IRS ruling clarifies when TV program package is qualified film
Rev. Rul. 2013-03 reverses position in 2016 guidance
TAX ALERT |
If you like your tax law riddled with confusing application and contradictory guidance, Section 199 – Income Attributable to Domestic Production Activities rarely disappoints – both in tax court cases and IRS rulings. The most recent example is the application of the Section 199 deduction to ‘qualified films’ production.
The IRS recently issued Revenue Ruling 2018-03. At issue is the case where a corporation licenses a package of films (e.g., a television channel) to customers for a fee in the normal course of its business. The package contains films licensed to the corporation by unrelated third parties and films produced by the corporation. In addition the corporation pays license fees for distribution rights of the licensed films. Central to the rules under Section 199 is the definition of an ‘item.’ An item must be tested for its provision of qualified domestic production gross receipts (DPGR) and other combinations of items for testing are generally not allowed.
However, critical to a new Rev. Rul. 2018-3, is the regulation stating that the term ‘item’ means the property offered by the taxpayer in the normal course of the taxpayer's business for disposition to customers, if the gross receipts from the disposition of such property qualify as DPGR. The ruling goes on to focus this regulation to the above description of the corporation’s activities and favorably determines the entire ‘package’ of films can be an item. Therefore utilizing the proper tests for qualified films, which provides guidance on the determination of DPGR with specific rules for qualified film, a taxpayer may have more benefit in categorizing larger amounts of receipts from the package as DPGR.
This ruling is potentially favorable for a taxpayer under the right situation as compared to more recent technical advice memorandums (TAM). Keep in mind that TAMs have no precedential value except to a particular taxpayer, and in the following TAMs, the advice is to IRS agents auditing specific taxpayer’s Section 199 deduction. Fortunately the new ruling is appropriate guidance for all taxpayers. In TAM 201647007 and TAM 201646004 multichannel video programming distributor's described packages were not qualified film. However a portion of the taxpayer's gross receipts from packages may qualify as domestic production gross to the extent that its receipts were derived and qualified under the appropriate tests for any individual film included in packages. Therefore if the individual film meet the tests and is qualified film, each such film produced by taxpayer may be considered ‘item’ that renders DPGR. Clearly the narrowing of the definition of item in these TAMs had the effect of restricting the Section 199 benefit in comparison to the analysis in the new 2018 ruling.
Keep in mind the ruling reinforces essential guidance in applying the tests necessary for use of the deduction. Examples include:
- While using the safe harbor tests in the regulation for the “not-less-than-50-percent-of-the-total-compensation” the ruling explains it is a fraction where the numerator is the compensation paid to actors, production personnel, directors, and producers for services performed in the United States that are directly related to the films in the package and the denominator is such compensation regardless of where the film production activities were performed.
- To satisfy another of the safe harbors, direct labor and overhead for the package of films must be 20 percent or more of taxpayer’s unadjusted depreciable basis in the package of films, or 20 percent or more of the cost of goods sold of the package of films. Direct labor and overhead include the costs for any films that are treated as self-produced by the taxpayer, and do not include license fees for the films licensed from third parties. Unadjusted depreciable basis includes costs of self-produced films plus license fees X paid to acquire distribution rights in the licensed films.
- Costs reasonably attributable to transmission and distribution activities should not be included, however, in direct labor, overhead, or unadjusted depreciable basis or cost of goods sold.
Nevertheless, if the gross receipts of the package cannot meet the required tests the taxpayer can treat any individual film included in the package of films as an item. If that item meets the proper tests the gross receipts attributable to the individual film qualify as DPGR. In such situations the taxpayer cannot combine films that meet the requirements with films that do not meet the requirements.
Finally IRS (in particular the Large Business and International Division's (LB&I)) recently announced application of the new ruling to its compliance campaign focused on the Section 199 domestic production activities deduction for multi-channel video program distributors and TV broadcasters.