LB&I Directive Updates Examiner Guidance on Domestic Production Activities Deduction

This Directive is not an official pronouncement of law, and cannot be used, cited, or relied on as such. In addition, nothing in this Directive should be construed as affecting the operation of any other provision of the Code, regulations, or guidance thereunder.

To prevent more than one taxpayer from claiming the section 199 deduction in contract manufacturing arrangements, the Service adopted the benefits and burdens test. See Treas. Reg. § 1.199-3(f)(1). Under the benefits and burdens test, which is based on all facts and circumstances, only the party with the benefits and burdens of ownership over the Qualifying Property during the period of the Qualifying Activity may be entitled to the section 199 deduction. Often both parties to a contract manufacturing arrangement have some of the indicia of benefits and burdens over the Qualifying Activities and thus, it may be difficult to determine which party may claim the section 199 deduction with respect to the same economic activity. Therefore, both parties or neither party may claim the deduction. As a result, application of the facts and circumstances approach results in extensive resource expenditures for taxpayers and the Service. The Prior Directive instructed LB&I examiners to apply a three-part test to determine which party in a contract manufacturing arrangement had the benefits and burdens under Treas. Reg. § 1.199-3(f)(1). LB&I has reconsidered the approach in the Prior Directive.

Examination Guidance

In deciding whether or not to challenge a Taxpayer's position (the entity under examination) that it has the benefits and burdens of ownership under a contract manufacturing arrangement with a Counterparty (the other party to a contract manufacturing arrangement with the Taxpayer), an LB&I examiner should request that the Taxpayer provide to the examiner:

The benefits and burdens statement and Certification Statements described in (1), (2) and (3) above must be provided for each contract and cannot be changed for the term of the contract. If there is a change as to which party to a multi-year contract has the benefits and burdens of ownership, this Directive is no longer applicable and examiners should apply regular audit procedures for the year of change or any subsequent year(s) to which that contract applies.

For this Directive to apply, the Taxpayer and the Counterparty must complete all sections of the Certification Statements included in Appendices I and 2, as applicable. The Certification Statements must be signed under penalty of perjury by the individuals who are authorized to execute the Taxpayer's and the Counterparty's Federal income tax returns. For a consolidated Federal income tax return, the common parent is the sole agent for the group and an individual authorized to sign the common parent's Federal income tax returns must sign the Certification Statement for each member of the group.

If the Taxpayer provides the benefits and burdens statement and Certification Statements described in (1), (2) and (3) above, examiners should not challenge that the Taxpayer has the benefits and burdens of ownership for purposes of section 199 over each Qualifying Property upon which a Qualifying Activity is performed under the contract manufacturing arrangement. If the Taxpayer does not provide both of the Certification Statements, it should not be presumed that the Taxpayer does not have the benefits and burdens. Rather, examiners should apply regular audit procedures to determine which entity (the Taxpayer or the Counterparty) has the benefits and burdens of ownership for purposes of the section 199.

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Appendix 1

 

 

LB&I Directive on Section 199 Benefits and Burdens of

 

Ownership

 

Analysis in Contract Manufacturing Arrangements

 

 

 

 

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Appendix 2

 

 

LB&I Directive on Section 199 Benefits and

 

Burdens of Ownership

 

 

Analysis in Contract Manufacturing Arrangements