DocketNumber: Docket No. 17247-10.
Citation Numbers: 141 T.C. 298, 2013 U.S. Tax Ct. LEXIS 29, 141 T.C. No. 9
Judges: WHERRY
Filed Date: 10/24/2013
Status: Precedential
Modified Date: 1/13/2023
An appropriate order will be issued.
R disallowed a deduction P claimed under
*299 WHERRY,
The only issue for decision in this Opinion in this bifurcated case is whether petitioner is entitled to a
The parties' stipulation of facts, with accompanying exhibits, and the stipulations of settled issues are incorporated herein by this reference. At the time petitioner filed the petition, its principal place of business was in Connecticut.
Petitioner, ADVO, Inc. (ADVO), was the common parent of the consolidated group ADVO, Inc., & Subsidiaries for the tax years ending September 24, 2005, and September 30, 2006, and for the short taxable year ending March 2, 2007. On March 3, 2007, ADVO was acquired by Valassis Communications, Inc., and continues to exist as its wholly owned subsidiary.
*300 During *31 2005, 2006, and 2007, 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 services 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 package, 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 *32 and department 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 households 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 supplies the materials for distribution (ADVO-supplied material). When ADVO supplied the advertising material, ADVO contracted with third-party commercial printers to print it. The
ADVO's shared mail packages were distributed weekly, and each included a "wrap" and various "inserts". A detached *301 address label *33 (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 different Shopwise wrap with different advertisers. There were approximately 580 wrap zones, and each one was composed of a cluster of ZIP Codes.
ADVO developed and marketed a portfolio of ADVO-supplied *34 inserts, each of which was differentiated by a set of defined product specifications, which included paper dimensions, 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 3,500 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.3 ADVO had about 133 million mailing addresses in its system.
ADVO classified its ADVO-supplied material as either "turnkey" or "custom". A turnkey product was a print *302 product that was included in ADVO's portfolio of products that met specifications defined by ADVO. A lump sum which included the advertising *35 services, printing, and distribution was billed to the client for turnkey products.4 The pricing for turnkey products was one rate for the entire process: creating the advertisement, producing the advertisement, delivering the advertisement, and targeting the desired end consumers. 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 turnkey 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
During the years at issue ADVO employed around 600 sales executives. The sales force was responsible for selling advertising space in the shared mail package. ADVO distributed 60 to 80 million packages every week of the year.
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 45% to 50% of the graphic art work *303 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 30% to 35% of the graphic art work designed by ADVO and involved circumstances where a previously developed graphic design was reused after ADVO made changes, such as to the coupon expiration dates or as required *37 for a different holiday promotion. In these two situations, ADVO retained ownership of all intellectual property associated with the artwork and advertisement.5 Client-s upplied art made up the final 15% to 20% 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 106,000 and 107,000 graphic designs per year.
ADVO employed 40 to 45 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 understood the graphic *38 art applications used to create graphic designs, the development of four-color photography as supported by the CMYK6*39 printing, and the printing process itself, to ensure the best printable product according to the functional capabilities of the specific printing press. ADVO employed 50 to 60 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 *304 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 20 to 25 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.
After the desktop artist created an advertisement art file and it was reviewed by the quality control artist, a low-resolution PDF would be uploaded to the ADVO online graphics gallery for the client to view and approve the advertisements.7 ADVO maintained a file of all the information 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.
As discussed
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. *305 ADVO did not guarantee payment to the broker in the event a printer defaulted on the purchase contract.
ADVO spent approximately $125 million per year on its turnkey printing needs, $50 million of that for paper and $75 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 *41 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 Products 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 insurance 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 *42 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 client's other graphic designs. Ganging involves the arrangement *306 of the advertisements of multiple advertisers for placement 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 clients 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 *43 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 development 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 performs 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 *44 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 35 *307 and 50 million wraps, inserts, and DALS every week. Each wrap is comprised of 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 *45 that pictures look pleasing to the eye, i.e. that food looked appetizing without 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 registration 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 properly 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).
ADVO had 17 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 138,000 square feet and employed around 150 associates and 80 temporary associates, the number of which would fluctuate according to the season and workload. During the years *308 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 $1,150,000, 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 hoppers. Optimally the Muller 227 could process about 7,000 packages per hour and the Alphaliner could process about 15,000 packages per hour.
ADVO spent $25 million a year transporting materials to the USPS. *47 ADVO spent approximately $500 million in postage 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.
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.8*49 Mr. Bolte has a bachelor of industrial *309 engineering degree from the Georgia Institute of Technology and a master of business administration degree from the Colgate Darden Graduate School of Business Administration at the *48 University of Virginia. He has been a print consultant to the printing industry since 1984, 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.
Respondent engaged Raymond J. Prince to opine on the printing practices involved in the production of direct *50 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 Technology and a master of science degree in printing management from South Dakota State University. He has worked in the printing industry for the past 53 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 *310 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.
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 business model. He emphasized the job-specific and individualized, as compared to the generic, *51 work done by ADVO and the broader scope of service and production supervision and control of all aspects of the work. He explained that The 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 mailbox of the intended recipient or the direct mailer has not supplied the printed product purchased by its client. * * *
Respondent's expert, Mr. Prince, also prepared a rebuttal report. He focused on ADVO's factual claims regarding *52 the uniqueness of their product and integrated delivery and targeted 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 *311 ADVO or ADVO customer supplied pre-press intangibles, and not by ADVO.
On October 9, 2012, 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
For the years at issue,
ADVO contends that its gross receipts attributable to its printed direct *55 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 qualifying 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 packages or produced only intangible property used by printers to produce tangible personal property in the form of the advertising mail packages.10*56 *57 The broad issue confronted here is *313 how
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
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 taxpayer 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.
In *62 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)."
*316
Congress did not define "manufacture" in the Code. However, it did direct the Secretary to "prescribe such regulations as are necessary to carry out the purposes of this section".
The Secretary in response promulgated
*317 The initial interim guidance to taxpayers on One 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 commentator requested that the final regulations permit unrelated parties to a contract manufacturing arrangement to designate, through a written and signed agreement between the parties, which of them shall be treated for purposes of
The predecessor to
Note the similarity of the
The intent of
*321 ADVO directs the Court's attention to
Respondent argues that While
*322 We are aware that the Court has previously been unpersuaded by a preamble to regulations.
We noted
The *81 examples in the
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 *82 the factors of
The factors we use to determine the benefits and burdens of ownership under
As discussed
According to
We are less concerned with the label that the parties give the transaction; we look to what the parties actually intended to happen.
ADVO asserts that the parties' *86 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 manufacturing 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 contract printers, testified that Doodad claimed a deduction under
*327 The parties contemplated and agreed that the third-party printers would print the specific advertising material that ADVO *87 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 intangible pre-press materials. Therefore we find this factor weighs in favor of respondent.
While these factors were relevant in
In determining whether ADVO had the benefits and burdens of ownership of the advertising material during the printing process, "[t]ransfer of possession is also significant."
However, because we are tailoring the factors from
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 their's, and at which locations they were allowed to print ADVO's materials.22*328 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' property. The third-party printers and their employees set up the machines, loaded the paper, fine-tuned the color keys, ran the printing process, *89 supervised the quality, and then delivered the advertising materials to ADVO.
Respondent contends in the interim guidance that a taxpayer who is contracting the printing services out to a third party *90 must have the benefits and burdens of ownership to qualify for the
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.
Along with the benefits of ownership must go the burdens.
As noted
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 burdens.
Furthermore, we realize that in the event damage or loss of the advertising material resulted in the material's not getting timely delivered to the end consumers, ADVO bore the economic risk vis-a-vis its clients. ADVO's contracts with clients often required quick turnaround periods. If the printer *330 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 clients, and more ethereal, in terms of reputation damage. In the light of these considerations, we find *93 that this factor to be neutral.
Similar to the example in
The test under
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.23*331 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".
The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, the Court concludes that they are meritless, *95 moot, or irrelevant.
To reflect the foregoing,
*. Brief amici curiae was filed by Mario J. Verdolini and Ethan R. Goldman, as attorneys for Limited Brands, Inc., and Judith A. Mather, as attorney for Meredith Corp.↩
1. 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 Practice and Procedure.↩
2. There remains a second issue for resolution, in a separate trial, whether ADVO is entitled to a credit pursuant to
3. Psychographics is the study of personality, values, attitudes, interests, and lifestyles.↩
4. With respect to turnkey products, ADVO's calculation of "domestic production gross receipts" for the purposes of
5. 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".↩
6. 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 process 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.
7. 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.↩
8. At trial respondent objected to this report as well as the rebuttal report also written by Mr. Bolte discussed
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 demonstrated qualifications and all other evidence in the record.
9. Both of the years at issue began before the phase-in increased the amount of the deduction.
10. 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
The problem is that ADVO, unlike some printers or publishers, pursuant to ADVO's customer and/or printer contracts never sold, leased, rented, licensed, 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 advertising materials. Therefore, the electronic files themselves do not constitute or generate "domestic production gross receipts" for purpose of determining a
We also note that the deduction is limited by
11. 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 addressed in
12.
13. The
14. 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
15. The Court recognizes that
In explanation of this apparent contradiction, when Treasury issued the
Further, in
16. As discussed above, the policy motivating the enactment of First, the existing rules may allow costs that are in reality costs of producing, 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 economic resources and the manner in which certain economic activity is organized. * * * [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 * * *.
17. The Commissioner now recognizes that in contract manufacturing relationships, each party, as in this case, will often have some of the benefits and burdens of ownership. Consequently the Commissioner, the taxpayer, and ultimately the courts may expend significant resources to determine which party may claim the deduction. I.R.S. LB&I Directive, LB&I-04-0713-006 (July 24, 2013). In recognition of the cost of such determinations, the Acting Commissioner of the IRS' Large Business and International Division has instructed his examiners not to challenge a taxpayer's claim to have the benefits and burdens for a
18. In
19. In 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 necessarily 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 identified from the facts and circumstances of the case, see
For whatever reason Treasury created two distinctly different tests for
20. The amici curiae note at 23 of their brief that the Court found as a factual matter in
21. 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,
The guidance focuses on three areas. It first looks to the terms of the contract: (1) did the taxpayer have title to the work in process; (2) did the taxpayer have risk of loss over the work in process; and (3) was the taxpayer primarily responsible for insuring the work in process? Then it looks to the production activities: (1) did the taxpayer develop the qualifying activity process; (2) did the taxpayer exercise oversight and direction over the employees engaged in the qualifying activity; (3) did the taxpayer conduct more than 50% of the quality control tests while the qualifying activity was occurring? And finally, the guidance looks to the economic risks: (1) was the taxpayer primarily liable under the "make-good" provisions of the contract; (2) did the taxpayer provide more than 50%, based on cost, of the raw materials and components used to produce the property; (3) did the taxpayer have the greater opportunity for profit increase or decrease from production efficiencies and fluctuations in the cost of labor and factory overhead?
22. On March 29, 2013, the Office of Chief Counsel released a memorandum in which it addressed a fact pattern similar to the one at issue in this case. Our Office believes that print specification activities are non-MPGE activities. While providing the print specifications to the contract manufacturer gives the contract manufacturer a detailed description of how the Taxpayer desires the mass-produced books to look (e.g., size, color, print type, etc.), the print specifications do not produce QPP.↩
23. On brief petitioner also argued that its gross receipts with respect to graphic design, processing, and distribution activities were also DPGR. Because we did not find that petitioner had the benefits and burdens of ownership during the manufacturing activity, we need not address these issues.↩
Medchem (P.R.), Inc. v. Commissioner , 295 F.3d 118 ( 2002 )
Robinson Knife Manufacturing Co. v. Commissioner , 600 F.3d 121 ( 2010 )
Taproot Administrative Services, Inc. v. Commissioner , 679 F.3d 1109 ( 2012 )
Suzy's Zoo (R) v. Commissioner of Internal Revenue , 273 F.3d 875 ( 2001 )
Marmolejo-Campos v. Holder , 558 F.3d 903 ( 2009 )
Commissioner of Internal Revenue v. Segall , 114 F.2d 706 ( 1940 )
Skidmore v. Swift & Co. , 65 S. Ct. 161 ( 1944 )
United States v. Mead Corp. , 121 S. Ct. 2164 ( 2001 )
Gordon J. Harmston and Alice C. Harmston v. Commissioner of ... , 528 F.2d 55 ( 1976 )
Helvering v. National Grocery Co. , 58 S. Ct. 932 ( 1938 )
Indopco, Inc. v. Commissioner , 112 S. Ct. 1039 ( 1992 )
Daubert v. Merrell Dow Pharmaceuticals, Inc. , 113 S. Ct. 2786 ( 1993 )
Mayo Foundation for Medical Education & Research v. United ... , 131 S. Ct. 704 ( 2011 )
Walburga Oesterreich v. Commissioner of Internal Revenue , 226 F.2d 798 ( 1955 )
Hutchinson v. Commissioner , 116 T.C. 172 ( 2001 )
Advo, Inc. & Subsidiaries v. Commissioner , 141 T.C. No. 9 ( 2013 )
Gibson & Assocs. v. Comm'r , 136 T.C. 195 ( 2011 )
Dobin v. Commissioner , 73 T.C. 1121 ( 1980 )
LaPoint v. Commissioner , 94 T.C. 733 ( 1990 )
Shea Homes v. Comm'r , 142 T.C. 60 ( 2014 )
Webber v. Comm'r , 144 T.C. 324 ( 2015 )
Estate of Morrissette v. Comm'r , 146 T.C. 171 ( 2016 )
Advo, Inc. & Subsidiaries v. Commissioner , 141 T.C. No. 9 ( 2013 )
TGS-NOPEC Geophysical Company and Subsidiaries v. ... , 155 T.C. No. 3 ( 2020 )
Bats Global Markets Holdings, Inc. and Subsidiaries ( 2022 )