The American Institute of CPAs (AICPA) has recommended modifications to the regulations determining qualifying gross receipts from dispositions of computer software under Internal Revenue Code section 199, often referred to as the manufacturing deduction. The AICPA believes implementation of its recommendations would result in reduced controversies between taxpayers and the IRS and a more equitable application of section 199.
In the letter, Troy K. Lewis, CPA, CGMA, chair of the AICPA Tax Executive Committee, wrote, “The current regulatory framework makes a determination of whether gross receipts from software development are qualified for section 199 purposes based on whether the software is disposed via a tangible medium, by download, or through local or remote servers connected to the Internet (“online”). The statutory language of section 199 does not provide for this distinction. The AICPA believes the distinction in the regulations denies taxpayers developing certain software in the United States (U.S.) a section 199 deduction for otherwise qualifying activities. The result is inconsistent with the broad legislative intent of section 199 to incentivize domestic production.”
Lewis recommended in the letter that the IRS and the U.S. Department of the Treasury “eliminate the distinction and allow gross receipts derived from the disposition of computer software to include gross receipts derived from providing software online without relying on the disposition of comparable software via download or tangible medium.”
He wrote that the AICPA recognizes the concern that eliminating the regulatory distinction with respect to the means of software disposition may result in taxpayers claiming, as domestic production gross receipts, amounts derived from non-qualified services. The IRS and Treasury could, he wrote, clarify the definition under section 199 that the provision of software online excludes the provision of non-qualifying services. “Specifically,” he stated, “we recommend that Treasury explicitly state that the use of software by a customer online, while connected to the Internet, is not by itself considered the provision of a non-qualifying service.”
Lewis also recommended that, where an allocation of gross receipts is required, the IRS and Treasury include a safe harbor in the regulations, providing for the allocation of gross receipts between the provision of software and non-qualifying services. Such a safe harbor would eliminate the need for taxpayers to pay for specialists or perform burdensome computations to determine gross receipts attributable to qualifying software dispositions versus non-qualifying services, he stated.
“We believe that these modifications to the regulations under section 199, for determining qualifying dispositions of computer software and qualifying gross receipts, are necessary to provide taxpayers with much-needed clarity in applying the rules,” Lewis wrote. “We also believe the modifications will reduce future controversies between taxpayers and the IRS, and are consistent with the legislative intent to incentivize domestic development of all software, regardless of the medium of its disposition.”