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Simplify Rules for Claiming Manufacturing Deduction, Firm Says

NOV. 25, 2015

Simplify Rules for Claiming Manufacturing Deduction, Firm Says

DATED NOV. 25, 2015
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November 25, 2015

 

 

Internal Revenue Service

 

Room 5203

 

1111 Constitution Avenue NW.

 

Washington, D.C. 20224

 

Re: Proposed Regulations; Comment Request for Benefits and Burdens

 

To Whom it May Concern:

Pursuant to a Request for Comments contained in REG-136459-09 issued on September 14, 2015 (the "Notice"), alliantgroup, L.P ("alliantgroup") respectfully submits the following comment on proposed Treas. Reg. § 1.199-3(f)(1). We are grateful for the opportunity to comment on the Regulations and welcome the chance to discuss the following comment in greater detail or to answer any questions that you may have.

 

Background

 

 

Pursuant to § 199 in the Internal Revenue Code ("Code") the Domestic Production Activities Deduction ("DPAD") allows a deduction equal to 9% of the lesser of a taxpayer's Qualified Production Activities Income ("QPAI") or its taxable income.1 Regarding sub-contract manufacturing agreements, only the taxpayer who is deemed to hold the "Benefits and Burdens" of ownership of the qualifying production property ("QPP") during the manufacturing process is eligible to claim the DPAD with respect to that property. Currently, the Regulations do not provide a bright line test for determining which taxpayer has Benefits and Burdens in the case of sub-contract manufacturing agreements. Courts have attempted to clarify the Benefits and Burdens test, as the U.S. Tax Court did in ADVO v. Commissioner ("ADVO").2 The court in ADVO promulgated a nine-part test to identify the party with the Benefits and Burdens. However, even this test requires the subjective balancing of multiple factors.

In an effort to eliminate taxpayer confusion, the Treasury has proposed the removal of all "Benefits and Burdens" language from the regulations. In its place, the proposed regulations provide that the taxpayer which performs the manufacturing/production/extraction/growth ("MPGE) of the qualifying production property is eligible to claim the DPAD with respect to that property. The proposed regulations suggest that this alteration will further "incentivize domestic manufactur[ing] and product[ion]"3 and clarify questions regarding which taxpayer is allowed the deduction. The proposed regulations also provide an exception which would allow a taxpayer not performing MPGE activities to claim the DPAD deduction in certain situations. Specifically, the proposed regulations request comments concerning certain fully cost-plus or cost-reimbursable contracts that may allow the taxpayer not performing the MPGE activities to claim the DPAD.

 

Provide Clearer Language in the Regulationsto Define

 

Situations Where a Taxpayer Who Sub-Contracts Out Manufacturing

 

Can Take Advantage of the DPAD

 

 

We believe that the proposed regulation's elimination of the Benefits and Burdens test and adoption of a test focusing on which taxpayer performed the manufacturing activity will discourage domestic manufacturing. The DPAD incentive currently provides a significant tax savings for many taxpayers using domestic subcontractors for manufacturing and these tax savings, which require that the manufacturing activity take place in the U.S., incentivizes these taxpayers to keep production in the U.S. However, if Treasury were to finalize the proposed regulations, a large portion of taxpayers using subcontractors will no longer qualify for the incentive because these companies typically do not actually perform the manufacturing activity. No longer able to avail themselves of the DPAD, these companies will seek to reduce costs by moving production activities abroad.

The proposed regulations suggest that the new test will incentivize taxpayers that perform manufacturing activity at the expense of those that subcontract, and therefore the regulations will have no net effect on domestic manufacturing jobs or will possibly produce a net gain. However, we believe that proposed regulations will have a negative net effect on domestic manufacturing. Large taxpayers who subcontract their manufacturing will relocate their manufacturing activities abroad to reduce costs in lieu of the no longer available DPAD. Many taxpayers that actually perform manufacturing activities do so under subcontracting agreements. Although the proposed regulations will allow these taxpayers to reduce their tax burden by claiming the DPAD, these taxpayers will lose many manufacturing subcontracts because the prime contractor outsourced production activities. The actual manufacturers will realize a tax savings equal to 3.15% of QPAI4 but will lose a significant source of revenue as a result of the lost subcontracts. The net effect for these actual manufacturers will almost certainly be negative and these companies may reduce their workforce as a result of the economic detriment.

To ensure that any modification to the DPAD will result in a net gain for domestic manufacturing, we propose that Treasury not adopt the proposed changes and continue to use the Benefits and Burdens test to determine which taxpayer is entitled to the deduction in subcontracting arrangements. We further propose that Treasury add provisions clarifying which taxpayer is considered to have the Benefits and Burdens of ownership. We suggest that Treasury look to the nine part test used in ADVO v. Commissioner for guidance in developing the provisions with the caveat that Treasury clarify how the nine tests are to be applied. For example, how many of the tests must be met for a taxpayer to have Benefits and Burdens, or which of the nine tests are most important in a Benefits and Burdens analysis.

 

Conclusion

 

 

In summary, alliantgroup believes that the changes to the proposed regulations will not incentivize domestic manufacturing. Rather, the proposal, as promulgated, will stifle domestic manufacturing by failing to incentivize the use of domestic subcontractors over subcontractors located abroad. In order to prevent a decrease in domestic manufacturing, we would suggest that the Treasury retain the Benefits and Burdens language in the regulations but provide additional guidance which would simplify the identification of the taxpayer eligible to claim the DPAD. Please do not hesitate to contact us with any questions or for any additional information that you may find useful.
Respectfully submitted,

 

 

Dean Zerbe

 

alliantgroup -- National Office

 

National Managing Director

 

alliantgroup

 

Washington, DC

 

FOOTNOTES

 

 

1 I.R.C. § 199(a)(1)

2 ADVO v. Commissioner, 141 T.C. No. 9 (2013)

3 REG-136459-09

4 Deduction equals 9% of QPAI and assume a 35% tax rate.

 

END OF FOOTNOTES
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