Federal Register / Vol. 72, No. 53 / Tuesday, March 20, 2007 / Rules and Regulations 12969 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9317] 

RIN 1545–BF56 

Computer Software Under Section 

199(c)(5)(B) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final and temporary 

regulations. 

SUMMARY: This document contains final 

regulations concerning the application 

of section 199 of the Internal Revenue 

Code, which provides a deduction for 

income attributable to domestic 

production activities. The final 

regulations are necessary to provide 

guidance regarding certain transactions 

involving online software and to clarify 

the rules regarding the application of 

section 199 to certain cooperatives. The 

regulations will affect taxpayers engaged 

in certain domestic production activities 

involving computer software and 

taxpayers engaged in certain domestic 

production activities in cooperative 

form. 

DATES: Effective Date: These regulations 

are effective March 20, 2007. 

Applicability Date: For dates of 

applicability, see § 1.199–8(i)(4) and 

(i)(7). 

FOR FURTHER INFORMATION CONTACT: Paul 

Handleman or Lauren Ross Taylor, (202) 

622–3040 (not a toll-free number). 

SUPPLEMENTARY INFORMATION: 

Background 

This document amends 26 CFR part 1 

to provide rules relating to the 

deduction for income attributable to 

domestic production activities under 

section 199 of the Internal Revenue 

Code (Code). Section 199 was added to 

the Code by section 102 of the American 

Jobs Creation Act of 2004 (Pub. L. 108–

357, 118 Stat. 1418), and amended by 

section 403(a) of the Gulf Opportunity 

Zone Act of 2005 (Pub. L. 109–135, 119 

Stat. 25) and section 514 of the Tax 

Increase Prevention and Reconciliation 

Act of 2005 (Pub. L. 109–222, 120 Stat. 

345). On June 1, 2006, the IRS and 

Treasury Department published in the 

Federal Register final regulations under 

section 199 (71 FR 31268). Also on June 

1, 2006, the IRS and Treasury 

Department published in the Federal 

Register temporary and proposed 

regulations under section 199 providing 

guidance on certain transactions 

involving computer software (71 FR 

31074 and 71 FR 31128, respectively). 

Written and electronic comments 

responding to the temporary and 

proposed regulations were received. 

After consideration of the comments, 

the proposed regulations are adopted as 

amended by this Treasury decision. 

General Overview 

Section 199(a)(1) allows a deduction 

equal to 9 percent (3 percent in the case 

of taxable years beginning in 2005 or 

2006, and 6 percent in the case of 

taxable years beginning in 2007, 2008, 

or 2009) of the lesser of (A) the qualified 

production activities income (QPAI) of 

the taxpayer for the taxable year, or (B) 

taxable income (determined without 

regard to section 199) for the taxable 

year (or, in the case of an individual, 

adjusted gross income (AGI)). 

Qualified Production Activities Income 

Section 199(c)(1) defines QPAI for any 

taxable year as an amount equal to the 

excess (if any) of (A) the taxpayer’s 

domestic production gross receipts 

(DPGR) for such taxable year, over (B) 

the sum of (i) the cost of goods sold 

(CGS) that are allocable to such receipts; 

and (ii) other expenses, losses, or 

deductions (other than the deduction 

under section 199) that are properly 

allocable to such receipts. 

Section 199(c)(4)(A)(i) defines DPGR, 

in part, to mean the taxpayer’s gross 

receipts that are derived from any lease, 

rental, license, sale, exchange, or other 

disposition of qualifying production 

property (QPP) that was manufactured, 

produced, grown, or extracted (MPGE) 

by the taxpayer in whole or in 

significant part within the United 

States. Section 199(c)(5) defines QPP to 

mean: (A) Tangible personal property; 

(B) any computer software; and (C) any 

property described in section 168(f)(4) 

(certain sound recordings). 

Patrons of Certain Cooperatives 

Section 199(d)(3)(A) provides that any 

person who receives a qualified 

payment from a specified agricultural or 

horticultural cooperative shall be 

allowed for the taxable year in which 

such payment is received a deduction 

under section 199(a) equal to the 

portion of the deduction allowed under 

section 199(a) to such cooperative 

which is (i) allowed with respect to the 

portion of the QPAI to which such 

payment is attributable, and (ii) 

identified by such cooperative in a 

written notice mailed to such person 

during the payment period described in 

section 1382(d). 

Section 199(d)(3)(B) provides that the 

taxable income of a specified 

agricultural or horticultural cooperative 

shall not be reduced under section 1382 

by reason of that portion of any 

qualified payment as does not exceed 

the deduction allowable under section 

199(d)(3)(A) with respect to such 

payment. 

Section 199(d)(3)(C) provides that, for 

purposes of section 199, the taxable 

income of a specified agricultural or 

horticultural cooperative shall be 

computed without regard to any 

deduction allowable under section 

1382(b) or (c) (relating to patronage 

dividends, per-unit retain allocations, 

and nonpatronage distributions). 

Section 199(d)(3)(E) provides that, for 

purposes of section 199(d)(3), the term 

qualified payment means, with respect 

to any person, any amount that (i) is 

described in section 1385(a)(1) or (3), 

(ii) is received by such person from a 

specified agricultural or horticultural 

cooperative, and (iii) is attributable to 

QPAI with respect to which a deduction 

is allowed to such cooperative under 

section 199(a). 

Authority To Prescribe Regulations 

Section 199(d)(8) authorizes the 

Secretary to prescribe such regulations 

as are necessary to carry out the 

purposes of section 199, including 

regulations that prevent more than one 

taxpayer from being allowed a 

deduction under section 199 with 

respect to any activity described in 

section 199(c)(4)(A)(i). 

Temporary Regulations 

Section 1.199–3T(i)(6)(ii) provides 

that gross receipts derived from 

customer and technical support, 

telephone and other telecommunication 

services, online services (such as 

Internet access services, online banking 

services, providing access to online 

electronic books, newspapers, and 

journals), and other similar services do 

not constitute gross receipts derived 

from a lease, rental, license, sale, 

exchange, or other disposition of 

computer software. 

However, § 1.199–3T(i)(6)(iii) 

provides two exceptions under which 

gross receipts derived by a taxpayer 

from providing computer software to 

customers for the customers’ direct use 

while connected to the Internet will be 

treated as being derived from the lease, 

rental, license, sale, exchange, or other 

disposition of such computer software. 

Such gross receipts will be treated as 

DPGR if all the other requirements of 

section 199 are met (for example, the 

taxpayer MPGE computer software in 

whole or in significant part within the 

United States). 


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The exception in § 1.199–

3T(i)(6)(iii)(A) applies to a taxpayer that 

derives gross receipts from providing 

computer software to customers for the 

customers’ direct use while connected 

to the Internet (online software) and also 

derives gross receipts from customers 

that are unrelated to the taxpayer from 

the lease, rental, license, sale, exchange, 

or other disposition of computer 

software affixed to a tangible medium or 

downloaded from the Internet. The 

exception in § 1.199–3T(i)(6)(iii)(B) 

applies if a taxpayer derives gross 

receipts from providing online software 

and an unrelated person derives, on a 

regular and ongoing basis in the 

unrelated person’s business, gross 

receipts from the lease, rental, license, 

sale, exchange, or other disposition of 

substantially identical software to its 

customers affixed to a tangible medium 

or by allowing its customers to 

download the substantially identical 

computer software from the Internet. 

Section 1.199–3T(i)(6)(iv) defines 

substantially identical software as 

computer software that, from a 

customer’s perspective, has the same 

functional result as the online software 

and has a significant overlap of features 

or purpose with the online software. 

Section 1.199–3T(i)(6)(iv)(B) provides a 

safe harbor under which all computer 

software games are deemed to be 

substantially identical software. 

The exceptions outlined in § 1.199–

3T(i)(6)(iii) permit gross receipts 

derived from providing online software 

to be treated as gross receipts derived 

from the lease, rental, license, sale, 

exchange, or other disposition of 

software. However, because the rules for 

online software are exceptions, all other 

provisions of the temporary and final 

regulations do not necessarily apply to 

online software. Specifically, § 1.199–

3T(i)(6)(iv)(E) provides that the 

computer software maintenance 

agreement exception provided in 

§ 1.199–3(i)(4)(i)(B)(5) does not apply to 

online software. Section 1.199–

3(i)(4)(i)(B)(5) provides that a taxpayer 

may include in DPGR, the gross receipts 

derived from services performed 

pursuant to a qualified computer 

software maintenance agreement. 

Summary of Comments and 

Explanation of Provisions 

A commentator suggested that the 

online software exceptions should apply 

to transactions where access to 

computer software is provided over any 

public or private communications 

network and not just the Internet. The 

final regulations adopt this suggestion. 

A commentator suggested that the 

final regulations provide an example 

where computer software would not be 

considered substantially identical 

software. This suggestion has been 

adopted. 

Commentators noted that, in the 

future, some computer software will 

only be available over the Internet. In 

addition, newly developed computer 

software provided over the Internet may 

not have a substantially identical 

counterpart. The IRS and Treasury 

Department recognize that the computer 

software industry is evolving and 

current industry trends may result in a 

more limited applicability of the online 

software exceptions provided in the 

final regulation. However, there are 

significant differences between 

transactions which provide customers 

with access to online software and 

transactions involving the transfer of 

software to customers affixed to a 

tangible medium or by download. 

Accordingly, in order to give meaning to 

the statutory language requiring a lease, 

rental, license, sale, exchange, or other 

disposition, the online software 

exceptions have been narrowly tailored 

and are intended to apply only to gross 

receipts derived from providing 

customers access to computer software 

for the customers’ direct use while 

connected to the Internet and only when 

the taxpayer (or another person) also 

derives gross receipts from the lease, 

rental, license, sale, exchange, or other 

disposition of the computer software (or 

substantially identical software) affixed 

to a tangible medium or by download. 

The final regulations clarify that, with 

respect to online software, taxpayers are 

providing customers with access to the 

taxpayers’ software as opposed to 

actually transferring the software to 

customers either affixed to a tangible 

medium or by allowing them to 

download the computer software from 

the Internet. 

Commentators suggested that the rule 

in § 1.199–3T(i)(6)(iv)(E), precluding the 

application of the qualified computer 

software maintenance provision to 

online software, be deleted because it 

places taxpayers providing access to 

online software at a competitive 

disadvantage with taxpayers providing 

computer software to customers either 

affixed to a tangible medium or by 

allowing them to download the 

computer software from the Internet. In 

addition, commentators suggest that the 

advertising exception in § 1.199–3(i)(5) 

should be extended to include online 

software. The final regulations do not 

adopt these suggestions. As previously 

noted, the online software exceptions 

have been narrowly tailored and the IRS 

and Treasury Department do not believe 

the exceptions should be extended 

beyond gross receipts derived from 

providing customers access to computer 

software for the customers’ direct use. 

Therefore, the final regulations do not 

extend the exception for qualified 

computer software maintenance 

agreements in § 1.199–3(i)(4)(i)(B)(5) or 

the advertising exception in § 1.199–

3(i)(5) to online software. 

The final regulations in § 1.199–

3(i)(5)(ii)(B) do, however, extend the 

advertising exception to computer 

software that is provided to customers 

either affixed to a tangible medium (for 

example, a disk or DVD) or by allowing 

them to download the computer 

software from the Internet. However, the 

advertising exception only applies to 

advertising placed or integrated into 

software that is either affixed to a 

tangible medium or provided through 

download and does not apply to 

advertising incorporated into online 

software. In addition, the IRS and 

Treasury Department have clarified that, 

except as otherwise provided in 

§ 1.199–3(i)(5)(ii), gross receipts derived 

from the lease, rental, license, sale, 

exchange, or other disposition of QPP, 

a qualified film, or utilities do not 

include advertising income or productplacement income. 

A commentator expressed concern 

that the exception for qualified 

computer software maintenance 

agreements in § 1.199–3(i)(4)(i)(B)(5) 

does not apply if the taxpayer separately 

offers maintenance in subsequent years. 

The mere fact that a taxpayer separately 

offers maintenance in subsequent years 

does not preclude eligibility for the 

exception. 

A commentator interpreted the rule in 

§ 1.199–3T(i)(6)(iii)(E) as possibly 

treating gross receipts derived from the 

lease, rental, license, sale, exchange, or 

other disposition of future updates, 

cyclical releases, and rewrites of the 

underlying software as non-DPGR if the 

underlying software is online software. 

The rule in § 1.199–3T(i)(6)(iii)(E) only 

provides that the qualified computer 

software maintenance agreement 

exception does not apply to online 

software. Therefore, to the extent a 

taxpayer providing online software 

derives gross receipts from the lease, 

rental, license, sale, exchange, or other 

disposition of future updates, cyclical 

releases, and rewrites of the underlying 

software, the gross receipts are DPGR 

assuming all the other requirements of 

§ 1.199–3 are met. 

A commentator noted that Example 6 

in the temporary regulations concludes 

that the gross receipts derived from 

storage of customers’ data and telephone 

support are non-DPGR. Example 6 is 

silent as to the amount of gross receipts 


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Federal Register / Vol. 72, No. 53 / Tuesday, March 20, 2007 / Rules and Regulations 12971 

derived from the storage of customers’

data and telephone support and does 

not address whether the de minimis 

exception in § 1.199–3(i)(4)(i)(B)(6) is 

available. Numerous examples in the 

final regulations under section 199 also 

conclude that gross receipts are nonDPGR without reference to the de 

minimis exception in § 1.199–

3(i)(4)(i)(B)(6). However, assuming all 

the requirements are met, the de 

minimis exception in § 1.199–

3(i)(4)(i)(B)(6) can apply when an 

example concludes the gross receipts 

are non-DPGR. 

The IRS and Treasury Department 

received a comment letter on the 

application of section 199 to agricultural 

and horticultural cooperatives under 

§ 1.199–6 of the final regulations (71 FR 

31312) published on June 1, 2006. The 

commentator noted that the sentence in 

§ 1.199–6(h) stating that the cooperative 

may not apply section 199(d)(3) and 

§ 1.199–6 to any portion of the section 

199 deduction that is not passed 

through to its patrons is inconsistent 

with section 199(d)(3) which has no 

such limitation. These final regulations 

amend § 1.199–6(h) to remove the 

sentence. 

In addition, consistent with the 

change to § 1.199–6(h), these final 

regulations amend § 1.199–6(l) to 

remove the phrase, ‘‘To the extent a 

cooperative passes through the section 

199 deduction to a patron’’ and add the 

phrase, ‘‘by the patron.’’

The final regulations also amend 

§ 1.199–6(c) to clarify that a 

cooperative’s QPAI is computed without 

taking into account any deduction 

allowable under section 1382(b) or (c) 

(relating to patronage dividends, perunit retain allocations, and 

nonpatronage distributions). 

Effective Date 

Section 199 applies to taxable years 

beginning after December 31, 2004. 

These final regulations are applicable 

for taxable years beginning on or after 

March 20, 2007. In addition, § 1.199–

8(i)(1) provides that, in certain 

circumstances, a taxpayer may rely on 

the guidance in Notice 2005–14 (2005–

7 IRB 498), see § 601.602(d)(2), the 

proposed regulations under section 199 

that were published in the Federal 

Register on November 4, 2005 (70 FR 

67220), or the final regulations under 

section 199 that were published in the 

Federal Register on June 1, 2006 (71 FR 

31268). Regardless of which guidance a 

taxpayer applies, the taxpayer may 

apply these final regulations to taxable 

years beginning after December 31, 

2004, and before March 20, 2007. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

also has been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to this regulation, and because the 

regulation does not impose a collection 

of information on small entities, the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) does not apply. Pursuant to 

section 7805(f) of the Internal Revenue 

Code, the notice of proposed rulemaking 

preceding this regulation was submitted 

to the Chief Counsel for Advocacy of the 

Small Business Administration for 

comment on its impact on small 

business. 

Drafting Information 

The principal authors of these 

regulations are Paul Handleman and 

Lauren Ross Taylor, Office of the 

Associate Chief Counsel (Passthroughs 

and Special Industries), IRS. However, 

other personnel from the IRS and 

Treasury Department participated in 

their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Adoption of Amendments to the 

Regulations 

■ Accordingly, 26 CFR part 1 is 

amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

■ Par. 2. Section 1.199–0 is amended 

by: 

■ 1. Revising the entries for §§ 1.199–

3(i)(5)(i) and (ii), 1.199–3(i)(6)(ii) 

through (v), 1.199–6(c), and 1.199–

8(i)(4). 

■ 2. Adding a new entry for § 1.199–

8(i)(7). 

The revisions and addition read as 

follows: 

§ 1.199–0 Table of contents. 

* * * * * 

§ 1.199–3 Domestic production gross 

receipts. 

* * * * * 

(i) * * * 

(5) * * * 

(i) In general. 

(ii) Exceptions. 

(A) Tangible personal property. 

(B) Computer software. 

(C) Qualified film. 

* * * * * 

(6) * * * 

(ii) Gross receipts derived from services. 

(iii) Exceptions. 

(iv) Definitions and special rules. 

(A) Substantially identical software. 

(B) Safe harbor for computer software 

games. 

(C) Regular and ongoing basis. 

(D) Attribution. 

(E) Qualified computer software 

maintenance agreements. 

(F) Advertising income and productplacement income. 

(v) Examples. 

* * * * * 

§ 1.199–6 Agricultural and horticultural 

cooperatives. 

* * * * * 

(c) Determining cooperative’s qualified 

production activities income and taxable 

income. 

* * * * * 

§ 1.199–8 Other rules. 

* * * * * 

(i) * * * 

(4) Computer software. 

* * * * * 

(7) Agricultural and horticultural 

cooperatives. 

* * * * * 

■ Par. 3. Section 1.199–3 is amended 

by: 

■ 1. Revising paragraphs (i)(5)(i) and 

(i)(5)(ii). 

■ 2. Removing the language ‘‘(i)(5)(ii)’’

each place it appears in paragraph 

(i)(5)(iii) and adding the language 

‘‘(i)(5)(ii)(C)’’ in its place. 

■ 3. Revising paragraphs (i)(6)(ii), 

(i)(6)(iii), (i)(6)(iv), and (i)(6)(v). 

The revisions read as follows: 

§ 1.199–3 Domestic production gross 

receipts. 

* * * * * 

(i) * * * 

(5) * * * 

(i) In general. Except as provided in 

paragraph (i)(5)(ii) of this section, gross 

receipts derived from the lease, rental, 

license, sale, exchange, or other 

disposition of QPP, a qualified film, or 

utilities do not include advertising 

income and product-placement income. 

(ii) Exceptions—(A) Tangible personal 

property. A taxpayer’s gross receipts 

that are derived from the lease, rental, 

license, sale, exchange, or other 

disposition of newspapers, magazines, 

telephone directories, periodicals, and 

other similar printed publications that 

are MPGE in whole or in significant part 

within the United States include 

advertising income from advertisements 

placed in those media, but only if the 

gross receipts, if any, derived from the 


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lease, rental, license, sale, exchange, or 

other disposition of the newspapers, 

magazines, telephone directories, or 

periodicals are (or would be) DPGR. 

(B) Computer software. A taxpayer’s 

gross receipts that are derived from the 

lease, rental, license, sale, exchange, or 

other disposition of computer software 

that is MPGE in whole or in significant 

part within the United States include 

advertising income and productplacement income with respect to that 

computer software, but only if the gross 

receipts, if any, derived from the lease, 

rental, license, sale, exchange, or other 

disposition of computer software are (or 

would be) DPGR. For this purpose, 

advertising income and productplacement income mean compensation 

for placing or integrating advertising or 

a product into the computer software. 

This paragraph (i)(5)(ii)(B) does not 

extend to the exceptions provided in 

paragraph (i)(6)(iii) of this section. See 

paragraph (i)(6)(iv)(F) of this section. 

(C) Qualified film. A taxpayer’s gross 

receipts that are derived from the lease, 

rental, license, sale, exchange, or other 

disposition of a qualified film include 

advertising income and productplacement income with respect to that 

qualified film, but only if the gross 

receipts, if any, derived from the lease, 

rental, license, sale, exchange, or other 

disposition of a qualified film are (or 

would be) DPGR. For this purpose, 

advertising income and productplacement income mean compensation 

for placing or integrating advertising or 

a product into the qualified film. 

* * * * * 

(6) * * * 

(ii) Gross receipts derived from 

services. Gross receipts derived from 

customer and technical support, 

telephone and other telecommunication 

services, online services (such as 

Internet access services, online banking 

services, providing access to online 

electronic books, newspapers, and 

journals), and other similar services do 

not constitute gross receipts derived 

from a lease, rental, license, sale, 

exchange, or other disposition of 

computer software. 

(iii) Exceptions. Notwithstanding 

paragraph (i)(6)(ii) of this section, if a 

taxpayer derives gross receipts from 

providing customers access to computer 

software MPGE in whole or in 

significant part by the taxpayer within 

the United States for the customers’

direct use while connected to the 

Internet or any other public or private 

communications network (online 

software), then such gross receipts will 

be treated as being derived from the 

lease, rental, license, sale, exchange, or 

other disposition of computer software 

only if—

(A) The taxpayer also derives, on a 

regular and ongoing basis in the 

taxpayer’s business, gross receipts from 

the lease, rental, license, sale, exchange, 

or other disposition to customers that 

are not related persons (as defined in 

paragraph (b)(1) of this section) of 

computer software that—

(1) Has only minor or immaterial 

differences from the online software; 

(2) Has been MPGE by the taxpayer in 

whole or in significant part within the 

United States; and 

(3) Has been provided to such 

customers either affixed to a tangible 

medium (for example, a disk or DVD) or 

by allowing them to download the 

computer software from the Internet; or 

(B) Another person derives, on a 

regular and ongoing basis in its 

business, gross receipts from the lease, 

rental, license, sale, exchange, or other 

disposition of substantially identical 

software (as described in paragraph 

(i)(6)(iv)(A) of this section) (as compared 

to the taxpayer’s online software) to its 

customers pursuant to an activity 

described in paragraph (i)(6)(iii)(A)(3) of 

this section. 

(iv) Definitions and special rules—(A) 

Substantially identical software. For 

purposes of paragraph (i)(6)(iii)(B) of 

this section, substantially identical 

software is computer software that—

(1) From a customer’s perspective, has 

the same functional result as the online 

software described in paragraph 

(i)(6)(iii) of this section; and 

(2) Has a significant overlap of 

features or purpose with the online 

software described in paragraph 

(i)(6)(iii) of this section. 

(B) Safe harbor for computer software 

games. For purposes of paragraph 

(i)(6)(iv)(A) of this section, all computer 

software games are deemed to be 

substantially identical software. For 

example, computer software sports 

games are deemed to be substantially 

identical to computer software card 

games. 

(C) Regular and ongoing basis. For 

purposes of paragraph (i)(6)(iii) of this 

section, in the case of a newly-formed 

trade or business or a taxpayer in its 

first taxable year, the taxpayer is 

considered to be engaged in an activity 

described in paragraph (i)(6)(iii) of this 

section on a regular and ongoing basis 

if the taxpayer reasonably expects that 

it will engage in the activity on a regular 

and ongoing basis. 

(D) Attribution. For purposes of 

paragraph (i)(6)(iii)(A) of this section—

(1) All members of an expanded 

affiliated group (as defined in § 1.199–

7(a)(1)) are treated as a single taxpayer; 

and 

(2) In the case of an EAG partnership 

(as defined in § 1.199–3T(i)(8)), the EAG 

partnership and all members of the EAG 

to which the EAG partnership’s partners 

belong are treated as a single taxpayer. 

(E) Qualified computer software 

maintenance agreements. Paragraph 

(i)(4)(i)(B)(5) of this section does not 

apply if the computer software is online 

software under paragraph (i)(6)(iii) of 

this section. 

(F) Advertising income and productplacement income. Paragraph 

(i)(5)(ii)(B) of this section does not apply 

if the computer software is online 

software under paragraph (i)(6)(iii) of 

this section. If a taxpayer provides a 

customer with access to online software 

in conjunction with providing computer 

software to such customer either affixed 

to a tangible medium or by download, 

paragraph (i)(5)(ii)(B) of this section will 

only apply to compensation for the 

placement or integration of advertising 

or a product into the computer software 

transferred to such customer either 

affixed to the tangible medium or by 

download. 

(v) Examples. The following examples 

illustrate the application of this 

paragraph (i)(6): 

Example 1. L is a bank and produces 

computer software within the United States 

that enables its customers to receive online 

banking services for a fee. Under paragraph 

(i)(6)(ii) of this section, gross receipts derived 

from online banking services are attributable 

to a service and do not constitute gross 

receipts derived from a lease, rental, license, 

sale, exchange, or other disposition of 

computer software. Therefore, L’s gross 

receipts derived from the online banking 

services are non-DPGR. 

Example 2. M is an Internet auction 

company that produces computer software 

within the United States that enables its 

customers to participate in Internet auctions 

for a fee. Under paragraph (i)(6)(ii) of this 

section, gross receipts derived from online 

auction services are attributable to a service 

and do not constitute gross receipts derived 

from a lease, rental, license, sale, exchange, 

or other disposition of computer software. 

M’s activities constitute the provision of 

online services. Therefore, M’s gross receipts 

derived from the Internet auction services are 

non-DPGR. 

Example 3. N provides telephone services, 

voicemail services, and e-mail services. N 

produces computer software within the 

United States that runs all of these services. 

Under paragraph (i)(6)(ii) of this section, 

gross receipts derived from telephone and 

related telecommunication services are 

attributable to a service and do not constitute 

gross receipts derived from a lease, rental, 

license, sale, exchange, or other disposition 

of computer software. Therefore, N’s gross 

receipts derived from the telephone and 

other telecommunication services are nonDPGR. 


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Example 4. O produces tax preparation 

computer software within the United States. 

O derives, on a regular and ongoing basis in 

its business, gross receipts from both the sale 

to customers that are unrelated persons of O’s 

computer software that has been affixed to a 

compact disc as well as from the sale to 

customers of O’s computer software that 

customers have downloaded from the 

Internet. O also derives gross receipts from 

providing customers access to the computer 

software for the customers’ direct use while 

connected to the Internet. The computer 

software sold on compact disc or by 

download has only minor or immaterial 

differences from the online software, and O 

does not provide any other goods or services 

in connection with the online software. 

Under paragraph (i)(6)(iii)(A) of this section, 

O’s gross receipts derived from providing 

access to the online software will be treated 

as derived from the lease, rental, license, 

sale, exchange, or other disposition of 

computer software and are DPGR (assuming 

all the other requirements of this section are 

met). 

Example 5. The facts are the same as in 

Example 4, except that O does not sell the 

tax preparation computer software to 

customers affixed to a compact disc or by 

download. In addition, one of O’s 

competitors, P, derives, on a regular and 

ongoing basis in its business, gross receipts 

from the sale to customers of P’s substantially 

identical tax preparation computer software 

that has been affixed to a compact disc as 

well as from the sale to customers of P’s 

substantially identical tax preparation 

computer software that customers have 

downloaded from the Internet. Under 

paragraph (i)(6)(iii)(B) of this section, O’s 

gross receipts derived from providing access 

to its tax preparation online software will be 

treated as derived from the lease, rental, 

license, sale, exchange, or other disposition 

of computer software and are DPGR 

(assuming all the other requirements of this 

section are met). 

Example 6. Q produces payroll 

management computer software within the 

United States. For a fee, Q provides 

customers access to the payroll management 

computer software for the customers’ direct 

use while connected to the Internet. This is 

Q’s sole method of providing access to its 

payroll management computer software to 

customers. In conjunction with the payroll 

management computer software, Q provides 

storage of customers’ data and telephone 

support. One of Q’s competitors, R, derives, 

on a regular and ongoing basis in its 

business, gross receipts from the sale to 

customers of R’s substantially identical 

payroll management software that has been 

affixed to a compact disc as well as from the 

sale to customers of R’s substantially 

identical payroll management software that 

customers have downloaded from the 

Internet. Under paragraph (i)(6)(iii)(B) of this 

section, Q’s gross receipts derived from 

providing access to its payroll management 

online software will be treated as derived 

from the lease, rental, license, sale, exchange, 

or other disposition of computer software 

and are DPGR (assuming all the other 

requirements of this section are met). 

However, Q’s gross receipts derived from the 

fees that are properly allocable to the storage 

of customers’ data and telephone support are 

non-DPGR. 

Example 7. The facts are the same as in 

Example 6, except that R produces inventory 

computer software, not payroll management 

computer software. R’s inventory computer 

software is not substantially identical 

software as defined in paragraph (i)(6)(iv)(A) 

of this section because R’s inventory 

software, from a customer’s perspective, does 

not have the same functional result as Q’s 

payroll management computer software and 

does not have significant overlap of features 

or purpose with Q’s payroll management 

computer software. No other person provides 

substantially identical software to customers 

affixed to a compact disc or by download. 

Under paragraph (i)(6)(ii) of this section, 

gross receipts derived from providing access 

to Q’s payroll online software do not 

constitute gross receipts derived from a lease, 

rental, license, sale, exchange or other 

disposition of payroll computer software. 

Therefore, Q’s gross receipts derived from the 

payroll management computer software are 

non-DPGR. 

Example 8. S produces computer software 

games within the United States. S derives, on 

a regular and ongoing basis in its business, 

gross receipts from both the sale to customers 

that are not related to S of S’s computer 

software games that have been affixed to a 

compact disc as well as from the sale to 

customers of S’s computer software games 

that customers have downloaded from the 

Internet. S also derives gross receipts from 

providing customers access to the computer 

software games for the customers’ direct use 

while connected to the Internet (online 

software games). The computer software 

games sold on compact disc or by download 

have only minor or immaterial differences 

from the online software games, and S does 

not provide any other goods or services in 

connection with the online software games. 

Under paragraph (i)(6)(iii)(A) of this section, 

S’s gross receipts derived from providing 

customers access to its online software games 

will be treated as derived from the lease, 

rental, license, sale, exchange, or other 

disposition of computer software and are 

DPGR (assuming all the other requirements of 

this section are met). 

Example 9. The facts are the same as in 

Example 8, except S’s gross receipts also 

include advertising income from integrating 

advertisers’ logos into the computer software 

games. Under paragraph (i)(5)(ii)(B) of this 

section, for S’s computer software games sold 

affixed to a compact disc or by download, S’s 

advertising income is treated as gross receipts 

derived from the sale of the computer 

software games and, therefore, is DPGR 

(assuming all the other requirements of this 

section are met). However, under paragraphs 

(i)(5)(i) and (i)(6)(iv)(F) of this section, for S’s 

online software games, S’s advertising 

income is not derived from the lease, rental, 

license, sale, exchange, or other disposition 

of computer software and, therefore, is nonDPGR. 

■ Par. 4. Section 1.199–3T is amended 

by revising paragraphs (i)(1), (i)(2), 

(i)(3), (i)(4), (i)(5), and (i)(6) to read as 

follows: 

§ 1.199–3T Domestic production gross 

receipts (temporary). 

* * * * * 

(i) Derived from the lease, rental, 

license, sale, exchange or other 

disposition. 

(1) through (6) [Reserved]. For further 

guidance, see § 1.199–3(i)(1) through (6). 

* * * * * 

■ Par. 5. Section 1.199–6 is amended 

by: 

■ 1. Revising paragraphs (c) and (l). 

■ 2. Removing the language ‘‘qualified 

production activities income (QPAI) (as 

defined in § 1.199–1(c))’’ from 

paragraph (e) and adding ‘‘QPAI’’ in its 

place. 

■ 3. Removing the language ‘‘However, 

the cooperative may not apply section 

199(d)(3) and this section to any portion 

of the section 199 deduction that is not 

passed through to its patrons.’’ from 

paragraph (h). 

The revisions read as follows: 

§ 1.199–6 Agricultural and horticultural 

cooperatives. 

* * * * * 

(c) Determining cooperative’s 

qualified production activities income 

and taxable income. For purposes of 

determining its section 199 deduction, 

the cooperative’s qualified production 

activities income (QPAI) (as defined in 

§ 1.199–1(c)) and taxable income are 

computed without taking into account 

any deduction allowable under section 

1382(b) or (c) (relating to patronage 

dividends, per-unit retain allocations, 

and nonpatronage distributions). 

* * * * * 

(l) No double counting. A qualified 

payment received by a patron of a 

cooperative is not taken into account by 

the patron for purposes of section 199. 

■ Par. 6. Section 1.199–8 is amended 

by: 

■ 1. Revising paragraph (i)(4). 

■ 2. Adding new paragraph (i)(7). 

The revision and addition read as 

follows: 

§ 1.199–8 Other rules. 

* * * * * 

(i) * * * 

(4) Computer software. Section 1.199–

3(i)(5)(ii)(B) and (i)(6)(ii) through (v) are 

applicable for taxable years beginning 

on or after March 20, 2007. A taxpayer 

may apply § 1.199–3(i)(5)(ii)(B) and 

(i)(6)(ii) through (v) to taxable years 

beginning after December 31, 2004, and 

before March 20, 2007. 

* * * * * 

(7) Agricultural and horticultural 

cooperatives. Section 1.199–6(c) is 


erjones on PRODPC74 with RULES
12974 Federal Register / Vol. 72, No. 53 / Tuesday, March 20, 2007 / Rules and Regulations 

applicable for taxable years beginning 

on or after March 20, 2007. A taxpayer 

may apply § 1.199–(6)(c) to taxable years 

beginning after December 31, 2004, and 

before March 20, 2007. 

■ Par. 7. Section 1.199–8T is amended 

by revising paragraphs (i)(1), (i)(2), 

(i)(3), and (i)(4) to read as follows: 

§ 1.199–8T Other rules (temporary). 

* * * * * 

(i) Effective dates. (1) through (4) 

[Reserved]. For further guidance, see 

§ 1.199–8(i)(1) through (4). 

* * * * * 

Kevin M. Brown, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: March 14, 2007. 

Eric Solomon, 

Assistant Secretary of the Treasury. 

[FR Doc. 07–1354 Filed 3–19–07; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9316] 

RIN 1545–BG14 

Corporate Reorganizations; Guidance 

on the Measurement of Continuity of 

Interest 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final and temporary 

regulations. 

SUMMARY: This document contains final 

and temporary regulations that provide 

guidance regarding the satisfaction of 

the continuity of interest requirement 

for corporate reorganizations. These 

regulations affect corporations and their 

shareholders. The text of the temporary 

regulations also serves as the text of the 

proposed regulations set forth in the 

notice of proposed rulemaking on this 

subject in the Proposed Rules section in 

this issue of the Federal Register. 

DATES: Effective Date: These regulations 

are effective March 20, 2007. 

Applicability Date: For dates of 

applicability, see § 1.368–1T(e)(8)(ii). 

FOR FURTHER INFORMATION CONTACT: Lisa 

S. Dobson at (202) 622–7790 (not a tollfree number). 

SUPPLEMENTARY INFORMATION: 

Background and Explanation of 

Provisions 

The Internal Revenue Code of 1986 

(Code) provides general nonrecognition 

treatment for reorganizations described 

in section 368 of the Code. In addition 

to complying with the statutory and 

certain other requirements, to qualify as 

a reorganization, a transaction generally 

must satisfy the continuity of interest 

(COI) requirement. COI requires that, in 

substance, a substantial part of the value 

of the proprietary interests in the target 

corporation be preserved in the 

reorganization. 

On August 10, 2004, the IRS and 

Treasury Department published a notice 

of proposed rulemaking (REG–129706–

04) in the Federal Register (69 FR 

48429) (2004 proposed regulations) 

identifying certain circumstances in 

which the determination of whether a 

proprietary interest in the target 

corporation is preserved would be made 

by reference to the value of the issuing 

corporation’s stock on the day before 

there is an agreement to effect the 

potential reorganization. On September 

16, 2005, the IRS and Treasury 

Department published final regulations 

in the Federal Register (TD 9225, 70 FR 

54631) (2005 final regulations) which 

retained the general framework of the 

2004 proposed regulations but made 

several modifications in response to the 

comments received regarding the 

proposed regulations. Specifically, the 

2005 final regulations provide that in 

determining whether a proprietary 

interest in the target corporation is 

preserved, the consideration to be 

exchanged for the proprietary interests 

in the target corporation pursuant to a 

contract to effect the potential 

reorganization is valued on the last 

business day before the first date such 

contract is a binding contract (the 

signing date), if the contract provides for 

fixed consideration (the signing date 

rule). 

After consideration of comments 

relating to the 2005 final regulations, the 

IRS and Treasury Department are 

revising those regulations as set forth in 

this Treasury decision. These temporary 

regulations provide guidance for 

measuring whether the COI requirement 

is satisfied. The following sections 

specifically describe the revisions. 

A. Applicability of the Signing Date 

Rule 

For purposes of determining whether 

COI is satisfied, the 2005 final 

regulations require the consideration to 

be exchanged for the proprietary 

interests in the target corporation to be 

valued on the last business day before 

the first date such contract is a binding 

contract, if such contract provides for 

fixed consideration. As noted in the 

preamble to the 2005 final regulations, 

the signing date rule is based on the 

principle that, where a binding contract 

provides for fixed consideration, the 

target corporation shareholders can 

generally be viewed as being subject to 

the economic fortunes of the issuing 

corporation as of the signing date. 

However, if the contract does not 

provide for fixed consideration, the 

signing date value of the issuing 

corporation stock is not relevant for 

purposes of determining the extent to 

which a proprietary interest in the target 

corporation is preserved. 

These temporary regulations continue 

to apply the signing date rule where the 

contract provides for fixed 

consideration. If the contract does not 

provide for fixed consideration, the 

temporary regulations provide that the 

signing date rule is not applicable. 

Further, these temporary regulations 

clarify that where fixed consideration 

includes other property that is 

identified by value, that specified value 

is the value of such other property to be 

used in determining whether COI is 

satisfied. 

B. Definition of Fixed Consideration 

As noted above, the temporary 

regulations provide that the signing date 

rule only applies to contracts that 

provide for fixed consideration. These 

temporary regulations modify the 

definition of fixed consideration. 

The 2005 final regulations provide 

four circumstances in which a contract 

will be treated as providing for fixed 

consideration. Generally, under the 

2005 final regulations, a contract 

provides for fixed consideration if (1) 

the contract states the number of shares 

of the issuing corporation plus the 

amount of money and any other 

property to be exchanged for all 

proprietary interests in the target 

corporation; (2) the contract states the 

number of shares of the issuing 

corporation plus the amount of money 

and any other property to be exchanged 

for each proprietary interest in the target 

corporation; (3) the contract states the 

percentage of proprietary interests in the 

target corporation to be exchanged for 

stock of the issuing corporation; or (4) 

the contract states the percentage of 

each proprietary interest in the target 

corporation to be exchanged for stock of 

the issuing corporation. 

These temporary regulations combine 

the first two circumstances into one 

sentence that defines fixed 

consideration. No substantive change to 

these two definitions of fixed 

consideration is intended with this 

amendment. 

The target corporation shareholders 

are generally subject to the economic 

fortunes of the issuing corporation as of 


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