Sec. 199 prop. regs. clarify treatment of intercompany transactions.

• Author: Hecimovich, Gary

Significant controversy has arisen as to the application of Sec. 199 to intercompany transactions. Taxpayers that want to take advantage of the Sec. 199 qualified production activities deduction (QPAD) and that license intangible assets from one affiliate to another for use in producing qualified production property (QPP) must do so with affiliates in the same consolidated group in order to include the royalty income in qualified production activities income (QPAI) and, thus, maximize the QPAD.

Background

To encourage domestic production, American Jobs Creation Act of 2004 Section 102(a) established the QPAD in Sec. 199. Generally, for 2005 and 2006, Sec. 199(a)(1) allows a 3% deduction (rising to 6% in 2007-2009, and 9% in 2010 and beyond) of the lesser of (1) QPAI or (2) taxable income for the tax year. Sec. 199(b)(1) limits the deduction to 50% of W-2 wages paid by the taxpayer.

Definitions: Sec. 199(c)(1) defines QPAI as the excess of domestic production gross receipts (DPGR) over the sum of (1) the cost of goods sold (COGS) allocable to such receipts; (2) other deductions, expenses or losses directly allocable to such receipts; and (3) a ratable portion of deductions, expenses or losses not directly allocable to such receipts or another class of income.

Sec. 199(c)(4)(A) defines DPGK to include, among other things, a taxpayer's gross receipts derived from the lease, rental, license, sale, exchange or other disposition of QPP that the taxpayer manufactured, produced, grew or extracted, in whole or in significant part, within the U.S. Sec. 199(c)(5) defines QPP as (1) tangible personal property, (2) computer software and (3) property described in Sec. 168(f)(4) (certain sound recordings). QPP does not include intangibles such as patents or trademarks. Sec. 199(c)(7)(A) excludes from DPGK gross receipts derived from property leased, licensed or rented by a taxpayer to a related person.

Sec. 199(d) (4) (A) provides that an expanded affiliated group (EAG) is treated as a single corporation for Sec. 199 purposes. Sec. 199(d)(4)(B) defines an EAG as an affiliated group as determined in Sec. 1504(a), determined by substituting "more than 50 percent" for "at least 80 percent" without regard to Sec. 1504(b)(2) and (4). Sec. 199 provides no guidance on the QPAD calculations for consolidated groups. However, recently issued proposed regulations (REG-105847-05, 11/4/05) provide some guidance on this issue.

Prop. Regs.

Both the preamble and Prop...