advo inc subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date r disallowed a deduction p claimed under sec_199 of dollar_figure for the tax_year and dollar_figure for the short tax_year r determined that p was not considered to have manufactured produced grown or extracted qualifying verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner production property under sec_199 with respect to p’s direct advertising mailings held p did not have the benefits_and_burdens_of_ownership of the direct advertising materials and is not entitled to the sec_199 deduction michael p walutes craig a raabe john r shaugnessy jr gary d yeats and scott e sebastian for petitioner donald k rogers charles e buxbaum and william t derick for respondent wherry judge this case is before the court on a petition for redetermination of deficiencies in income_tax respondent determined for petitioner’s tax_year and short tax_year the only issue for decision in this opinion in this bifurcated case is whether petitioner is entitled to a sec_199 deduction for manufactured produced grown or extracted qualifying_production_property with respect to peti- tioner’s direct advertising mailings findings_of_fact the parties’ stipulation of facts with accompanying exhibits and the stipulations of settled issues are incor- porated herein by this reference at the time petitioner filed the petition its principal_place_of_business was in con- necticut petitioner advo inc advo was the common parent of the consolidated_group advo inc subsidiaries for the tax years ending date and date and for the short taxable_year ending date on date advo was acquired by valassis commu- nications inc and continues to exist as its wholly owned subsidiary brief amici curiae was filed by mario j verdolini and ethan r gold- man as attorneys for limited brands inc and judith a mather as at- torney for meredith corp unless otherwise indicated all section references are to the internal_revenue_code_of_1986 code as amended and in effect for the taxable years at issue and all rule references are to the tax_court rule_of prac- tice and procedure there remains a second issue for resolution in a separate trial wheth- er advo is entitled to a credit pursuant to sec_41 for increasing research activities in connection with the development of internal use software verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports during and advo distributed direct mail advertising in the united_states direct mail advertisers such as advo distribute advertising material through the u s postal service usps to residential recipients who are the targeted potential customers for the products and serv- ices sold by advo’s clients the advertisers the advertising material can be either solo direct mail or cooperative direct mail for solo direct mail the printed advertising material of a single advertiser is delivered in a stand-alone envelope or as a postcard to a residential recipient for cooperative direct mail also known as a shared mail pack- age the printed advertising material for several different advertisers is consolidated into a single delivery mechanism such as an envelope or sleeve and delivered as a single unit to residential recipients this allows advo’s clients to share the advertisements’ costs of mailing and postage to reach the target consumers’ mailboxes advo’s clients are typically businesses whose products and services are used by the general population or specific subgroups thereof these businesses include supermarkets quick-serve restaurants drug stores discount and depart- ment stores home furnishing stores and other retailers print advertising companies such as newspapers regional and local mailers direct marketing firms so-called shoppers and pennysavers in the same type of business as advo compete primarily on the ability to effectively target the delivery of the client’s advertisement to the consumer house- holds with the highest propensity to purchase the product being advertised on a cost-effective basis the companies also compete on the extent to which they provide coverage the reliability of delivery and most importantly the ability to provide a satisfactory return on the advertiser’s investment either advo’s clients supply the advertising material for advo to distribute client-supplied material or advo sup- plies the materials for distribution advo-supplied mate- rial when advo supplied the advertising material advo contracted with third-party commercial printers to print it the sec_199 deductions at issue were attributable to direct mail advertising involving only the advo-supplied material advo’s shared mail packages were distributed weekly and each included a wrap and various inserts a detached verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner address label dal also known as a missing_child card was also associated with each shared mail package the dal was a card with the address of the consumer recipient and a missing child’s information printed on one side and an advertisement printed on the other side during the years at issue the wrap was a branded turnkey product known as shopwise the shopwise wrap was printed on both sides of a single sheet of paper and folded in half and then multiple inserts were loosely inserted into the wrap to form the shared mail package all in accordance with specifications defined by advo an insert was a printed advertising piece for a single advertiser advo marketed the shopwise wrap to potential customers by selling page positions on the wrap including billboard inside page and outside page as well as multipage options each wrap could accommodate advertising for one or more customers advo sold the shopwise wrap across hundreds of wrap zones nationally and each wrap zone could have a dif- ferent shopwise wrap with different advertisers there were approximately wrap zones and each one was composed of a cluster of zip codes advo developed and marketed a portfolio of advo-sup- plied inserts each of which was differentiated by a set of defined product specifications which included paper dimen- sions paper weight and bleed availability an advo client could choose to advertise on both sides of a single page insert or on an insert consisting of multiple pages advo sold advo-supplied inserts for distribution via both zip codes and advo targeting zones atz an atz is a cluster of consumers located on specific mail delivery routes averaging approximately big_number households and is smaller than a wrap zone to allow for finer targeting of marketing materials to potential consumers atzs were proprietary configurations of households developed by advo which took into account demographic and psychographic information and could target the potential buying habits of the target consumers advo had about million mailing addresses in its system advo classified its advo-supplied material as either turnkey or custom a turnkey product was a print psychographics is the study of personality values attitudes interests and lifestyles verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports product that was included in advo’s portfolio of products that met specifications defined by advo a lump sum which included the advertising services printing and distribution was billed to the client for turnkey products the pricing for turnkey products was one rate for the entire process cre- ating the advertisement producing the advertisement deliv- ering the advertisement and targeting the desired end con- sumers advo handled everything from the design of the advertisement through distribution of the turnkey product and specifications were designed to facilitate cost-efficient assembly and distribution of the shared mail packages the dal shopwise wrap and advo-supplied inserts were turn- key products a custom print product was an insert that was not part of advo’s portfolio of turnkey products because of the client’s specifications for the insert advo billed two separate charges for custom inserts one for the printing and one for the advertising and distribution we discuss infra the general process for advo’s products much of the trial was dedicated to the minutest details of the process and we by no means list every single step our intention is not to discount those important and necessary steps not mentioned but to give merely a general idea of how the cooperative mailings were produced the sales process during the years at issue advo employed around sales executives the sales force was responsible for selling advertising space in the shared mail package advo distrib- uted to million packages every week of the year the design process in varying degrees advo’s graphic print department assisted advo’s clients with the design of the advertisement graphics the graphic design requirements with respect to advo-supplied materials generally fell into three categories rough art reprint with changes and client-supplied art rough art made up to of the graphic art work with respect to turnkey products advo’s calculation of domestic pro- duction gross_receipts for the purposes of sec_199 included all receipts de- rived from advo’s lump-sum charge verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner designed by advo and it was anything from a sketch on the back of a napkin to an advertisement created from a client’s general concept for a product or service the client wanted to advertise reprint with changes made up to of the graphic art work designed by advo and involved cir- cumstances where a previously developed graphic design was reused after advo made changes such as to the coupon expiration dates or as required for a different holiday pro- motion in these two situations advo retained ownership of all intellectual_property associated with the artwork and advertisement client-supplied art made up the final to of the graphic work when advo’s clients supplied the art the client retained the ownership of intellectual_property related to that art client-supplied art still required advo’s artwork department to analyze and normalize the files in order to make sure that they were printable advo produced between big_number and big_number graphic designs per year advo employed to graphic print coordinators whose role was to coordinate among advo’s sales organization advo’s graphics personnel working on a design and the third-party printers the graphic print coordinators under- stood the graphic art applications used to create graphic designs the development of four-color photography as sup- ported by the cmyk printing and the printing process itself to ensure the best printable product according to the functional capabilities of the specific printing press advo employed to desktop artists during the years at issue the desktop artists were responsible for actually creating the advertisements using the graphic design applications on macintosh computers the desktop artists would also pre- flight all of the graphic designs before they were sent to the a sample example of one of advo’s invoices to one of its clients states we retain the copyright to all artwork and other materials that we create for you further advo states on brief that t he petitioner’s third-party printers do not transfer title to the printing plates and that petitioner’s interest in the graphic design and related pdf-x1a file does not pass to the petitioner’s clients the printer usually uses four printing plates one for each of the three subtractive primary colors cyan magenta and yellow and black for this reason the process is sometimes referred to as the four-color printing proc- ess or cmyk printing we take judicial_notice that black is represented by k for key because often black is the key printing plate which is used to position the other colors verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports third-party printer advo’s purpose for the preflight process was to ensure that the image the desktop artist saw on the computer screen would accurately print advo also employed to quality control artists who proofread the ads and reviewed the graphic design files to make sure that they met the printing specifications for the job for the client after the desktop artist created an advertisement art file and it was reviewed by the quality control artist a low-reso- lution pdf would be uploaded to the advo online graphics gallery the advertisements advo maintained a file of all the informa- tion for a client’s advertising job in a job jacket which included the order and the art work after the client approved the advertisement it was released to the printer in an adobe pdf x1a format the printing process colors were already separated in the pdf sent to the printer to view and approve the paper supply as discussed infra the printing machines used a contin- uous stream of paper which was pulled through the press from large rolls advo’s paper supply arrangement between its paper broker and its third-party printers was known in the paper and printing industries as a directed buy agree- ment pursuant to this agreement a broker a t clayton for the years at issue sold paper advo prespecified to advo’s third-party printers for use in fulfilling the printers’ con- tracts with advo the third-party printers ordered and pur- chased the paper directly from the broker and the paper was shipped directly to the printers advo’s advertisements made it one of the top print paper users in the united_states consuming approximately big_number tons of paper pur- chased pursuant to advo’s directed buy agreements each year the printers understood that absent special specific authorization from advo they were not allowed to use that paper for any of their clients but advo advo never took physical possession of the raw paper stock and did not pay for any paper until the print contract was completed and it received an invoice from the printer pdf is an acronym for portable document format it is a computer file upon which graphics and other data or information can be stored and transferred verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner advo did not guarantee payment to the broker in the event a printer defaulted on the purchase contract the printing process advo spent approximately dollar_figure million per year on its turnkey printing needs dollar_figure million of that for paper and dollar_figure million of it for printing services advo contracted with third-party printers to print the advertising material for the years at issue advo entered into printing agreements with various printers including quebecor world usa inc trend offset printing handbill printers esp shared mail acquisitions llc kar windward print star inc d b a adplexrhodes adplex inserts east and american color graphics inc the contracts each contained similar risk of loss sections an example of which provides that title to and risk of loss damage to and delay of the manufactured prod- ucts shall pass to advo upon delivery to advo’s branch facility f o b advo’s dock all mechanicals paper film plates etc not supplied by advo or its clients but used to perform the services hereunder shall remain the exclusive property of printer unless otherwise agreed in writing the third-party printers were required to maintain insur- ance with respect to all of advo’s work in progress and all materials insurance limits did not limit the printer’s liability to advo and advo was not responsible for the deductible all of the policies were to extend coverage to advo as loss payee the third-party printers that advo contracted with to print the advertising material it created for its clients used a process known as web offset lithography during this process a continuous stream of paper is pulled through the press from rolls of paper which can weigh more than one ton each the process is known as offset printing because the printing plates do not actually touch the paper instead the plates transfer ink to rubber blankets rollers that in turn transfer the image to the paper upon receipt of the electronic file the printer preflighted the file typically using computer_software after the preflight process the printer determined whether the client’s graphic design could be ganged together or combined with the cli- ent’s other graphic designs ganging involves the arrange- verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports ment of the advertisements of multiple advertisers for place- ment on the set of printer plates used with respect to a single press run when ganging is feasible the printer then typically uses the electronic file in the computer for creation of the press run printing plates advo prohibited its third- party printers from ganging jobs for the printer’s other cli- ents on the same press run used for advo’s products after the printer verifies that the imposition has been done correctly the printer makes the printing plates the plates are typically made using a computer-to-plate exposure unit which uses an infrared laser to expose or impart the image onto the plate once the plates are exposed the printer then runs the plate through an automatic processor for develop- ment and a water-attracting finisher and preservative is applied the printer generally makes four printing plates one for each of the three primary colors cyan magenta and yellow and one for black additional ink colors if any are commonly referred to as spat colors and may necessitate another printing plate and or a fifth inkwell the printer per- forms these tasks with little or no direct operational control from advo the printer inspects the plates for and corrects any defects when no defects are found or none remain the printer uses a machine to bend each plate to conform to the plate cylinder on which it will be clamped the bending machine uses anvils to bend the plates into the shape required to fit on the plate cylinder the press operator then mounts each plate on a cylinder in a separate printing unit or tower for each of the colors and loads the paper onto the press the press operator starts the press and makes adjustments to bring the press up to the proper color during this process the press operator compares print samples with a proof and adjusts the color using ink keys which control the thickness of the ink applied to each portion of the plate the color information contained in advo’s pdf files received by the printer provide instructions to the press that automatically set the ink keys near where they are needed to bring the press run initially up to color again the printer executes these manufacturing and or production steps with little active direct involvement by advo advo creates hundreds of graphic designs every day and millions of mailers every week advo’s pittsburgh facility alone processed between verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner and million wraps inserts and dals every week each wrap comprises numerous pages given this taxing weekly production cycle the number of items involved and the geographic scope of its activities advo’s close day-to-day supervision of the massive printing operation is not achieved or practically feasible advo required its third-party printers to achieve a pleasing color standard with respect to its turnkey orders and it required its clients to accept the standard for their order the pleasing color standard required that pictures look pleasing to the eye ie that food looked appetizing with- out a green cast and flesh tones look natural not too red or yellow and smooth if a client was unwilling to accept the pleasing color standard it could purchase a custom print product with a higher exacting color standard the pleasing color standard facilitated the ganging of advo’s products by minimizing in-line color conflicts during the print run the printer must also check the reg- istration of the plates registration is the alignment of the printing plates as they apply their respective colors to the portion of the image being printed if the plates are not prop- erly lined up the image will not be in focus and the color may be incorrect once the press operator was confident that the color and registration were correct then the press speed was increased and the run was completed periodically during the run the printer would examine samples of the printed product for quality review after the press run depending on the finishing requirements for the job the printer cut and or folded the individual print product into shippable packages and then shipped the product to advo designated location s the package assembly advo had shared mail processing facilities around the country where the shared mail packages were assembled the facilities ranged in size depending on the size of the market served by the facility a middle-size facility such as the one in pittsburgh pennsylvania comprised about big_number square feet and employed around associates and temporary associates the number of which would fluc- tuate according to the season and workload during the years verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports at issue advo’s processing facilities used large pieces of muller martini manufactured equipment known as muller 227s and alphaliners these were used to group the wraps and inserts into shared mailed packages these machines with a cost for new alphaliners exceeding dollar_figure have a series of hoppers in which wraps or inserts are placed then the machine collates the wraps and inserts into a shared mail package each machine requires a number of people with each person maintaining inserts for three or four hop- pers optimally the muller could process about big_number packages per hour and the alphaliner could process about big_number packages per hour advo spent dollar_figure million a year transporting materials to the usps advo spent approximately dollar_figure million in post- age per year during the years at issue because advo wanted to achieve the largest possible discount from the usps it limited the amount of handling required by the usps in delivering advo’s packages to that end advo prepared the dals in the delivery route walk sequence of each postal carrier which enabled that postal carrier to deliver advo’s shared mail packages in the sequence of the residences as they appeared on the carrier’s route the postal carrier would have a stack of advo’s shared mail packages and an ordered stack of the dal cards at each address he would pull the dal card and associate it with a shared mail package for delivery expert report-c clint bolte advo engaged c clint bolte to describe the customary working relationship between print buyers and printers the six steps that are generally performed for commercial printing and his analyses of the benefits and burdens of advo’s printing process mr bolte has a bachelor of indus- at trial respondent objected to this report as well as the rebuttal report also written by mr bolte discussed infra respondent argues that the re- ports do not assist the trier of fact and constitute legal arguments as such they constitute arguments that require the court to address its gate- keeper function and determine the proper weight to be accorded to the con- clusions of the bolte reports see generally 700_f3d_428 9th cir esgar corp v commissioner tcmemo_2012_35 slip op pincite citing 509_us_579 fed r evid and and kumho verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner trial engineering degree from the georgia institute of tech- nology and a master of business administration degree from the colgate darden graduate school of business administra- tion at the university of virginia he has been a print consultant to the printing industry since working with commercial printing organizations regarding technology best practices of the business trade customs and manufacturing management audits as well as serving as an expert witness for commercial printing matters mr bolte concluded that advo exercised a comprehensive and unique level of control_over the entire production of their printed direct mail products as a result of their comprehensive policies and processes advo exercised an uncommon level of control even over that portion of the process during which a third party printer fulfilled its assigned role of printing the direct mail piece in accordance with advo’s detailed specifications expert report-raymond j prince respondent engaged raymond j prince to opine on the printing practices involved in the production of direct mail advertising during the years at issue and used by the printers advo contracted with mr prince has an associate of applied science degree and a bachelor of science degree in printing management from the rochester institute of tech- nology and a master of science degree in printing manage- ment from south dakota state university he has worked in the printing industry for the past years serving clients in the public and private sectors mr prince’s report gives a statistical overview of the printing industry provides a brief summary of the direct tire co v carmichael 526_us_137 appeal filed 10th cir date mr bolte’s testimony explained that the report represented his own findings my opinions concerning the elements facts of this case relative to the printing industry norm and relative to advo’s production process from graphic design all the way through we find his testimony credible and overrule respondent’s objection the court evaluates expert opinions in the light of each expert’s dem- onstrated qualifications and all other evidence in the record see 86_tc_547 we are not bound by an expert’s opinions and may accept or reject an expert opinion in full or in part in the exercise of sound judgment see 304_us_282 parker v commissioner t c pincite verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports mail advertising business and describes the four phases of the direct mail advertising business the report then focuses on printers generally including their production financial and operational responsibilities the report ends with a listing of ways printers can increase profitability rebuttal report-c clint bolte advo also engaged mr bolte to write a rebuttal report to mr prince’s report mr bolte criticized mr prince’s report because it failed to recognize advo’s niche in the direct mailer market and ignored the unique traits of advo’s busi- ness model he emphasized the job-specific and individual- ized as compared to the generic work done by advo and the broader scope of service and production supervision and control of all aspects of the work he explained that t he cradle-to-grave nature of advo’s highly standardized shared mail product as compared to the generic direct mail circular as referenced but not even described by mr prince was a vitally important point that is missing in his report mr prince’s report is of little value to the court’s analysis because it ignores the industry reality that a direct mailer like advo who supplies the printed product as part of a direct mail contract must successfully deliver the printed product to the mail- box of the intended recipient or the direct mailer has not supplied the printed product purchased by its client according to mr bolte’s rebuttal report advo’s comprehen- sive policies and processes allowed it to exercise an uncommon level of control even over the process during which a third-party printer fulfilled its assigned role of printing the direct mail piece in accordance with advo’s detailed specifications rebuttal report-raymond j prince respondent’s expert mr prince also prepared a rebuttal report he focused on advo’s factual claims regarding the uniqueness of their product and integrated delivery and tar- geted marketing service he contrasted advo’s product to that of other print producers and found in his opinion few if any truly unique qualities he concluded that advo interacted with its printers in a manner not dissimilar to those of many print customers and consumers in short mr prince concluded that the printing was done by the printers who produced the tangible_personal_property product using verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner advo or advo customer supplied pre-press intangibles and not by advo brief amici curiae of limited brands inc and meredith corp on date the court granted limited brands inc and meredith corp ’s motion for leave to file a brief as amici curiae and filed the brief in the brief the amici curiae express support for the examples set forth in sec_1 f income_tax regs discuss the application of the sec_263a benefits and burdens test argue for the applica- tion of 114_tc_1 aff ’d 273_f3d_875 9th cir in this case and dispute respondent’s application of the factors set forth in 77_tc_1221 respondent submitted a reply brief to the brief of the amici curiae and advo submitted a reply brief to respondent’s reply i introduction to sec_199 opinion sec_199 enacted as part of the american_jobs_creation_act_of_2004 ajca pub_l_no sec_102 sec_118 stat pincite is in effect for tax years beginning after date sec_199 commonly referred to as the domestic_production_deduction allows a taxpayer to deduct subject_to a limitation based on wages paid a speci- fied percentage of the lesser_of either its qualified_production_activities_income or taxable_income sec_199 and b sec_199 was intended to stimulate job cre- ation in the united_states and strengthen the economy see 136_tc_195 the name of the ajca and the statute’s wage limitation on the amount of the deduction under sec_199 indicate that congress intended that sec_199 create jobs in the united_states and otherwise strengthen the u s economy the blue_book from the joint_committee on taxation explained that the congress was of the view that a reduced tax burden on domestic manufactur- ers will improve the cash_flow of domestic manufacturers and make investments in domestic manufacturing facilities more verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports attractive such investment will assist in the creation and preservation of u s manufacturing jobs staff of j comm on taxation general explanation of tax legislation enacted in the 108th congre sec_170 j comm print for the years at issue sec_199 allows a taxpayer to deduct an amount equal to of the taxpayer’s qualified_production_activities_income for the year the amount of the deduction cannot exceed of the taxpayer’s taxable_income for the year and is also limited to of the w-2_wages of the taxpayer for the taxable_year sec_199 and b for the purposes of this section qualified_production_activities_income means the excess if any of the taxpayer’s domestic_production_gross_receipts dpgr over the cost_of_goods_sold and other expenses properly allocable to such gross_receipts sec_199 we discuss the concept of dpgr in more detail infra advo contends that its gross_receipts attributable to its printed direct mail advertising and distribution products qualify as domestic_production_gross_receipts respondent counters that because advo contracted its actual printing out to third-party printers it did not manufacture any quali- fying production property in order for the gross_receipts advo received from the sale of its advertising mail packages to qualify as dpgr the mail package must be determined to be qualified production property manufactured in the united_states by advo therefore the critical issue in this case is whether advo manufactured the advertising mailing pack- ages or produced only intangible_property used by printers to produce tangible_personal_property in the form of the adver- tising mail packages the broad issue confronted here is both of the years at issue began before the phase-in increased the amount of the deduction see sec_199 as an initial matter the court notes that at a minimum the original advo electronic file for each print job constitutes qualifying_production_property as defined in sec_199 or b as either computer_software or tangible_personal_property manufactured and or produced by advo courts have frequently reached conflicting results in their classification of electronic files software etc as tangible or intangible for sales and use_tax and investment_credit purposes compare chittenden trust co v king a 2d vt with bank of vt v united_states a f t r 2d ria ustc cch para d vt 90_tc_74 and 108_tc_358 verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner how sec_199 applies to u s_corporations that manufac- ture products through agreements with contract manufac- tures that subject is an issue of first impression in this court respondent is in a real sense a stakeholder in this dispute the printed advertising materials were manufactured and produced by someone in the united_states and that someone is entitled to the sec_199 deduction to the extent they otherwise meet the requirements of that section here the question is whether advo or the contract printer is the appropriate recipient as only one of them may claim the credit as to each item sold sec_199 sec_1 the problem is that advo unlike some printers or publishers pursuant to advo’s customer and or printer contracts never sold leased rented li- censed exchanged or otherwise_disposed_of the prepress electronic file advo instead elected to retain ownership thereof and used the file as a tool for the manufacturing and producing of the mailing packages adver- tising materials therefore the electronic files themselves do not constitute or generate domestic_production_gross_receipts for purpose of determining a sec_199 deduction we also note that the deduction is limited by sec_199 to of the w-2_wages of the taxpayer for the taxable_year there is no evidence in the record that advo’s approximately sales executives were employ- ees whose wages were reported on forms w-2 wage and tax statement or perhaps commission-based sales persons whose compensation was re- ported on forms 1099-misc miscellaneous income the to graphic print coordinators the to desktop artists the numerous associates and temporary associates at each of the mail processing facilities and the to quality control artists may well have been form_w-2 employ- ees because we do not find infra that they or advo actually produced any qpp this has no effect on our holding however had this case come out the other way and had it been disputed advo would have borne the burden of proving that its employees were form_w-2 employees see sec_199 a somewhat similar problem involving houdini inc a producer of gift baskets consisting of food and alcoholic products produced by third parties and gift baskets and cardboard or styrofoam void fillers also manufactured by third parties according to houdini’s specifications was recently ad- dressed in 945_fsupp2d_1110 c d cal we note that opinions of a u s district_court do not constitute binding precedent in this court even so we see no need to distinguish dean given the factually specific nature of the benefits and burdens test discussed infra sec_199 was amended by the tax relief and health care act of pub_l_no div a sec_401 sec_120 stat pincite effective continued verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports f income_tax regs if advo is entitled to the deduc- tion a second question arises namely the amount of domestic_production_gross_receipts attributable to and derived from the lease rental license sale exchange or other_disposition of qualifying_production_property as opposed to income derived for providing services of course if advo is entitled to the deduction it may well be a larger deduction than if the printer is the entitled party ii dpgr sec_199 allows the taxpayer a deduction computed by multiplying an applicable_percentage here by the lesser_of the taxpayer’s qualified_production_activities_income qpai resulting from domestic_production activities or the taxpayer’s taxable_income sec_199 qpai is computed by determining the taxpayer’s dpgr and then reducing the dpgr by the cost_of_goods_sold and other expenses deduc- tions and losses computed without regard to the sec_199 for tax years beginning after date id sec_401 this amendment inserted a new sec_199 and redesignated what had pre- viously been sec_199 as sec_199 id sec_401 the sec_199 regulations apply for taxable years beginning on or after date sec_1_199-8 income_tax regs for taxable years begin- ning on or before date taxpayers may apply sec_1_199-1 through income_tax regs provided they apply all provisions id for taxables years beginning in between date and date taxpayers may apply sec_1_199-1 through income_tax regs id but a taxpayer whose taxable_year began before date may choose to rely on notice_2005_14 2005_1_cb_498 or the proposed_regulations id advo claimed a deduction based on the dpgr derived from its direct mail advertising business those receipts included inter alia payment for the production of the electronic computer file transmitted to the contract printer review and monitoring of the printing cutting and folding process operation of the shared mail processing facilities including the muller 227s and alphaliners to group the wrap and inserts into shared mail packages and the selection of mail recipients using advo’s proprietary demographic wrap zone and atz information because some elements of this turnkey product such as sorting packaging and mailing may constitute a service rather than manufacturing or production an allocation of receipts might be necessary however as we have concluded advo did not have dpgr and is not entitled to a sec_199 deduction we need not address this issue here see generally h_r conf rept no pincite ndollar_figure u s c c a n verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner deduction that are properly allocable to dpgr sec_199 sec_199 defines domestic_production_gross_receipts which are subject_to certain enumerated exceptions in sec_199 as the gross_receipts of the taxpayer which are derived from- i any lease rental license sale exchange or disposition of- i qualifying_production_property qpp which was manufactured produced grown or extracted mpge by the taxpayer in whole or in significant part within the united_states ii any qualified_film produced_by_the_taxpayer or iii electricity natural_gas or potable water produced by the tax- payer in the united_states ii in the case of a taxpayer engaged in the active_conduct of a construction trade_or_business construction of real_property performed in the united_states by the taxpayer in the ordinary course of such trade_or_business or iii in the case of a taxpayer engaged in the active_conduct of an engineering or architectural services trade_or_business engineering or architectural services performed in the united_states by the taxpayer in the ordinary course of such trade_or_business with respect to the construction of real_property in the united_states dpgr includes gross_receipts from qpp that was manufac- tured produced grown or extracted mpge in the united_states sec_199 longino v commissioner tcmemo_2013_80 at in order to determine dpgr the taxpayer may use any reasonable method that is satisfactory to the secretary based on all of the facts and circumstances to determine whether gross_receipts qualify as dpgr on an item-by-item basis and not for example on a division-by-division product line-by- product line or transaction-by-transaction basis sec_1_199-3 income_tax regs the regulations also state that t he term item means the property offered by the tax- payer in the normal course of the taxpayer’s business for lease rental license sale exchange or other_disposition sec_1_199-3 income_tax regs advo’s broadly defined industry is direct mail advertising advo specializes in coordinating the entire process from the initial design of the artwork to delivering the printed material to the targeted consumers the primary product produced in this industry is the printed advertisements verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports sec_199 defines qpp as tangible_personal_property any computer_software and any property described in sec_168 sound_recordings tangible_personal_property is any tangible_property other than land real_property com- puter software sound_recordings qualified films and elec- tricity natural_gas or potable water sec_1_199-3 income_tax regs iii manufactured congress did not define manufacture in the code how- ever it did direct the secretary to prescribe such regulations as are necessary to carry out the purposes of this section sec_199 on date congress as an aspect of the gulf_opportunity_zone act of pub_l_no sec_403 sec_119 stat pincite directed the secretary to includ e regulations which prevent more than taxpayer from being allowed a deduction under this section with respect to any activity described in subsection c a i the secretary in response promulgated sec_1 e income_tax regs which defines manufactured pro- duced grown or extracted mpge to include manufac- turing producing growing extracting installing developing improving and creating qpp making qpp out of scrap sal- vage or junk material as well as from new or raw material by processing manipulating refining or changing the form of an article or by combining or assembling two or more arti- cles the regulation further states that when the taxpayer contracts with an unrelated third party for the manufac- turing of its products the taxpayer must have the benefits_and_burdens_of_ownership of the qpp under federal_income_tax principles during the period the mpge activity occurs sec_1_199-3 income_tax regs neither party chal- lenges the validity of the regulations nor that the benefits and burdens standard should be applied in this case and we note that the commissioner’s regulatory efforts are gen- erally entitled to the same chevron standard as those of any other agency 136_tc_373 citing mayo found for med educ research v united_states u s ll 131_sct_704 verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner the initial interim guidance to taxpayers on sec_199 released by the treasury on date explains that the benefits_and_burdens_of_ownership standard under fed- eral income_tax principles is based on the principles under sec_936 and sec_263a notice_2005_14 sec_3 2005_1_cb_498 the final sec_199 regulations do not specifically adopt the code sections mentioned in the interim guidance for the benefits and burdens test nor do they abandon the standard discussed in the interim guidance see sec_1 f income_tax regs the only mention of the definition of taxpayer in the prologue to the final regulations explains that o ne commentator suggested a simplifying convention to determine which party to a contract manufacturing arrangement has the benefits_and_burdens_of_ownership under federal_income_tax principles the com- mentator requested that the final regulations permit unrelated parties to a contract manufacturing arrangement to designate through a writ- ten and signed agreement between the parties which of them shall be treated for purposes of sec_199 as engaging in mpge activities con- ducted pursuant to the arrangement the final regulations do not adopt the commentator’s suggestion the irs and treasury_department con- tinue to believe that the benefits_and_burdens_of_ownership must be determined based on all of the facts and circumstances and a designa- tion of benefits and burdens would not be appropriate t d 2006_1_cb_1063 but cf infra note this discussion is enlightening because it highlights the importance of the fact-specific benefits and burdens test for each individual situation also thi sec_15 the court recognizes that sec_199 is not the only code section that with respect to property contains the phrase manufactured produced grown or extracted sec_954 which defines the term foreign_base_company_sales_income for the purposes of subpt f inclusions also con- tains the phrase as do for example sec_904 sec_971 and sec_993 and d c the treasury_department has previously issued regulations concerning sec_954 including guidance on the manufacturing producing growing or extracting language sec_1_954-3 income_tax regs and we have had cause to interpret these and other relevant regula- tions and statutes over the years see eg 95_tc_7 sec_993 and noting sec_1_993-3 in- come tax regs which addressed contract manufacturing supplemented by tcmemo_1991_363 91_tc_131 sec_993 59_tc_338 sec_954 bausch lomb inc v commissioner t c continued verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports discussion explicitly states that the irs and the treasury_department continue to believe in the benefits and burdens standard implying that the original connection of the test to sec_936 and sec_263a is still relevant the predecessor to sec_936 was enacted to ease the burden of double_taxation american companies faced when operating in u s possessions and to encourage american business to invest in the u s possessions see 116_tc_308 aff ’d 295_f3d_118 1st cir sec_936 allows a credit against federal income taxes it requires that the american company be in an active_conduct_of_a_trade_or_business within a possession in order to avail itself of the tax_credit sec_936 while the test for an active_conduct_of_a_trade_or_business including situations underlying a manufac- turing contract is different from the benefits and burdens test it has similar relevant factors a taxpayer actively conducts a trade_or_business in a u s possession only if it participates regularly continually extensively and actively in the management and operation of its profit-motivated memo sec_954 on the contract manufacturing issue those regulations reach a different result from that reached with respect to the sec_199 regulations although the statutory language is the same or simi- lar in explanation of this apparent contradiction when treasury issued the sec_199 regulations the preamble specifically stated c ase law and other precedent under sec_954 are not relevant for purposes of the sub- stantial-in-nature requirement under sec_199 nor are they relevant for purposes of determining whether an activity is an mpge activity under sec_199 t d 2006_1_cb_1063 by adopting these regula- tions treasury clearly intended a different interpretation of these terms further in sec_199 congress specifically tasked the secretary with pro- mulgating regulations which before mayo found for med educ re- search v united_states u s ll 131_sct_704 would have been classified by tax specialists as legislative regulations that prevent more than taxpayer from being allowed a deduction under sec_199 sec_199 this same concern does not seem to be present in sec_954 nor did congress give the secretary a similar instruction in addition congress specifically intended to exclude from sec_954 cases where any significant amount of manufacturing major assembling or construction ac- tivity is carried on with respect to the product by the selling corporation s rept no pincite 1962_3_cb_703 again no similar concern appears to have existed with respect to sec_199 verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner activity in that possession medchem p r inc v commis- sioner t c pincite sec_263a requires the capitalization of expenses in relation to the production of tangible_property in general a taxpayer is not considered to be producing the tangible prop- erty unless it is an owner of the property sec_1 263a- a ii income_tax regs the sec_263a regulations define the owner based on all of the facts and cir- cumstances including the various benefits_and_burdens_of_ownership vested with the taxpayer a taxpayer may be considered an owner of property produced even though the taxpayer does not have legal_title to the property sec_1_263a-2 and b income_tax regs as the court_of_appeals for the ninth circuit noted in addition sec_263a provides that ‘ t he taxpayer shall be treated as producing any property produced for the taxpayer under a contract with the taxpayer’ suzy’s zoo v commissioner f 3d pincite but this is not necessarily so under sec_199 note the similarity of the sec_263a regulation dis- cussed above to sec_1_199-3 income_tax regs in which the sec_199 test asks whether the taxpayer has the benefits_and_burdens_of_ownership however as the amici curiae point out the sec_263a owner test is arguably broader that the sec_199 benefits and burdens test because the sec_263a test asks whether the taxpayer is an owner of the property while the sec_199 test requires a finding that the taxpayer is the owner of the prop- erty and has the benefits_and_burdens_of_ownership during the period of the mpge activity sec_1 263a- a ii a e f income_tax regs although this may seem like a distinction without a difference for rea- sons discussed infra it stands to reason that there may be more than one owner of sec_263a property and more than one taxpayer may have the benefits_and_burdens_of_ownership while only one taxpayer may have the benefits_and_burdens_of_ownership under sec_199 as discussed above the policy motivating the enactment of sec_199 was to encourage domestic manufacturing and create jobs in the united_states sec_263a was enacted as part of the tax_reform_act_of_1986 pub_l_no sec_803 stat pincite to address what was per- continued verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports a benefits and burdens the intent of sec_199 was to encourage domestic manu- facturing and it was intended that only one taxpayer may claim the deduction for the product manufactured in the event as is the case here where one taxpayer pursuant to a contract performs a qualifying production activity with another taxpayer then only the taxpayer that has the bene- fits and burdens of ownership of the qpp under fed- eral income_tax principles during the period in which the qualifying activity occurs is treated as engaging in the quali- fying activity sec_1_199-3 income_tax regs ceived as two significant problems concerning the expense capital expendi- ture boundary first the existing rules may allow costs that are in reality costs of pro- ducing acquiring or carrying property to be deducted currently rather than capitalized into the basis of the property and recovered when the property is sold or as it is used by the taxpayer this produces a mismatching of expenses and the related_income and an unwarranted deferral of taxes second different capitalization_rules may apply under present law depending on the nature of the property and its intended use these differences may create distortions in the allocation of eco- nomic resources and the manner in which certain economic activity is or- ganized i n order to more accurately reflect income and make the income_tax system more neutral a single comprehensive set of rules should govern the capitalization of costs of producing acquiring and holding property s rept no pincite 1986_3_cb_1 see also 600_f3d_121 2d cir rev’g tcmemo_2009_9 therefore congress necessarily intended sec_263a to have a broad sweep in order to capture the costs of producing acquiring and carrying of property and courts including this one have interpreted this section broadly see suzy’s zoo v commissioner 273_f3d_871 9th cir aff ’g 114_tc_1 112_tc_14 real_estate_taxes had to be capitalized under sec_263a as indirect_costs of producing property even though property was not developed 104_tc_207 costs of meeting with government officials obtaining building per- mits and drafting architectural plans were development costs amounting to production under sec_263a carpenter v commissioner tcmemo_1994_289 construction costs incurred by building contractor for an unsold home had to be capitalized under sec_263a because the home was pro- duced by the contractor the commissioner now recognizes that in contract manufacturing re- lationships each party as in this case will often have some of the benefits_and_burdens_of_ownership consequently the commissioner the taxpayer verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner advo directs the court’s attention to 114_tc_1 a case whose facts seem at first glance to be very close to the case at hand in that case this court held that a corporation which developed cartoon char- acters for its line of paper products and then contracted with independent printing companies was the owner of the paper products through production and until they were sold for the purposes of sec_263a id pincite the printers in suzy’s zoo would receive original drawings photograph the drawings create proofs and then use their own ink and paper to print the products id pincite respondent argues that suzy’s zoo involving a sec_263a dispute is not determinative of the sec_199 issue here on date the treasury_department issued proposed rules that included a preamble stating while sec_199 sec_263a and sec_936 all have benefits and burdens standards the standard under sec_199 is not the same as those under sec_263a and sec_936 the determination of whether a tax- payer is considered the owner is based on all of the facts and cir- cumstances including the various benefits_and_burdens_of_ownership vested with the taxpayer because the standard under the sec_263a regulation is broad it has been interpreted to allow two taxpayers to be considered the producer of the same property compare for example 114_tc_1 aff ’d 273_f3d_875 9th cir and golden gate litho v comm’r t c memo notice of proposed rulemaking and notice of public hearing fed reg date and ultimately the courts may expend significant resources to determine which party may claim the deduction i r s lb_i directive lb i-04- date in recognition of the cost of such determinations the acting commissioner of the irs’ large business and international di- vision has instructed his examiners not to challenge a taxpayer’s claim to have the benefits and burdens for a sec_199 deduction if that taxpayer provides a certification executed by both parties designating the party who is to receive the sec_199 deduction an acceptable form of certification is included as an exhibit to the guidance that form included a counterpart written certification that it did not claim the deduction for any taxable_year governed by the contract id while expressly stating that the guid- ance provided is not an official pronouncement of law and cannot be used cited or relied on as such id the commissioner’s policy as long as it remains in effect can resolve in advance cases like this one it also high- lights the factually intensive nature of the inquiry of determining to whom the benefits_and_burdens_of_ownership belong when both parties to a con- tract manufacturing relationship may potentially claim the sec_199 deduc- tion verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports we are aware that the court has previously been unpersuaded by a preamble to regulations see 118_tc_1 ndollar_figure in addition to the obvious fact that these documents also are not items of legis- lative history these documents are afforded little weight in this court citing 73_tc_1121 n suffice it to say that we never have under- stood the preamble to proposed_regulations to be preceden- tial we are not bound by the preamble but because it is an agency’s interpretation of its statute we apply the standard enunciated by the supreme court in 323_us_134 therefore respondent is entitled to at least the lowest level of deference in interpreting his own regulations and their statutes see 533_us_218 we noted supra that sec_263a is an inclusive section and more than one taxpayer can be the owner of the prop- erty sec_199 is a section that allows a deduction deduc- tions and credits are a matter of legislative grace and tax- payers must prove entitlement to the deductions and credits claimed rule a 503_us_79 94_tc_733 in 533_us_218 the supreme court recognized that there are various types of agency pronouncements that may be entitled to different levels of deference and that the lowest level of deference skidmore deference has continuing vitality see id pincite chevron did nothing to eliminate skidmore’s holding that an agen- cy’s interpretation may merit some deference whatever its form given the ‘specialized experience and broader investigations and information’ avail- able to the agency quoting 323_us_134 see also 133_tc_202 ndollar_figure aff ’d 679_f3d_1109 9th cir the supreme court has established a two-prong test for determining whether to afford an agency pronouncement chevron_deference mead corp u s pincite we hold that administrative implementation of a particular statutory provision qualifies for chevron_deference when it appears that congress delegated authority to the agency generally to make rules car- rying the force of law and that the agency interpretation claiming def- erence was promulgated in the exercise of that authority see also 558_f3d_903 9th cir 129_tc_131 commissioner’s inter- pretation of a statute in a revenue_ruling is entitled to some deference ie consideration by this court william j wilkins implications of home concrete aba sec of tax’n news q summer verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner under sec_199 the alleged manufacturer must establish that it is the only taxpayer who may be deter- mined to be the owner of the property with the benefits_and_burdens_of_ownership consequently we find that although the factors used to determine ownership under sec_263a are helpful in determining ownership under sec_199 we are not bound in applying sec_199 by the holding in suzy’s zoo we agree with respondent that congress did not intend for sec_199 to be broadly inclusive in deter- mining the owner of property in suzy’s zoo v commissioner t c pincite we noted that unlike the test in sec_199 the test in sec_263a does not focus specifically on who bore the benefits_and_burdens_of_ownership when the item was manufac- tured and or produced instead the court stated petitioner focuses on the fact that the printers bear the risk of loss during the printing process we do not find this fact dispositive as to who owns and thus produces the paper products the identification of the owner of property for purposes of the unicap_rules does not nec- essarily rest on who bears the risk of loss when the product is fabricated or assembled or for that matter on who actually turns the screws or hammers the nails into the product the owner of property must be iden- tified from the facts and circumstances of the case see sec_1 263a- a ii income_tax regs and who bears the risk of loss is merely one factor to consider for whatever reason treasury created two distinctly different tests for sec_263a purposes and sec_199 purposes while this is complicating and not totally consistent with legislative_history and treasury’s interim guid- ance which as previously noted provides that sec_199 is based on the principals of sec_936 and sec_263a we do not conclude it is invalid as alluded to supra neither party challenges the regulations and in the light of mayo found u s ll 131_sct_704 we agree the amici curiae note pincite of their brief that the court found as a factual matter in suzy’s zoo v commissioner t c pincite that the tax- payer was the only ‘owner’ of the greeting cards under sec_263a al- though the sec_263a test and the sec_199 test are very similar each test is very fact specific and the result in one case is not necessarily dispositive in another similar but factually different case the amici contend that the party that engages the printer and the printer can both be ‘producers’ but that this does not mean there can be two owners the court_of_appeals for the ninth circuit in affirming suzy’s zoo explained although the printers use their own supply of paper in producing the greeting cards and during the printing manufacture and production bear the risk of loss until shipment of the printed product suzy’s zoo is the owner of the cards from the beginning stage of production due to the degree of control it exercises over the manufacturing process therefore suzy’s zoo is a ‘pro- continued verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports b benefits and burdens test for sec_199 the examples in the sec_199 regulations shed some light on the factors that the irs and treasury find relevant in determining which taxpayer had the benefits_and_burdens_of_ownership during manufacture and or production of par- ticular interest to this case is example of sec_1 f income_tax regs in this example x designs machines and contracts with y an unrelated_person to manufacture the machines x owns the intellectual_property attributable to the design and y is allowed to use that property only to manufacture x’s machines y has no right to independently exploit the intellectual_property y controls the details of the manufacturing process bears the risk of loss or damage during manufacturing has legal_title to the machines during manufacturing and enjoys the economic gain or bears the loss from the sale of the machines measured by the dif- ference between y’s costs and the fixed contract_price on these facts example explains that y had the benefits_and_burdens_of_ownership during production caselaw has also developed factors for the benefits_and_burdens_of_ownership test with respect to other sections of the code the parties each cite and discuss the factors of grodt mckay realty inc v commissioner t c pincite and we find these factors plus the sec_936 test are useful in determining whether advo had the benefits and burdens of the printed advertisements while they were being printed the factors we use to determine the benefits_and_burdens_of_ownership under sec_199 for the purposes of this case are whether legal_title passes how the parties treat the transaction whether an equity_interest was acquired whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments whether the right of possession is vested in the purchaser and which party has control of the property or process which party pays the property taxes which party bears the risk of loss or dam- ducer’ under sec_263a suzy’s zoo v commissioner f 3d pincite em- phasis added in this case we have concluded as a factual matter that the degree of manufacturing control was not equivalent to that in suzy’s zoo and that advo was not the only owner verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner age to the property which party receives the profits from the operation and sale of the property and whether advo actively and extensively participated in the manage- ment and operations of the activity id see also sec_936 116_tc_172 as discussed supra both the prologue to the proposed_regulations and the prologue to the final regulations explain that the benefits and burdens during manufacture and or production standard is based on all of the facts and cir- cumstances of each particular case we agree and also note that no one factor is determinative c application of the benefits and burdens test legal_title according to 114_f2d_706 6th cir rev’g and remanding 38_bta_43 passage of title is perhaps the most conclusive cir- cumstance in determining the owner of the property for fed- these are not the only factors that may be considered in the benefits and burdens test which is fact intensive for examples of other factors that the irs has indicated may be relevant in determining which party had the benefits_and_burdens_of_ownership see the guidance for exam- iners on sec_199 benefits_and_burdens_of_ownership analysis in con- tract manufacturing arrangements released on date by the large_business_and_international_division i r s lb_i directive lb i- date many of the factors focused on by the guidance are addressed in this opinion we mention these factors not to suggest that this guidance is persuasive or controlling but rather to illustrate how the factors we use are not exclusive in this particular case they are suffi- cient for us to determine the benefits_and_burdens_of_ownership the guidance focuses on three areas it first looks to the terms of the contract did the taxpayer have title to the work in process did the taxpayer have risk of loss over the work in process and was the tax- payer primarily responsible for insuring the work in process then it looks to the production activities did the taxpayer develop the qualifying ac- tivity process did the taxpayer exercise oversight and direction over the employees engaged in the qualifying activity did the taxpayer con- duct more than of the quality control tests while the qualifying activ- ity was occurring and finally the guidance looks to the economic risks was the taxpayer primarily liable under the make-good provisions of the contract did the taxpayer provide more than based on cost of the raw materials and components used to produce the property did the taxpayer have the greater opportunity for profit increase or decrease from production efficiencies and fluctuations in the cost of labor and fac- tory overhead verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports eral taxation purposes see also 61_tc_216 passage of title in deciding when ‘ownership’ has passed is certainly an important consideration aff ’d 528_f2d_55 9th cir we also note that example discusses and concludes that y the party which had the benefits and burdens had legal_title to the property while it was in production sec_1_199-3 income_tax regs while we recognize that title to the intan- gible property ie the actual design of the art as transmitted on the pdf file never transferred to the printers or to advo’s clients advo’s printing agreements with its con- tract printers clearly state that title to and risk of loss of the product ie the printed material does not transfer to advo until the products have left the printers’ facilities this factor weighs in favor of respondent intention of the parties we are less concerned with the label that the parties give the transaction we look to what the parties actually intended to happen 226_f2d_798 9th cir advo asserts that the parties’ intention is demonstrated by the section of the printing agreement entitled governing law which in relevant part states the parties hereto agree that although this agreement is for printing services and not goods the uniform commercial code shall be applicable advo believes that this term establishes that the parties believed that they were contracting with the third-party printers for services not for the manufacturing of a product respondent contends that the contracts explicitly state that advo will pay printer for its manufac- turing services which shows that the parties intended that the printers were the manufacturers at trial thomas mccloskey the chief_executive_officer and one of the principal owners of doodad one of advo’s con- tract printers testified that doodad claimed a deduction under sec_199 for the income attributable to producing advo’s advertising material implicitly this printer obvi- ously intended that it qualify as the manufacturer of the advertising material for purposes of claiming the sec_199 deduction verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner the parties contemplated and agreed that the third-party printers would print the specific advertising material that advo required and then send the printed material to advo it was always their intent that the printers produce the actual tangible paper materials using the advo intan- gible pre-press materials therefore we find this factor weighs in favor of respondent equity_interest and present obligation while these factors were relevant in grodt mckay in determining whether the transactions were bona_fide sales and they may prove relevant in future sec_199 benefits and burdens tests they are not significantly relevant to determining whether advo had the benefits_and_burdens_of_ownership while the advertising material were printed by the third-party printers thus this factor is neutral right of possession and control in determining whether advo had the benefits and bur- dens of ownership of the advertising material during the printing process t ransfer of possession is also significant commissioner v segall f 2d pincite the third-party printers necessarily had the right of possession during the printing process it was the printers who produced the hard copies of the advertising material and advo did not have the right of possession until the printed material was deliv- ered to it however because we are tailoring the factors from grodt into the context of sec_199 the analysis cannot merely end with the party that has the right of possession the par- ties spent an extensive amount of time discussing each step of the printing process with each trying to prove whether advo or the third-party printers were in control of the process see sec_1_199-3 example income_tax regs advo contends that it was ultimately in control of the printing process advo asserts that its pdf documents essentially set the color keys for the printer that their paper contracts determined which paper the printers were allowed to use and that the printing agreements specify exactly which machines the printers where allowed to use that the printers could not gang other parties’ work with theirs and at which locations they were allowed to print advo’s mate- verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports rials on the other hand the third-party printers owned or leased and operated the machinery sometimes purchasing it at the behest of advo but it was always the printers’ prop- erty the third-party printers and their employees set up the machines loaded the paper fine-tuned the color keys ran the printing process supervised the quality and then deliv- ered the advertising materials to advo respondent contends in the interim guidance that a tax- payer who is contracting the printing services out to a third party must have the benefits_and_burdens_of_ownership to qualify for the sec_199 deduction and that this test applies even if the customer exercises direct supervision and control_over the activities of the contractor notice_2005_14 sec_3 we do not find that in practice advo exercised day-to-day control_over the activities of the printer this factor weighs in favor of respondent property taxes there is no evidence in the record that advo or anyone else paid property taxes on any of the pre-press pdf files or the printed property during the manufacturing process we find that this factor is neutral risk of loss or damage along with the benefits of ownership must go the burdens harmston v commissioner t c pincite in the instant case this factor requires us to determine which party bore the risk of loss or damage to the advertising material during on date the office_of_chief_counsel released a memo- randum in which it addressed a fact pattern similar to the one at issue in this case see c c a date in the memo the tax- payer published books using third-party printers although such a memo- randum reflects only the opinion of one of the parties and is in no way con- trolling on this court we find the agency’s interpretation of its own regu- lations enlightening specifically the memo states our office believes that print specification activities are non-mpge activities while providing the print specifications to the contract man- ufacturer gives the contract manufacturer a detailed description of how the taxpayer desires the mass-produced books to look eg size color print type etc the print specifications do not produce qpp although the memo did not address the benefits and burdens test we have concluded independently for the reasons discussed above that print speci- fications do not produce qpp verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner its production while it was at or in the possession of the third-party printers see sec_1_199-3 income_tax regs example discusses risk of loss or damage during the manufacturing process as an important factor in the benefits and burdens test as noted supra the risk of loss or damage did not transfer to advo until the advertising materials had either left the printers’ facilities or been delivered to advo advo also did not assume any risk with respect to the directed buy paper supply agreements although advo required its printers to purchase the paper from a specific source advo did not guarantee payments to the broker in the event the printers defaulted on the payments nor did advo reimburse the printer for the paper costs until the printed product had been completed and shipped per advo’s specifications the third- party printers were also required to maintain insurance with respect to all of advo’s work in progress and all materials given the insurance and the fact that the risk of loss did not transfer to advo until after completion of the manufac- turing process advo did not have the burden of the risk of loss or damage with respect to the advertising materials the regulations also suggest that the type of contract plays a role in determining risk of loss and is one of the facts and circumstances in determining who has the benefits and bur- dens id the examples imply a difference between fixed cost contracts and reimbursable cost type contracts sec_1 f examples and income_tax regs thus the fact that the manufacturing taxpayer may bear a greater risk of loss in a fixed cost contract as opposed to a reimbursable con- tract is significant one version of advo’s contracts bore ele- ments of a reimbursable contract such as agreements to allow price adjustments for increases in freight rates and ink prices and increases tied to the consumer_price_index the other contracts kept costs firm but included terms implying that if sufficiently documented some price changes for example to reflect new printing developments in the graphic arts might be allowed or even required furthermore we realize that in the event damage or loss of the advertising material resulted in the material’s not get- ting timely delivered to the end consumers advo bore the economic risk vis-a-vis its clients advo’s contracts with cli- ents often required quick turnaround periods if the printer verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie united_states tax_court reports does not print an acceptable product in that short amount of time advo certainly suffers economic harm this harm is both quantifiable in terms of its contract_price with its cli- ents and more ethereal in terms of reputation damage in the light of these considerations we find this factor to be neutral profits from operation and sale similar to the example in sec_1_199-3 income_tax regs the third-party printing companies enjoyed the eco- nomic gain or bore the loss from the sale of the advertising material according to the difference between the printing companies’ costs and as to some of the contracts the fixed contract_price therefore we find that this factor weighs in favor of respondent active and extensive participation the test under sec_936 asks whether advo actively and extensively participated in the management and oper- ations of the activity medchem p r inc v commissioner t c pincite as discussed under right of possession and control see supra p advo argues that it actively and extensively participated in the management and oper- ation of the printing of the advertising material however we find that it did not extensively participate in the oper- ation of the printing presses or in the cutting or folding proc- esses and thus this factor weighs in favor of respondent advo did extensively participate in the mailing and dissemi- nation of the advertising materials ie the solo or coopera- tive mail packages but that function is a service not qpp sec_1_199-3 and income_tax regs conclusion after careful review of all of the aforementioned factors in the light of the specific facts and circumstances of this case we find that advo did not have the benefits_and_burdens_of_ownership while the advertising material was printed on brief petitioner also argued that its gross_receipts with respect to graphic design processing and distribution activities were also dpgr be- cause we did not find that petitioner had the benefits and burdens of own- ership during the manufacturing activity we need not address these issues verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie advo inc subs v commissioner therefore advo did not have the benefits_and_burdens_of_ownership of the qpp under federal_income_tax principles during the period of mpge activity sec_1_199-3 income_tax regs the gross_receipts from the printing activity therefore are not dpgr see id as a result advo is not entitled to the claimed sec_199 deduction for its taxable_year and its short taxable_year the court has considered all of petitioner’s contentions arguments requests and statements to the extent not dis- cussed herein the court concludes that they are meritless moot or irrelevant to reflect the foregoing an appropriate order will be issued f verdate mar feb jkt po frm fmt sfmt v files boundv wit bvacdb advo_i su jamie


internal_revenue_service number release date index number r --------------------------------------------- --------------------------------------- ----------------------- ------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------- id no ------------- telephone number --------------------- refer reply to cc psi b06 plr-135088-05 date may re request for private_letter_ruling regarding normalization taxpayer ---------------------------------------------------------------- parent state bill a b c d e f g h i j k l m dear ----------- information submitted on behalf of taxpayer for a determination as to the normalization requirements under former sec_46 of the internal_revenue_code and e of the ----------------------------------------------------- -------- --------------------------------- ----------------------------------------------------------- ------------------- ---------------------- ----------------- -------------------------- -------------------------- ----------------------- ------------------- -------------------- ------------------ -------------------------------------------------------------- ---------------------------------------------------------------------------- ------------------------- this letter responds to a letter dated date and supplemental taxpayer represents that the facts are as follows taxpayer made the election to use the ratable flow-through method of taxpayer is an investor-owned electric transmission and distribution utility plr-135088-05 tax_reform_act_of_1986 vol c b the act for the accumulated deferred investment_tax_credit aditc and excess deferred federal income taxes edfit associated with certain generation assets that were sold by taxpayer facts delivering electricity to customers in central state taxpayer is subject_to the regulatory jurisdiction of a with regards to its terms and conditions of service including the rates it can charge for the provision of service taxpayer is a member_of_an_affiliated_group headed by parent and files a consolidated federal_income_tax return with parent normalizing its investment tax_credits under former sec_46 taxpayer also adopted a normalization method_of_accounting for purposes of claiming accelerated_depreciation for public_utility_property in accordance with former sec_167 and sec_168 and with sec_168 moreover taxpayer has normalized its edfit in accordance with e of the act and revproc_88_12 1988_1_cb_637 electric utility market structure and permitted customer choice of electric generation providers as of c specifically under bill the process of transition to deregulation consisted of the following general steps unbundling - bill required that each investor-owned state electric utility including taxpayer separate its electric utility activities into three separate units i a power generation company ii a retail electric provider rep certified by a and iii one or more separate transmission and distribution t d utilities this separation could be accomplished by either creating separate companies selling assets to third parties or creating separate affiliated companies owned by a common holding_company establishment of cost of service tariffs including a stranded cost estimate-on or before d each company was required to file proposed tariffs for its proposed t d utility ies the rates so determined took effect on c one element of these tariffs was a competition transition charge ctc if warranted the ctc was a charge intended to allow the recovery_of the company’s estimated generation-related stranded costs that were expected to exist as of e and its generation-related regulatory assets in existence as of f and stranded cost true- up - bill provided that after g each t d utility its affiliated rep and its affiliated generation company must jointly file with the a to finalize the quantity of stranded costs to reconcile this final quantity with the estimate used in the prior establishment of the ctc and to adjust the ctc prospectively to reflect the reconciliation on b bill became effective in state bill initiated changes to the regulated two other state electric utilities k and l have previously filed true-up taxpayer filed its initial restructuring plan with the a in h it provided for the legal plr-135088-05 separation of taxpayer’s assets into an affiliate power generation company a t d utility and various reps the plan was approved by the a in i however taxpayer has subsequently requested and the ---------has voted to approve the taxpayer’s request that it accomplish separation through the sale of generation assets taxpayer has since disposed of all of its generating assets except for an interest in a coal-fired facility that is the subject of a binding contract of sale pursuant to the requirements of bill on j taxpayer filed its true-up application with the a to finalize its stranded costs applications with the a k had some aditc but no edfit associated with its plant in the k true-up order the a ordered that stranded costs be reduced by the present_value of its aditc balance l had both aditc and edfit balances in l’s true-up order the a similarly ordered that stranded costs be reduced by the present_value of its aditc and edfit balances based on this taxpayer believed that it was likely that the a would reduce the amount of its stranded costs by the present_value of its aditc and edfit balances application which in fact did reduce the amount of taxpayer’s stranded costs by the present_value of the taxpayer’s aditc balance with respect to edfit the a reduced taxpayer’s stranded costs by the book_value of edfit grossed-up to a revenue requirements basis rulings requested on m the a issued a final order for taxpayer’s stranded cost true-up taxpayer requests the internal_revenue_service to rule on two issues taxpayer will not violate the requirements of the investment_tax_credit normalization rules set forth in former sec_46 if it reduces its stranded costs by the net present_value of its aditc associated with its generation assets taxpayer will not violate the requirements of the depreciation normalization rules set forth in former sec_167 sec_168 and e of the act if it reduces its stranded costs by the book_value of its edfit grossed-up to a revenue requirements basis associated with its generation assets law and analysis an elector under former sec_46 of its aditc relating to sales of its generating assets elector may flow through the investment_tax_credit to cost of service however former the first determination involves the proper normalization treatment by taxpayer former sec_46 provides an election for ratable flow through under which an former sec_46 provides that for purposes of determining ratable portions under sec_1_46-6 of the income_tax regulations ratable for purposes of plr-135088-05 sec_46 provides that no investment_tax_credit is available if the taxpayer's cost of service for ratemaking purposes or in its regulated books of account is reduced by more than a ratable portion of the credit determined under former sec_46 and allowable by sec_38 also under former sec_46 no investment_tax_credit is available if the base to which the taxpayer's rate of return for ratemaking purposes is applied is reduced by reason of any portion of the credit determined under former sec_46 and allowable by sec_38 under former sec_46 the period of time used in computing depreciation expense for purposes of reflecting operating results in the taxpayer's regulated books of account shall be used former sec_46 is determined by considering the period of time actually used in computing the taxpayer's regulated depreciation expense for the property for which a credit is allowed regulated depreciation expense is the depreciation expense for the property used by a regulatory body for purposes of establishing the taxpayer's cost of service for ratemaking purposes such period of time shall be expressed in units of years or shorter periods units of production or machine hours and shall be determined in accordance with the individual useful_life or composite or other group asset account system actually used in computing the taxpayer's regulated depreciation expense a method of reducing is ratable if the amount to reduce cost of service is allocated ratably in proportion to the number of such units thus for example assume that the regulated depreciation expense is computed under the straight_line method by applying a composite annual percentage rate to original cost as defined for purposes of computing depreciation expense if cost of service is reduced annually by an amount computed by applying a composite annual percentage rate to the amount of the credit cost of service is reduced by a ratable portion if such composite annual percentage rate were revised for purposes of computing depreciation expense beginning with a particular accounting_period the computation of ratable portion must also be revised beginning with such period a composite annual percentage rate is determined solely by reference to the period of time actually used by the taxpayer in computing its regulated depreciation expense without reduction for salvage or other items such as over and under accruals cost of service for ratemaking is reduced by more than a ratable portion of the investment_tax_credit depends upon correlating the credit with the regulatory depreciable useful_life actually used for the property that generated the credit that the correlation must remain constant and current is illustrated by the requirement that the ratable portion must be adjusted to reflect correspondingly any revision to the composite annual percentage rate applied for purposes of computing regulated depreciation expense the method prescribed by sec_1_46-6 for determining whether the taxpayer's the second determination involves the proper normalization treatment by in this case taxpayer has sold the assets that generated the aditc and as a should the property for which the aditc is allowed become no longer available sec_168 provides that the depreciation deduction determined under plr-135088-05 for computing the regulated depreciation expense there could no longer be any correlation between the property and the credit in that event the requirements of former sec_46 are violated if any portion of the credit is used to reduce the taxpayer's cost of service result the asset for which regulated depreciation expense is computed is no longer available consequently no portion of the related unamortized aditc remaining at the date of sale may be returned to ratepayers by amortizing those aditc amounts over the period taxpayer recovers stranded costs from its ratepayers taxpayer of its edfit relating to the sale of its generating assets sec_168 shall not apply to any public_utility_property within the meaning of sec_168 if the taxpayer does not use a normalization method_of_accounting the taxpayer in computing its tax expense for establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account to use a method_of_depreciation with respect to public_utility_property that is the same as and a depreciation period for such property that is not shorter than the method and period used to compute its depreciation expense for such purposes differs from the amount that would be allowable as a deduction under sec_167 using the method period first and last year convention and salvage_value used to compute regulated tax expense under sec_168 the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference will not be satisfied is if the taxpayer for ratemaking purposes uses a procedure or adjustment which is inconsistent with such requirements under sec_168 such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer's tax expense depreciation expense or reserve for deferred taxes under sec_168 unless such estimate or projection is also used for ratemaking purposes with respect to all three of these items and with respect to the rate base accelerated methods for depreciation if they used a normalization method_of_accounting a normalization method_of_accounting was defined in former sec_167 sec_168 provides that one way the requirements of sec_168 in order to use a normalization method_of_accounting sec_168 requires under sec_168 if the amount allowable as a deduction under sec_168 former sec_167 generally provided that public_utilities were entitled to use sec_1_167_l_-1 provides that the reserve established for public_utility plr-135088-05 in a manner consistent with that found in sec_168 sec_1_167_l_-1 provides that the normalization requirements for public_utility_property pertain only to the deferral of federal_income_tax liability resulting from the use of an accelerated method_of_depreciation for computing the allowance for depreciation under sec_167 and the use of straight-line_depreciation for computing tax expense and depreciation expense for purposes of establishing cost of services and for reflecting operating results in regulated books of account these regulations do not pertain to other book-tax timing differences with respect to state income taxes f i c a taxes construction costs or any other taxes and items property should reflect the total amount of the deferral of federal_income_tax liability resulting from the taxpayer's use of different depreciation methods for tax and ratemaking purposes sec_1_167_l_-1 provides that the amount of federal_income_tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess computed without regard to credits of the amount the tax_liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax_liability this amount shall be taken into account for the taxable_year in which the different methods of depreciation are used sec_1_167_l_-1 provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes a depreciation_reserve or other reserve_account this regulation further provides that the aggregate amount allocable to deferred taxes shall not be reduced except to reflect the amount for any taxable_year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under sec_1_167_l_-1 or to reflect asset retirements or the expiration of the period of depreciation used in determining the allowance for depreciation under sec_167 of accounting is not being used for public_utility_property shall not be treated as being used with respect to any public_utility_property for purposes of sec_167 or sec_168 if the taxpayer in computing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account reduces the excess_tax_reserve more rapidly or to a greater extent than this reserve would be reduced under the average rate assumption method aram excess of section e of the act provides another way in which a normalization method section e of the act provides that a normalization method_of_accounting the term excess_tax_reserve is defined in e a of the act as the plr-135088-05 section e b of the act defines the aram and explains the calculations i the reserve for deferred taxes as described in former sec_167 or sec_168 as in effect on the day before the date of the enactment of the act over ii the amount that would be the balance in this reserve if the amount of the reserve were determined by assuming that the corporate rate reductions provided in the act were in effect for all prior periods under this method aram is the method under which the excess in the reserve for deferred taxes is reduced over the remaining lives of the property as used in its regulated books of account that gave rise to the reserve for deferred taxes under the aram if timing differences for the property reverse the amount of the adjustment to the reserve for the deferred taxes is calculated by multiplying i the ratio of the aggregate deferred taxes for the property to the aggregate timing differences for the property as of the beginning of the period in question by ii the amount of the timing differences that reverse during this period revproc_88_12 1988_1_cb_637 provides further guidance as to the application of the aram to the excess_tax_reserve section dollar_figure of revproc_88_12 provides that under the aram excess tax_reserves pertaining to a particular vintage or vintage_account are not flowed through to ratepayers until such time as the timing differences in the particular vintage_account reverse moreover it is a violation of e of the act for taxpayers to adopt any accounting treatment that directly or indirectly circumvents the rule set forth in the previous sentence section dollar_figure also provides that e of the act does not modify the normalization requirements of former sec_167 or of sec_168 sec_3 and dollar_figure of revproc_88_12 provide that a taxpayer who lacks sufficient vintage_account data necessary to apply the aram can use the reverse south georgia method in general a taxpayer uses that method if it a computes the excess_tax_reserve on all public_utility_property included in the plant account on the basis of the weighted average life or composite rate used to compute depreciation for regulatory purposes and b reduces the excess_tax_reserve ratably over the remaining regulatory life of the property income_tax_liability e of the act requires that normalization_accounting be used to reduce the excess_tax_reserve in calculating the rates to be charged the utility's for a public_utility to use accelerated_depreciation in determining its federal section e of the act limits the rate at which the excess_tax_reserve may be plr-135088-05 customers and in maintaining the regulated books of account under e of the act the immediate flow through of the excess_tax_reserve to the utility's customers is prohibited instead the excess_tax_reserve is to be reduced and flowed through to cost of service no more rapidly that this reserve would be reduced under the aram or where appropriate the reverse south georgia method reduced and flowed through to the utility's customers in setting rates it does not require the utility to flow through the excess_tax_reserve to its customers but permits the utility to do so provided the reduction to cost of service is not more rapidly than would be under the aram thus e of the act imposes a limitation on when the excess_tax_reserve may be returned to the utility's customers in the form of reduced rates retirements of public_utility_property subject_to the normalization requirements of sec_168 are reflected in adjustments to taxpayer's deferred tax reserve as well as its excess_tax_reserve see sec_1_167_l_-1 and revproc_88_12 c b pincite as a result of the sale these reserves cease to exist a violation of the depreciation normalization rules will occur if there is any return to ratepayers after the sale date of the unamortized edfit attributable to accelerated_depreciation on public_utility_property that is sold further both aram and the reverse south georgia method rely on mechanisms requiring a regulatory life once the asset is sold the regulatory life ceases to exist in the present case taxpayer has sold the aforementioned public_utility_property hence in each of the two rulings requested by taxpayer there would be a conclusions normalization violation if the remaining unamortized aditc and edfit balances or a proportionate part thereof existing at the date of sale are returned to ratepayers by amortizing those amounts over the period taxpayer recovers stranded costs from its ratepayers because taxpayer has sold the assets that generated the aditc the asset for which regulated depreciation expense is computed is no longer available consequently no portion of the related unamortized aditc remaining at the date of sale may be returned to ratepayers by amortizing those aditc amounts over the period taxpayer recovers stranded costs from its ratepayers additionally the unamortized edfit associated with the sold generating assets ceases to exist at the date of sale consequently a violation of the depreciation normalization rules will occur if there is any return to ratepayers after the sale date of those unamortized edfit amounts attributable to accelerated_depreciation on public_utility_property this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent plr-135088-05 sincerely in accordance with the power_of_attorney we are sending a copy of this letter to taxpayer’s authorized representatives we are also sending a copy of this letter to the industry director natural_resources and construction lm nrc enclosures copy copy for return peter c friedman senior technician reviewer branch office of associate chief_counsel passthroughs and special industries peter c friedman