In a new Section 199 Domestic Production Activities Deduction case, the Tax Court has ruled that a third party contract printer is entitled to the Section 199 deduction and not the publisher. ADVO, Inc. v. Commissioner, 141 T.C. 9 (2013).
ADVO is a direct mail producer (i.e., mail inserts, flyers, mailing campaigns through the Post Office) and it argued that although it contracts out the printing process to third parties, it still retains control over the printing stages and also produces all the electronic (intangible) files necessary to produce the final product. ADVO thus argued that just because the final stage in the process (the printing) is performed by a third party, ADVO still gets the 199 production deduction because it retained the benefits and burdens of ownership throughout the production process.
This has been a contentious issue in the industry for several years, with printers arguing that they ultimately produce the tangible property eligible for the Section 199 Domestic Production Activities Deduction, while the printers (including ADVO) argue that it owns all the intellectual property and ultimate ownership of the both the IP and tangible property, produces all the content to print and exercises control over the printing process to some extent, and thus the publisher is ultimately the party entitled to the Section 199 deduction.
The Tax Court, however, found for the Respondent (IRS) and concluded that the printer is the only party who actually produces tangible personal property and the printer maintains the benefits and burdens of ownership during the printing process which in the Tax Court opinion was the only process that counts as part of the manufacturing process for Section 199 purposes. The printer also had the risk of loss according to the Tax Court during the printing process, including maintaining insurance in the event of loss during the printing stages.
The Court also sought to only have one party claim the 199 deduction (either the printer or the publisher ADVO) and contrasted Code Section 263A which allows for two parties to both be the ‘owner’ of the same property. See Suzy’s Zoo v. Comm’r, 114 T.C. 1 (2000), aff’d 273 F.3d 875 (9th Cir. 2001)(printer and publisher can both be ‘producers’ for purposes of Section 263A).
In weighing a number of factors relating to benefits and burdens of ownership, the Tax Court found that the printer produced the tangible product, had more control over the printing process than the publisher, had the risk of loss during the printing process, and had economic upside or downside under the fixed price contracts and therefore ruled that the printer is the single party entitled to claim the Section 199 Domestic Production Activities Deduction under these facts.