The IRS Large Business & International Division issued a memorandum outlining activities the division contends generally do not meet the definition of “manufactured, produced or grown” under §199 for computing the deduction for domestic production activities. LB&I Memorandum LB&I-04-0315-001 provides a specific list of “non-qualifying” activities.

IRC §199 allows a deduction of 9% of the lesser of “qualified production activities income” or taxable income of the taxpayer, though limited to ½ of the W-2 wages of the taxpayer for employees involved in the generation of domestic production gross receipts.

Under IRC §199(c)(4)(A)(i) domestic production gross receipts (the starting point to determine domestic production activities income) consists, in part, of the lease, rental, license, sale, exchange or other disposition of “qualified production property” that was “manufactured, produced, grown or extracted” in whole or a significant part inside the United States.

Qualified production property includes tangible personal property, computer software and §168(f)(4) sound recordings.

The memorandum points out that Reg. §1.199-3(e) contains the definition of “manufactured, produced, grown or extracted” (MPGE) that must be consulted to determine if a taxpayer’s activities are of that sort.

The memorandum then notes that the following generally would not, in the view of the memorandum’s authors, be MPGE activities when performed at a retail level:

Cutting blank keys to a customer’s specification;
Mixing base paint and a paint coloring agent;
Applying garnishments to cake that is not baked where sold;
Applying gas to agricultural products to slow or expedite fruit ripening;
Storing agricultural products in a controlled environment to extend shelf life; and
Maintaining plants and seedlings.

The ruling takes the position, implicitly, that if an entity’s major activity is retail, these minor “product improvement” activities would not lead to the generation of such income.

The memo concludes by asking agents to send to the Corporate Income & Losses Practice Group (CIL IPG) examples of similar activities where taxpayers are seeking to claim MPGE activities so that the IRS may expand this list to include such activities.