In a recent IRS chief counsel advice memorandum (CCA 201626024
) email, the IRS concluded that the taxpayer’s gross receipts derived from the sale of its products were not domestic production gross receipts (DPGRs) from advertising income.
The taxpayer, a specialty retailer of clothing and gift items, sells its products to customers in the U.S. and internationally. The manufacturing, producing, growing or extraction (MPGE) of the physical products is outside of the U.S.
The taxpayer claimed to be the manufacturer of its catalogs, mailers and other similar publications (print media) in the U.S. based on the benefits and burdens of ownership during the manufacturing of the printed media by third-party contractors. It distributed the print media to its customers free of charge. The retailer did not sell advertising to third parties for inclusion in in the print media. As a result, it did not derive advertising revenue from the print media.
The taxpayer expected to claim a Section 199 deduction for its print media because it viewed the advertising as a component of the clothing and accessories it sells. It argued that the price of its retail goods includes a component for the printed media distributed to customers, including a profit markup. The retailer determined its DPGR by using sophisticated software that tracked the incremental sales stemming from its print media for certain brands and argued that part of the gross receipts from the sale of its products should be treated as advertising income under Treas. Reg. Sec. 1.199-3(i)(5)(ii)(A) because the advertising increased sales.
The general rule in Treas. Reg. Sec. 1.199-3(i)(5)(i) states that gross receipts from the disposition of qualifying production property do not include adverting income. Treas. Reg. Sec. 1.99-3(i)(5)(ii)(A) includes an exception for certain printed publications like magazines for advertising income from advertisements placed in those media if the gross receipts from the disposition of the media are DPGR. The IRS said that for this exception to apply, the taxpayer’s customers would have to pay to advertise in the taxpayer’s print media and that this was not happening when a customer bought a product. Thus, the IRS stated that the taxpayer’s products are MPGE outside of the U.S. and gross receipts from their sale were non-DPGR.
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