposed regulations address a significant international tax issue - the treatment of compensatory stock options as a cost to be taken into account by related taxpayers participating in a cost-sharing arrangement for the joint development of intangible assets," stated Acting Assistant Secretary (Tax Policy) Pamela Olson. "The rules governing cost sharing arrangements are critically important. The proposed regulations represent a first step in ensuring that the rules regarding the treatment of cost-sharing arrangements reach appropriate results."

Participants in cost sharing arrangements are required to share all costs related to the development of intangibles in the same proportion as they share the reasonably anticipated benefits attributable to the intangible development. The proposed regulations clarify that compensatory stock options, like other compensation, are taken into account in determining the costs of a participant. The proposed regulations also provide rules for measuring the cost associated with stock-based compensation, generally allowing taxpayers a choice of measuring the cost based on the stock price at the date of exercise or the "fair value", as noted in financial statements, at the date of grant.

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