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IBM Seeks Clarification of Domestic Production Incentive

MAR. 13, 2006

IBM Seeks Clarification of Domestic Production Incentive

DATED MAR. 13, 2006
DOCUMENT ATTRIBUTES
  • Authors
    Forster, George B.
  • Institutional Authors
    IBM Corp.
  • Cross-Reference
    For REG-105847-05, see Doc 2005-21302 [PDF] or 2005 TNT 203-

    6 2005 TNT 203-6: IRS Proposed Regulations. For Notice 2005-14, 2005-7 IRB 498, see Doc 2005-1241 [PDF]

    or 2005 TNT 13-7 2005 TNT 13-7: Internal Revenue Bulletin.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2006-5528
  • Tax Analysts Electronic Citation
    2006 TNT 56-22

 

March 13, 2006

 

 

The Honorable Eric Solomon

 

Acting Deputy Assistant Secretary (Tax Policy)

 

Department of the Treasury

 

1500 Pennsylvania Avenue

 

Washington, DC 20220

 

Re: Proposed Regulations Concerning the Deduction for Income Attributable to Domestic Production Activities under Section 199

 

Dear Eric,

On behalf of International Business Machines Corporation ("IBM"), I am writing to describe an issue of significant concern to us. We respectfully request that Treasury and the Internal Revenue Service (IRS) clarify the following in the final regulations under Section 199: Gross receipts attributable to property, including in particular computer software, that is rented, leased, licensed, sold, exchanged or otherwise disposed of as part of a services arrangement, the price of which is not separately stated from the amount charged for the services arrangement as a whole ("embedded property"), qualify as DPGR, if the property otherwise meets the requirements of Section 199.

We appreciate the Service's willingness to address taxpayer concerns in preparing the final regulations, and respectfully request that the changes described below be incorporated in the final regulations. After your review of this letter, we request a meeting to discuss this issue in further detail with you.

 

1. Background on IBM

 

IBM is the world's largest information technology company. IBM's portfolio of capabilities includes services, software, hardware, fundamental research, financing and the component technologies used to build larger systems. IBM's total 2005 revenues were $91.1B, of which $47B came from providing IT services.

IBM's business model is based on helping our clients succeed in delivering business value by becoming more efficient and competitive through the use of business insight and information technology solutions. IBM executes its business model in several ways, including through Strategic Outsourcing ("SO") services arrangements delivered by IBM Global Services. Pursuant to an SO service arrangement, IBM partners with its clients to provide a comprehensive array of IT solutions tailored to each client's specific business needs.

 

2. Gross Receipts Attributable to Embedded Property

 

IBM's SO arrangements are flexible and adaptable, and reflect the individual technology and services needs, priorities and preferences of IBM's clients. As an integral part of an SO arrangement, IBM may provide its clients with embedded property -- including computer software -- that IBM has MPGE in whole or significant part within the United States. Assuming that the property otherwise meets the requirements of Section 199, IBM believes that the portion of the gross receipts attributable to the property qualifies as DPGR under Section 199.

We believe that this conclusion is completely consistent with the general principles stated both in Notice 2005-14 and in the proposed regulations. However, to provide clear and certain guidance both to taxpayers and to IRS compliance personnel, and to assure uniform application of this rule to all similarly situated taxpayers, we request that the final regulations explicitly discuss transactions involving embedded property, and acknowledge and confirm that the general rules applicable to embedded services apply in such cases as well. In particular, the final regulations should confirm that gross receipts attributable to embedded property, including computer software, are DPGR if the property is MPGE in significant part within the United States. We also request that the final regulations add an example to illustrate the treatment of embedded property.

We would like to clarify two points relevant to our request. First, IBM's request assumes that there has been a lease, rental, license, sale, exchange, or other disposition (a "transfer") of property, and therefore the clarification is an express provision stating that gross receipts attributable to the property transferred qualify as DPGR if the other requirements under Section 199 have been met.

We understand that Treasury and the IRS are currently considering what kinds of transactions involving computer software meet the statutory requirement that there be a transfer of the computer software. While we have strong views about how this issue should be resolved, our request for clarification simply presupposes that the requisite standard is met, and does not rely on any particular interpretation of the requirement. We would be pleased to discuss this further with you. In any event, no interpretation of the transfer requirement should disqualify transactions that otherwise meet the statutory requirements.

Second, the clarification we seek in the final regulations is that the legal principles and rules generally applicable under Section 199 and expressly applicable to embedded services also apply to embedded property. We wish to emphasize that IBM is not seeking any kind of regulatory factual determination.

 

3. Request for Clarification

 

We respectfully request that the final regulations explicitly address embedded property and clarify that the general Federal income tax principles applicable to embedded services also apply to embedded computer software. By way of illustration, we believe that language similar to the following would accomplish this objective:

 

"In the case of embedded property, that is, property leased, rented, licensed, sold, exchanged, or otherwise disposed of as part of a services arrangement, the price of which is not separately stated from the amount charged for the services arrangement as a whole, DPGR includes gross receipts attributable to the embedded property (if all the other requirements under this Section are met). Under Section 1.199-1(d)(1), applicable Federal income tax principles apply to determine whether a transaction in substance includes both services (including embedded services) and a lease, rental, license, sale, exchange, or other disposition of property (including embedded property)."

 

We also respectfully request that the final regulations include an example to illustrate the application of these principles and rules to computer software. We believe that an example similar to the following would accomplish this goal:

 

"Example. X MPGE a computer software program, XCode, in significant part within the United States. In Year 1, X enters into an IT Outsourcing Agreement with Y, under which X takes over management of Y's wired and wireless networks. Pursuant to the terms of the IT Outsourcing Agreement, X provides XCode to Y in a transaction that qualifies as a rental, lease, license, sale, exchange or other disposition of XCode. Y pays X monthly fees of $100 for services provided under the IT Outsourcing Agreement. No separate charge for Y's use of XCode is stated in the IT Outsourcing Agreement or in the monthly invoices X provides to Y.

"X appropriately concludes that, based on all the facts and circumstance, the substance of its IT Outsourcing Arrangement with Y, determined under Federal income tax principles, includes both the provision of services and a transfer of embedded property. As a result, the portion of the gross receipts paid to X reflecting the fair market value of XCode must be allocated to XCode, and qualifies as DPGR."

 

We appreciate the opportunity to submit these comments and would welcome the opportunity to offer any additional assistance to facilitate your work on the final regulations.
Sincerely,

 

 

George B. Forster

 

Cc: Donald Korb

 

Chief Counsel

 

Internal Revenue Service

 

 

Heather C. Maloy

 

Associate Chief Counsel (Passthroughs & Special Industries)

 

Internal Revenue Service

 

 

George Manousos

 

Office of Tax Legislative Counsel

 

Department of the Treasury
DOCUMENT ATTRIBUTES
  • Authors
    Forster, George B.
  • Institutional Authors
    IBM Corp.
  • Cross-Reference
    For REG-105847-05, see Doc 2005-21302 [PDF] or 2005 TNT 203-

    6 2005 TNT 203-6: IRS Proposed Regulations. For Notice 2005-14, 2005-7 IRB 498, see Doc 2005-1241 [PDF]

    or 2005 TNT 13-7 2005 TNT 13-7: Internal Revenue Bulletin.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2006-5528
  • Tax Analysts Electronic Citation
    2006 TNT 56-22
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