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Guidance for Examiners on I.R.C. § 199 Benefits and Burdens of Ownership Analysis in Contract Manufacturing Arrangements

July 24, 2013

LB&I Control No: LB&I-04-0713-006
Impacted IRM 4.51.2

MEMORANDUM FOR LB&I Employees
FROM: Paul D. DeNard /s/ Paul D. DeNard
Acting Commissioner, Large Business and International Division
SUBJECT: Guidance for Examiners on I.R.C. § 199 Benefits and Burdens of Ownership Analysis in Contract Manufacturing Arrangements

 

On February 1, 2012, the Large Business & International (LB&I) Division issued Directive LB&I-4-0112-001 (the “Prior Directive”) to LB&I examiners to assist in making a determination whether a taxpayer has the benefits and burdens of ownership under a contract manufacturing arrangement for purposes of Treas. Reg. § 1.199-3(f)(1).  This Directive supersedes the Prior Directive.  

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.

BACKGROUND

In general, section 199 of the Internal Revenue Code allows a deduction for income derived from any lease, rental, license, sale, exchange, or other disposition of qualifying production property manufactured, produced, grown, or extracted by the taxpayer in whole or significant part within the United States; any qualified film produced by the taxpayer; or electricity, natural gas, or potable water produced by the taxpayer in the United States.  Only one taxpayer may claim the section 199 deduction for a Qualifying Activity performed with respect to a Qualifying Property.  See I.R.C. § 199(d)(10) and Treas. Reg. § 1.199-3(f)(1).  As used in this Directive, the term “Qualifying Activity” means manufactured, produced, grown, or extracted (defined in Treas. Reg. § 1.199-3(e)) and the term “Qualifying Property” includes qualifying production property (defined in section 199(c)(5)); qualified film produced by the taxpayer; and electricity, natural gas, or potable water produced by the taxpayer in the United States.  

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.

SCOPE OF GUIDANCE

This Directive is limited in scope to determining which unrelated party (as defined in Treas. Reg. § 1.199-3(b)) in a contract manufacturing arrangement may claim the section 199 deduction because it satisfies the benefits and burdens test.  In order to claim the deduction, that party must also meet all other requirements of section 199.  This Directive does not change the special rules in the regulations under section 199 applicable to expanded affiliated groups (EAGs), qualifying in-kind partnerships, EAG partnerships, or government contracts.  This Directive also does not apply to any other provision of the Internal Revenue Code, including section 263A. 

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:

  1. Statement that explains the basis for the Taxpayer’s determination that it had the benefits and burdens of ownership in the year or years under examination;
  2. Certification Statement (using the form attached as Appendix 1) signed by the Taxpayer; and
  1. Certification Statement (using the form attached as Appendix 2) signed by the Counterparty.

BENEFITS AND BURDENS STATEMENT AND CERTIFICATION STATEMENT

In general, the Taxpayer should provide the benefits and burdens statement and Certification Statements described in (1), (2) and (3) above to the examiner within thirty days of the date that an information document request is issued to the Taxpayer with respect to the section 199 deduction.  If, however, the Benefits and Burdens determination is under examination on July 24, 2013, the Taxpayer must provide the benefits and burdens statements and the signed Certification Statements to the examiner within sixty days of the date of this Directive.

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.

CONTACT

For further guidance regarding this Directive, please contact Elizabeth Kovash at 505-837-5511 or the Corporate Income and Losses Issue Practice Group.

cc:  Division Counsel, LB&I

      Chief, Appeals

      Commissioner, Small Business/Self-Employed Division

 

Appendix 1

LB&I Directive on Section 199 Benefits and Burdens of Ownership

Analysis in Contract Manufacturing Arrangements

 

Certification Statement

 

Tax Year(s) under Examination:  ________

Taxpayer‘s Name: ___________________________________________________

Taxpayer’s EIN: _____________________________________________________

Contract Start Date: _________________________________________________

Contract End Date: __________________________________________________

Contract Identifying Information: ________________________________________

CERTIFICATION

By signing this Certification Statement, the Taxpayer agrees to readily provide (upon request of the IRS) all relevant data and records required under section 6001 of the Code to establish to the satisfaction of the IRS that the statements made in this Certification Statement are true, correct and complete.

(A) For purposes of section 199, the Taxpayer has determined that it had benefits and burdens over the Qualifying Property when the Qualifying Activities were performed and filed its Federal Income Tax return(s) consistent with this determination.

 

(B) The Taxpayer was not required to record a reserve for financial statement purposes under its accounting standard for its determination that it had benefits and burdens over the Qualifying Property.

 

(C) The Contract to which this Certification Statement applies was not governed by the rules applicable to: (1) expanded affiliated groups (EAGs) under Treas. Reg. § 1.199-7; (2) qualifying in-kind partnerships under Treas. Regs. §§ 1.199-3(i)(7) and 1.199-9(i); (3) EAG partnerships under Treas. Regs. §§ 1.199-3(i)(7) and 1.199-9(j); and (4) government contracts under Treas. Reg. § 1.199-(3)(f)(2).

 

(D) The Qualifying Activities occurred in whole or in significant part within the United States.

The Taxpayer certifies under penalty of perjury that it has examined this Certification Statement, and to the best of its knowledge and belief, it is true, correct, and complete.

Taxpayer’s Signature: ________________________________________________

Date (Taxpayer): ____________________________________________________

Title (Taxpayer):  ____________________________________________________

For corporations, the certification must be signed by an individual authorized under I.R.C. section 6062.


 

Appendix 2

 

LB&I Directive on Section 199 Benefits and Burdens of Ownership

Analysis in Contract Manufacturing Arrangements

 

Certification Statement

Counterparty’s Name: _______________________________________________

Counterparty’s EIN: _________________________________________________

Contract Start Date: _________________________________________________

Contract End Date: __________________________________________________

Contract Identifying Information: ________________________________________

CERTIFICATION

The Counterparty did not claim, and will not claim, the section 199 deduction for any taxable year covered by the Contract pursuant to which the same Qualifying Activities were performed.

The Counterparty certifies under penalty of perjury that it has examined this Certification Statement, and to the best of its knowledge and belief, it is true, correct, and complete.

Counterparty’s Signature:  _____________________________________________

Date (Counterparty): _________________________________________________

Title (Counterparty):__________________________________________________

For corporations, the certification must be signed by an individual authorized under I.R.C. section 6062.

Page Last Reviewed or Updated: 17-Jun-2014