Association Suggests Revisions to Proposed Domestic Production Deduction Regs

This letter is submitted on behalf of the Broadcast Cable Financial Management Association ("BCFM") and its member companies. BCFM submits for consideration by the Internal Revenue Service and the Treasury Department the following comments on the proposed regulations (REG-105847-05) on income attributable to domestic production activities under IRC Section 199 (the "Proposed Regulations"). BCFM did not request any time to speak at the scheduled hearing.

Founded in 1961, BCFM is a not-for-profit professional educational society comprised of nearly 1,000 top financial, accounting, information systems and human resource executives, station general managers and other broadcasting and cable management personnel from all four major television networks, more than 60% of all network affiliates, at least 4,000 radio stations, more than 30 cable programming networks and several cable multiple system operators ("MSOs") throughout the U.S. and Canada. In addition, BCFM welcomes associate members who provide our industry with accounting, financial, information systems, sales, tax, and legal expertise. BCFM unites these members through its mission statement: To be the premier source of education, networking, information, and signature products to meet the diverse needs of financial and business professionals in the broadcast, cable, and electronic media industries.

BCFM requests that a television station's advertising receipts from commercials placed in time slots during the distribution of qualified film that is produced by the television station be treated for purposes of Section 199 as domestic production gross receipts.

Broadcast stations with FCC television licenses to broadcast programming in a local market typically acquire rights to distribute television programming that is produced by the four major television networks (ABC, CBS, NBC and FOX), other networks (e.g., WB, UPN, Univision and Telemundo) and syndicated television programming produced by others (such as certain sports programming, first run syndicated programming or reruns of programs previously distributed (e.g., "I Love Lucy" reruns). Television stations also independently produce and distribute their own programming, particularly local news programs. A television station may also produce and distribute other shows in the local market, such as morning talk shows, sports programming, public interest programs, weather specials, political debates and election coverage, documentaries of local interest, and high school quiz shows. Programming produced by a television station may be distributed as produced ("live") or on a delayed basis.

The programming of local television stations is distributed to the public in three primary ways: (1) by local cable television operators through their wired connections to paying subscribers' homes; (2) by satellite operators who provide a wireless signal from a satellite to special receiving antennae at paying subscribers' homes; and (3) by traditional over-the-air broadcasting of an FCC-licensed signal from the station's transmitter to traditional television receiving antennae at viewers' homes. In the infant local television industry of the 1940's and early 1950's, a station's programming was distributed exclusively by free over-the-air broadcasting. By contrast, in 2005 a minimum of 87% of U.S. households received local television station programming either by cable (60%) or by satellite (27%).¹ The percentage of television station distribution achieved by cable and satellite continues to increase, reflecting their technically superior signal and the larger number of program offerings compared to traditional broadcast distribution.

During the broadcast of a television station's programming, including news and other programming produced by the station, the station typically inserts broadcast advertisements ("commercials") in time slots within and in between programming. The advertisers pay the television station for these advertisements.

B. Advertising Receipts in Section 199 and Notice 2005-14

Section 199(c)(4) states that "domestic production gross receipts" ("DPGR") include the gross receipts derived from the lease, rental, license, sale, exchange, or other disposition of "any qualified film produced by the taxpayer." Under Section 199(c)(6), a qualified film is a motion picture or videotape if at least 50% of the total compensation relating to its production is compensation for services performed in the United States by actors, production personnel, directors and producers.

The House Report to Section 199 makes it clear that the term, "qualified film," includes live or delayed television programming. See H.R. Conference Report No. 775, 108th Cong., 2d Sess. 273 n.30 (2004). Notice 2005-14 expressly states that qualified film includes live or delayed television programming. Id., Section 3.04(9)(a).

Notice 2005-14 did not mention advertising receipts in connection with television programming. However, Notice 2005-14 did mention advertising receipts in connection with newspapers and magazines, as set forth below:

C. Advertising Receipts in the Proposed Regulations

The recently issued Proposed Regulations clarify that a qualified film includes "live or delayed television programming . . . ." Prop. Treas. Reg. Section 1.199-3(j)(1). However, Section 1.199-3(j)(3) of the Proposed Regulations provides that "DPGR includes the gross receipts of the taxpayer which are derived from any lease, rental, license, sale, exchange, or other disposition of any qualified film produced by the taxpayer. Showing a qualified film on a television station is not a lease, rental, license, sale, exchange, or other disposition of any qualified film produced by a taxpayer."

In the accompanying examples, there is the following:

By contrast, the Proposed Regulations continued to treat advertising receipts of newspapers and magazines that were manufactured or produced in whole or in significant part in the United States as DPGR. Indeed, the Proposed Regulations extended the treatment of advertising receipts to advertising in telephone directories and periodicals. In the Proposed Regulations, the preamble summarizes the treatment of advertising receipts for newspapers and magazines in Notice 2005-14 and in the Proposed Regulations:

As noted in the "Background" section above, by 2005 at least 87% of the distribution of a local television station's programming was carried out by cable television and satellite operators. Much of this distribution is accomplished by negotiated agreements between local stations and cable or satellite operators known as retransmission consent agreements ("Retransmission Agreements"), entered into under provisions included in the 1992 Cable Act.² By enacting the retransmission consent provisions, Congress expressed an intention "to establish a marketplace for the disposition of the rights to retransmit broadcast signals; it is not the Committee's intention in this bill to dictate the outcome of the ensuing marketplace negotiations."³ Under Retransmission Agreements, local television stations negotiate for a variety of contract provisions in return for authorizing the retransmission of their programming by cable and satellite operators, including

Television broadcast stations with programming or other leverage which is not sufficiently compelling to negotiate a Retransmission Agreement nevertheless generally may obtain carriage rights on a local cable operator's system by electing the complimentary "must-carry" provisions also contained in The 1992 Cable Act (Section 4). Under these provisions, eligible stations may elect to be carried on cable systems in the market, thus receiving the expanded distribution of its programming without any change or manipulation, without additional compensation, in return for the programming being made available to the operator to provide to its subscribers. In 1999 a similar must-carry provision was extended to satellite operators.⁴ Under these provisions, a satellite provider that chooses to carry any qualified, full-power local station in a market becomes obligated to carry all such stations in the market. Distribution of programming through such must-carry arrangements also should be treated as a license for purposes of Section 199.

In addition to a television station's overwhelming distribution of programming by cable or satellite systems, the distribution of programming by over-the-air broadcasting also should be treated as a license or other disposition for purposes of Section 199. In order to effect the intent of Congress in enacting Section 199 with respect to qualified films, the terms "license" and "disposition" with respect to qualified films should be construed consistently with Congress' expressed intent. Congress expressly extended the benefit of Section 199 to the production of qualified films. The legislative history to Section 199 expressly states that a qualified film includes both "live" and "delayed" programming produced in the United States. Most of the "live" programming from qualified films is daily network and local news programs. Local news is produced primarily by local television stations and distributed as described above. Unless this distribution, overwhelmingly through third-party cable and satellite operators, is recognized for purposes of Section 199 as a license or other disposition of the programming, then the benefit of Section 199 largely will have been denied to television programming.

Congress also expressly directed that the method and means of delivery of qualified films should not affect their qualification under Section 199. The conference report, in specifically discussing qualified films, provides that "[t]he conferees intend that the nature of the material on which properties described in section 168(f)(3) are embodied and the methods and means of distribution or on any distinction between "live" and other programming. The preamble to the Proposed Regulations also gives this rationale for treating online newspapers as not qualifying for disposition treatment: "In addition, if online software were permitted to qualify as DPGR, it would be difficult to distinguish this online software from software that is used to facilitate a service." By contrast, as discussed above, the primary purpose of producing the bulk of television programs is to distribute the programming to public viewers; there would be no confusion in this regard.

B. Advertising Receipts from Television Programming are Inextricably Linked to Gross Receipts from the Sale, License or Other Disposition of the Television Programming

Just as advertising receipts from advertisements in newspapers, magazines, telephone directories and periodicals that are manufactured or produced in whole or in significant part in the United States are treated as DPGR, advertising receipts from commercials distributed as part of television programming that is produced in whole or in significant part in the United Stated should similarly be treated as DPGR. This should be the case because television commercial receipts are as "inextricably linked" to the gross receipts of the disposition of television programming as print advertising receipts are to gross receipts from the disposition of newspapers, magazines, and telephone directories and periodicals.

The sale of newspapers that qualify as manufactured or produced in whole or in significant part in the United States by a taxpayer, for example, would generate DPGR. However, not all newspapers are sold to readers and generate circulation receipts. Some types of newspapers, such as those that contain only advertisements and some others that have news content (including weeklies, shoppers and a growing number of dailies) are distributed for free to readers. In these cases, the publishers receive advertising receipts but no sales receipts. Accordingly, the newspaper manufacturer would not manufacture the newspapers but for the advertising receipts derived from the print advertisements. The newspapers are distributed broadly to the public, with no guarantee that a particular person will read the newspaper. In this case, because the advertising receipts are inextricably linked to the disposition of the newspapers to readers, the advertising receipts should be treated as DPGR. Of course, this conclusion is made explicit in Proposed Treasury Regulations Section 1.199-3(h)(5)(i).

Similarly, telephone directories contain advertising and are distributed for free to customers. There are advertising receipts but no sales receipts. Accordingly, the directory manufacturers would not manufacture the telephone directories but for the advertising receipts derived from the print advertisements in them. The directories are distributed broadly to the public, with no guarantee that a particular person will read the newspaper. In this case, because the advertising receipts are inextricably linked to the disposition of the telephone directories, the advertising receipts should be treated as DPGR. Again, this conclusion is stated in Proposed Treasury Regulations Section 1.199-3(h)(5)(i).

In a similar way, television programming is distributed by cable and satellite operators by license-type arrangements and also by broadcast over the public airwaves for free to viewers. Television programming is produced in order to sell commercials or sponsorships to advertisers. The television stations would not produce or distribute programming but for the advertising receipts derived from advertisements distributed with the programming. The television programming is distributed broadly to the public, with no guarantee that a particular person will view a program. Accordingly, because the advertising receipts are inextricably linked to the disposition of the television programming, the advertising receipts from commercials inserted in the programming should be treated as DPGR.

Finally, receipts from the distribution of advertisements inserted into television programming should be treated the same as advertising receipts from product placement in a television program. Example 3 in Proposed Treasury Regulations Section 1.199-3(h)(5)(iii) is an example in which receipts from product placement in television programming that is treated as a qualified film are DPGR. Again, the fact that the station both produces and distributes to ultimate consumers a qualified film should not disqualify the receipts as DPGR because there is a qualifying license or other disposition of the program.

Similarly, BCFM respectfully requests that the Service revise Proposed Treasury Regulations Section 1.199-3(j)(1) to confirm that advertising receipts from advertisements included in television programming that is a qualified film and is treated as so licensed and disposed qualifies as DPGR. Accordingly, BCFM respectfully requests that Example (3) be deleted and that a new example be substituted in its place consistent with the prior sentence.

We hope that the above information is useful as you clarify the Proposed Treasury Regulations under Section 199. Please feel free to contact me at 847-716-7000 if you need additional information or would like to meet with anyone from our industry.

² Cable Television Consumer Protection and Competition Act, Pub. L. No. 102-385, 106 Stat. 1460 (1992) (codified at various sections of 47 U.S.C.)

³ Senate Report No. 102-92, at 36.

⁴ Satellite Home Viewer Improvement Act of 1999, codified at 47 U.S.C. 338.