Internal Revenue Code Section 199 provides for a tax deduction equal to 9% of the lesser of the qualified production activities income of the taxpayer for the taxable year or taxable income for the taxable year. The taxpayer entitled to this deduction is often not clear when a contract manufacturing arrangement exists.
The IRS recently released new guidance to examiners in its Large Business & International (LB&I) Division regarding how to establish which taxpayer is entitled to claim the Section 199 Domestic Production Activities Deduction in a contract manufacturing arrangement. The latest directive replaces earlier guidance issued last year, which has used a nine-question test to determine whether a taxpayer conducting production activities under a contract manufacturing arrangement with an unrelated party meets the benefits-and-burdens-of-ownership prerequisite outlined in Section 199.
The new guidance allows the parties to the arrangement to certify which taxpayer has the benefits and burdens of ownership. 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 aspects 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. As a result, erroneously both parties or neither party claim the deduction.
The nine-step process, mentioned earlier, is replaced with three forms the taxpayer fills out:
- 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;
- Certification Statement signed by the Taxpayer; and
- Certification Statement signed by the Counterparty.
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is a change as to which party to a multi-year contract has the benefits and burdens of ownership, this Directive is no longer applicable and examiners can apply regular audit procedures for the year of change or any subsequent year(s) to which that contract applies.
Taxpayers should work closely with their tax advisor to assure proper compliance with Section 199 in light of this recently issued guidance. We encourage you to contact your RubinBrown engagement representative with any questions that you have.
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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