In PLR 201904004, the IRS allows a taxpayer to exclude from income reimbursements for a liability paid by the taxpayer on behalf of related parties pursuant to distribution contracts.
The taxpayer, a U.S. corporation, is a member of a controlled group with two foreign manufactures and one other U.S. corporation (collectively the “Group”). The Group develops, manufactures, and distributes prescription drugs and other medical products. The taxpayer operates as a limited risk distributor and receives a fixed percentage of sales from the Group’s drugs. The foreign manufactures own the intellectual property of the drugs they manufacture and benefit from all remaining profits.
The Patient Protection and Affordable Care Act (ACA) imposes a branded prescription drug (BPD) fee on manufacturers or importers of BPDs for sale to certain government programs. Controlled groups generally are treated as one employer for purposes of the BPD fee under Reg. section 51.2(e) and ACA section 9008(d)(2). The taxpayer remits the BPD fee to the U.S. Treasury on behalf of the Group. In accordance with their contracts with the taxpayer, the foreign manufactures reimburse the taxpayer for the BPD fee. The taxpayer requested a ruling that the payments to the taxpayer from the foreign manufactures as reimbursement for the BPD fee was not includible in the taxpayer’s income.
The letter ruling notes that while another person’s payment of a taxpayer’s expense is includible in the taxpayer’s gross income, a taxpayer does not have income when it receives reimbursement after paying the expense of another person. The ruling also indicates that, in the second case, such payments are analogous to loans.
The ruling concludes that taxpayer shares joint and several liability for the BPD fee with the other members of the Group. The IRS notes the following facts when considering the agreement of the parties and which party bore the burden of the BPD fee:
- According to the distribution contracts, the taxpayer and its related parties agree that the foreign manufacturers would bear the economic burden of 100 percent of the BPD fee because the manufacturers hold the intellectual property associated with the BPDs and are the primary economic beneficiaries of the BPD sales;
- Taxpayer lacks “complete dominion” over the funds; and
- Taxpayer does not receive a tax benefit from making the payment, because section 275(a)(6) treats the fee as a nondeductible tax under section 275(a)(6).
Upon considering the Group’s respective businesses and contractual relationship, the IRS concludes that the taxpayer’s action of remitting the BPD fee most closely resembled that of a conduit: one paying the liability on behalf of the members of the Group and receiving reimbursement from the same. As such, the taxpayer may exclude the reimbursement from the foreign manufacturers from income.
While this private letter ruling sheds light on some of the considerations involved in determining whether to respect a conduit arrangement for a particular expense, a proper analysis on this matter must always consider the facts and circumstances of each unique taxpayer. To determine how this ruling may effect your business, contact your tax advisor.