Opinion ID: 357
Heading Depth: 4
Heading Rank: 1

Heading: Whether To Capitalize

Text: Under the regulations, [t]axpayers subject to section 263A must capitalize all direct costs and certain indirect costs properly allocable to property produced.... 26 C.F.R. § 1.263A-1(e)(1). Direct costs consist primarily of materials and labor, id. § 1.263A-1(e)(2), and the Commissioner does not claim that Robinson's royalty payments are direct costs. As to indirect costs, the regulation states the following: Indirect costs are defined as all costs other than direct material costs and direct labor costs (in the case of property produced).... Taxpayers subject to section 263A must capitalize all indirect costs properly allocable to property produced.... Indirect costs are properly allocable to property produced ... when the costs directly benefit or are incurred by reason of the performance of production... activities. Indirect costs may be allocable to ... other activities that are not subject to section 263A. Taxpayers subject to section 263A must make a reasonable allocation of indirect costs between production ... and other activities. Id. § 1.263A-1(e)(3)(i). Paragraphs (ii) and (iii) contain lists of [e]xamples of indirect costs required to be capitalized, and [i]ndirect costs not capitalized, respectively. Id. § 1.263A-1(e)(3). Paragraph (ii) states that the items on its list are examples of indirect costs that must be capitalized to the extent they are properly allocable to property produced. Id. § 1.263A-1(e)(3)(ii). One of the items on the list is: (U) Licensing and franchise costs. Licensing and franchise costs include fees incurred in securing the contractual right to use a trademark, corporate plan, manufacturing procedure, special recipe, or other similar right associated with property produced.... These costs include the otherwise deductible portion (e.g., amortization) of the initial fees incurred to obtain the license or franchise and any minimum annual payments and royalties that are incurred by a licensee or a franchisee. Id. § 1.263A-1(e)(3)(ii)(U). Conversely, paragraph (iii) states that the items on its list are not required to be capitalized under section 263A. Id. § 1.263A-1(e)(3)(iii). The first item on that list is: (A) Selling and distribution costs. These costs are marketing, selling, advertising, and distribution costs. Id. § 1.263A-1(e)(3)(iii)(A).