IRS field advice concludes that merchant discount fees do not constitute domestic production gross receipts

The IRS released a field attorney advice memorandum (FAA 20174201F) concluding that merchant discount fees were not received for the use of the taxpayer’s proprietary software to process credit and debit card payment transactions by merchants, and do not constitute domestic production gross receipts (DPGR) eligible for the domestic production activities deduction under Section 199.

Under the facts of the FAA, the taxpayer, a corporation, submitted a claim seeking the net merchant discount fees it received from processing transactions as DPGR, asserting that the software used to process such transactions meets the third-party comparable exception definition for computer software. The merchants connect to the taxpayer’s software through an internet connection. The taxpayer interpreted the third-party comparable exception for software to include any online services provided through software.

According to the IRS, the taxpayer does not meet the requirement of deriving its gross receipts from any disposition of qualifying production property because the government viewed the taxpayer as generating its revenue by providing online services and not from direct use of its proprietary software.

The IRS concluded that the taxpayer’s interpretation of the third-party comparable exception was too broad, stating that the taxpayer was “essentially reading [the exception] as converting all gross receipts from the provision of online services to DPGR any time a third-party comparable exists, irrespective of the gross receipts’ actual derivation” (Emphasis in original).

The IRS also concluded that the third-party comparable exception wasn’t met in this case because the substantially identical software requirement wasn’t satisfied.

Contact: Sharon Kay
Partner, Washington National Tax Office
T +1 202 861 4140

Ellen Martin
Partner, Washington National Tax Office
T +1 202 521 1558

Dave Auclair
National Managing Principal, Washington National Tax Office
T +1 202 521 1515

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