SECTION 2. DEFINITIONS

.01 Application . The definitions contained in this section 2 apply only for purposes of this revenue procedure.

.02 Cross Licensing Arrangement . A “cross licensing arrangement” is a contractual arrangement between two or more parties that own intellectual property under which each party grants to the other a license of specified intellectual property that is properly characterized as a license under applicable U.S. tax law principles.

.03 Consideration . The term “consideration” means, with respect to a cross licensing arrangement, any license rights, cash, or other consideration paid or received pursuant to the arrangement.

.04 Controlled . The term “controlled” has the same meaning as in § 1.482–1(i)(4) of the Income Tax Regulations.

SECTION 3 . BACKGROUND

.01 Request for Comments . Notice 2006–34 requested comments, information, and documents on cross licensing arrangements, including the: (i) business circumstances in which the arrangements arise; (ii) legal and factual means for distinguishing between different types of, or uses for, the arrangements; (iii) means for sourcing income from the arrangements; (iv) means for valuing cross-licensed rights; (v) financial accounting treatment of the arrangements; and (vi) foreign tax treatment of the arrangements.

.02 Comments . In response to the requests for information contained in Notice 2006–34, several commentators stated that many cross licensing arrangements are entered into primarily to provide each party with unfettered use of its own patents. In this way, the parties seek “freedom to operate” or the freedom to use their own intellectual property without threat of costly patent litigation from the potentially competing patent claims of the other party. These arrangements may be worded to insure “patent exhaustion” (that is, they are worded to confer rights to make, have made, import, sell, lease, use, or otherwise dispose of patented products). Commentators also stated that the use of cross licensing arrangements in

this context would not typically include the transfer of other technology, such as know-how, copyright, or trademark rights. Commentators also indicated that these arrangements may or may not involve cash payments. These arrangements generally are nonexclusive.

Commentators indicated that parties to a cross licensing arrangement entered into to avoid patent litigation typically do not attempt to value the underlying patents prior to entering into the arrangement beyond a broad relative judgment that is reflected in the amount of cash payments, if any, between the parties.

Commentators pointed to the particular circumstances of patent law. Reports offered by the U.S. Patent and Trademark Office (USPTO) indicate drastic increases in the numbers of patents applied for and granted over the last 50 years. For instance, in 1950 the USPTO received 74,108 patent applications and granted 47,847 patents; by 2000, the USPTO received 315,015 patent applications and granted 175,455 patents. United States Patent and Trademark Office, Table of Annual U.S. Patent Activity Since 1790, available at http://www.uspto.gov/web/ offices/ac/ido/oeip/taf/h_counts.pdf . At the same time, commentators indicated that a large number of patent infringement suits are filed each year with large associated costs. Commentators indicated that businesses, when faced with a potential “patent thicket,” often choose to negotiate and enter into cross licensing arrangements rather than face uncertain results and expenses that might accompany patent litigation.

Commentators also described other technology sharing business arrangements that may involve a shared business purpose and the sharing of intellectual property beyond patent rights. In addition to providing information regarding the different uses for cross licensing and other technology sharing arrangements, commentators stated their view that, under established tax law principles, the execution of a cross licensing arrangement without any cash payment is not an income recognition event that would trigger withholding tax.

Commentators also indicated that attempting to value any rights granted under a cross licensing arrangement, or to source any income arising therefrom, would be extremely difficult, likely incorporating

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cult to ascertain the validity and scope of patent rights without incurring significant expense, which may include the cost of litigation. Thus, this unique interaction of patent and tax law creates administrative challenges for the taxation of QPCLAs.

For instance, while valuation of intellectual property is always difficult, valuation of patent rights is exceedingly difficult where the parties enter into the cross licensing arrangement to avoid or settle patent infringement disputes. Uncertainty in the patent law increases the difficulties of reaching a valuation when the parties enter into a cross licensing arrangement to avoid the costs and risks of determining their ultimate patent rights by litigation.

Similarly, the sourcing of gross income from QPCLAs entered into to avoid or settle patent infringement disputes may present administrative problems. In those arrangements, the difficulty in tracing the location and use of intangibles to a particular jurisdiction in the absence of objective benchmarks (for example, if a QPCLA did not provide for per-unit cash royalties based on sales of products) may make it difficult to allocate income to a particular source.

For these reasons, Treasury and the IRS have determined that, in the interest of sound tax administration, taxpayers are not required to take into account amounts other than the “net consideration” as defined in section 5.02 of this revenue procedure for QPCLAs described in section 4 of this revenue procedure.