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Section 199 Deduction for Marketing Materials Denied


Synopsis

In CCA201626024, the IRS addressed whether a retailer could take the section 199 deduction for marketing materials that were used to sell products that are manufactured and produced outside of the United States. The IRS concluded that none of the gross receipts derived from the sale of its products were domestic production gross receipts (DPGR) and that none of the receipts from the sale of its products were advertising income within the meaning of Treas. Reg. §1.199-3(i)(5)(ii)(A).

Facts: The taxpayer is a specialty retailer of clothing, intimates, accessories, and non-clothing gift items. The taxpayer makes its products available to customers in the United States and in international stores through the retailer’s website and call centers for its catalogs. The retailer’s physical products are manufactured and produced outside of the United States. The retailer prints its catalog and the advertising in its catalogs is only for the retailer’s brands – not third-party brands. 
 
Taxpayer’s Argument: The taxpayer argued that it develops and produces the catalogs, mailers and advertising material in order to drive traffic to its stores and websites, encourage repeat sales and foster customer loyalty. The taxpayer believed that it is the manufacturer of its printed material and that it has the benefits and burdens of ownership during the entire manufacturing process, including the printing process. Therefore, the taxpayer argued that a portion of its revenue from the sale of its products actually constituted advertising revenue generated from the disposition of its catalogs that it manufactured within the United States.
 
IRS Response: The IRS reasoned that characterizing any gross receipts derived from the sale of the taxpayer’s products as DPGR from advertising income pursuant to any section 199 rule would be inappropriate because the taxpayer’s products are manufactured, produced, grown or extracted outside of the United States, and therefore, the gross receipts from the sale of those products are non-DPGR. 
 
Deriving DPGR from advertising income does not apply to the taxpayer’s situation because the taxpayer’s revenue was not from the disposition or provision of advertising, but from the sale of goods produced outside the U.S.  The exception for advertising in tangible personal property is limited to certain printed publications and only applies to advertising income from advertisements placed in those media, i.e., when a third party pays to advertise in the printed publication and not when a taxpayer derives gross receipts from the sale of a product it advertises.
 
What Does CohnReznick Think
 
While the taxpayer in the above fact pattern could not attribute revenue to advertising its own goods, other taxpayers have claimed section 199 where they advertise third-party goods in catalogs produced by the taxpayer.  In the latter fact pattern, a section 199 deduction is a possibility – subject to the taxpayer meeting all of the other requirements. 
 
Contact
 
For more information, please contact your CohnReznick tax professional.
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