DPGR Archives - TAX CONTROVERSY 360

IRS and Taxpayers Continue to Battle over the IRC Section 199 Deduction for Computer Software

by Kevin Spencer and Robin L. Greenhouse | Oct 27, 2017 | IRS Guidance, Uncategorized

On October 20, 2017, the Internal Revenue Service (IRS) published Office of Chief Counsel Internal Revenue Service Memorandum 20174201F (FSA), legal advice written by a field attorney in the Office of Chief Counsel that was reviewed by an associate office, which deals with a merchant bank’s claim that its revenue from merchant discount fees qualifies as Domestic Product Gross Receipts (DPGR) under Internal Revenue Code (Code) Section 199. According to the FSA, on its amended return the taxpayer claimed a Code Section 199 deduction with respect to its merchant discount fees based on the third-party comparable exception for online software found in Treasury Regulation § 1.199-3(i)(6)(ii)(B). The taxpayer argued that the merchant discount fees were derived from the use of computer software, the software “Platform.” The taxpayer took solace in the fact that third parties derived gross receipts from the disposition of substantially identical software. Accordingly, the taxpayer argued that the merchant discount fees should be treated as DPGR pursuant to the third party comparable exception.

The IRS, however, had a very different perspective. Its analysis began with the threshold question of whether there was a “disposition” of the Platform. The IRS concluded that the taxpayer did not dispose of the Platform because the taxpayer did not lease, rent, license, sell, exchange or otherwise dispose of the Platform as required by Treasury Regulation § 1.199-3(i)(6)(i). Moreover, the IRS concluded that the merchant discount fees represented remuneration for “online services” (e.g., online banking services) per Treasury Regulation §1.199-3(i)(6)(i). Because the taxpayer did not establish that there was a disposition of the Platform, the third party comparability exception in Treasury Regulation § 1.199-3(i)(6)(ii)(B) is inapplicable—the merchant discount fees were derived “from the provision of merchant acquiring services.”

Practice Point: We have reported extensively on the IRS’s attacks on taxpayer’s ability to claim the IRC section 199 deduction for computer software and qualified film production. The issue is also on the IRS’s annual Guidance Plan as an area in which the IRS expects to issue regulations within the next year. The FSA is further proof that taxpayers and the IRS do not see eye-to-eye on these issues. Indeed, there are presently several docketed cases seeking judicial determinations regarding the applicability of the third-party comparable exception. Because we have several clients who have this same issue, we are watching it closely, and will report back with any developments.

The IRS’s Assault on Section 199 (Computer Software) Doesn’t Compute

by Jean A. Pawlow, Kevin Spencer and Robin L. Greenhouse | Apr 24, 2017 | Court Procedure Matters, IRS Appeals, IRS Audits, IRS Guidance, Trial Courts, Uncategorized

Internal Revenue Code Section 199 permits taxpayers to claim a 9 percent deduction related to the costs to develop software within the U.S. The relevant regulations and their interpretation, however, place substantial restrictions on claiming the benefit.

Moreover, the regulations and the government’s position haven’t kept up with the technological advances in computer software.

Before claiming the deduction on your return, consider that the Internal Revenue Service has this issue within its sights, and perhaps it will be the subject of one of their new “campaigns.”

In 2004, Congress enacted I.R.C. Section 199 to tip the scales of global competitiveness more in favor of American business. The main motivation of the statute was to create jobs by encouraging businesses to manufacture and produce their products in the U.S. The tax benefit, however, isn’t available for services, a theme that pervades many of the provisions in the statute and regulations.

Originally published in Bloomberg BNA Daily Tax Report – April 24, 2017 – Number 77

IRS Campaign Focuses on Definition of “Qualified Film” Under Section 199

by Elizabeth Chao and Roger J. Jones | Mar 9, 2017 | IRS Audits, IRS Guidance, Uncategorized

On January 31, the Internal Revenue Service (IRS) announced 13 Large Business & International (LB&I) “campaigns.” One campaign targets deductions claimed by multi-channel video programming distributors (MVPDs) and TV broadcasters under section 199 of the Internal Revenue Code (IRC). According to the IRS’s campaign announcement, these taxpayers make several erroneous claims, including that (1) groups of channels or programs constitute “qualified films” eligible for the section 199 domestic production activities deduction, and (2) MVPDs and TV broadcasters are producers of a qualified film when they distribute channels and subscription packages that include third-party content.

IRC section 199(a) provides for a deduction equal to 9 percent of the lesser of a taxpayer’s “qualified production activities income” (QPAI) for a taxable year and its taxable income for that year. A taxpayer’s QPAI is the excess of its “domestic production gross receipts” (DPGR) over the sum of the cost of goods sold and other expenses, losses or deductions allocable to such receipts. IRC section 199(c)(1). DPGR includes gross receipts of the taxpayer which are derived from any lease, rental, license, sale, exchange, or other disposition of “any qualified film produced by the taxpayer.” IRC section 199(c)(4)(A)(i)(II). A “qualified film” is “any property described in section 168(f)(3) if not less than 50 percent of the total compensation relating to the production of such property is compensation for services performed in the United States by actors, production personnel, directors and producers.” IRC section 199(c)(6). However, “qualified film” does not include property with respect to which records are required to be maintained under 18 U.S.C. § 2257 (i.e., sexually explicit materials). Id. Under regulations issued in 2006, “qualified film” also includes “live or delayed television programming.” Treas. Reg. § 1.199-3(k)(1); see also Notice 2005-14, 2005-1 C.B. 498, §§ 3.04(9)(a), 4.04(9)(a). “Qualified film” includes “any copyrights, trademarks, or other intangibles with respect to such film.” IRC section 199(c)(6). The “methods and means of distributing a qualified film” have no effect on the availability of the section 199 deduction. Id. IRC section 168(f)(3), entitled “Films and Video Tape,” provides an exclusion from accelerated depreciation for “[a]ny motion picture film or video tape.”

Though the January 31 announcement did not explain the IRS’s position on these issues in detail, the IRS rejected both claims in two Technical Advice Memoranda (TAMs) issued in late 2016. The IRS determined in TAM 201646004 (Nov.10, 2016) and TAM 201647007 (Nov.18, 2016) (the 2016 TAMs) that a subscription package of multiple channels of video programming transmitted by an MVPD to its customers via signal is not a “qualified film” as defined in IRC section 199(c)(6) and Treas. Reg. § 1.199-3(k)(1). It also determined that an MVPD’s gross receipts from its subscription package are not from the disposition of a qualified film produced by the MVPD and are therefore not DPRG included in calculating a section 199 deduction. The MVPD would only have DPRG from the subscription package to the extent its gross receipts are derived from an individual film or episode within the subscription [...]

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