IRS focuses on sec. 199 for cable, satellite, and broadcast TV.

• Author: Atkinson, James

Among the first wave of examination "campaigns" announced by the IRS's Large Business & International division (LB&I) is the application of the Sec. 199 domestic production activities deduction to "multi-channel video programming distributors" (such as cable and satellite TV providers) and TV broadcasters. In a related technical advice memorandum (TAJV1), the IRS National Office has adopted a previously rejected LB&I interpretation of "qualified films," raising potential red flags for some members of the media industry.

Sec. 199 provides a current deduction equal to (roughly) 9% of the taxpayer's net income from certain domestic production activities during the year (subject to numerous exceptions and special rules). Domestic production gross receipts (DPGR) eligible for this benefit include (among many other things) receipts derived from licensing any "qualified film." Sec. 199(c)(6) defines "qualified film" to include "any property described in section 168(f)(3)" that is produced in the United States (i.e., "if not less than 50 percent of the total compensation relating to the production of such property is compensation for services performed in the United States by actors, production personnel, directors, and producers," subject to certain exceptions). Sec. 168(f)(3) is equally expansive, defining films and videotape as "any motion picture film or video tape."

The Sec. 199 regulations require the taxpayer to determine whether gross receipts are eligible for Sec. 199 by identifying the "item" giving rise to those gross receipts. For this purpose, the relevant item is "the property offered by the taxpayer in the normal course of the taxpayer's business" (Regs. Sec. 1.199-3(d)(l)(i)).

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A qualifying item may include a finished product that the taxpayer produces using components acquired in whole or in part from third parties. So long as the taxpayer's domestic activities in combining the acquired components into a finished product are "substantial in nature," the aggregation of self-produced and purchased components into a new item falls squarely within the scope of Sec. 199 (Regs. Sec. 1.199-3(g)(2)).

Therefore, reading these provisions together, Sec. 199 permits a taxpayer to treat as DPGR any gross receipts that it derives from the licensing to customers of any "item" of motion picture film or videotape that the taxpayer produces in the United States. In addition, for this purpose, an item of qualified film can be...