Changes in Method of Accounting – Simplified Resale Method – Revocation of Erroneous Prior Letter Ruling

1. Changes in Method of Accounting – Simplified Resale Method – Revocation of Erroneous Prior Letter Ruling Technical Advise Memorandum 200631029, 8/4/2006 Presented by Antonia Kwan TAM 200631029, 8/4/2006

2. Facts Samples Taxpayer Design & Select Samples Outside Vendor (Samples) Samples Design In-House (Samples) TAM 200631029, 8/4/2006

3. Facts • Taxpayer (a retailer): • Does not manufacture any products. • Does not own any production facilities. • Provides instructions to vendors how the final products should look. • Selects most of the material used to make the finished products. TAM 200631029, 8/4/2006

4. Facts • Vendors • Will not disclose designs to any third party. • Will not use designs for their benefit. • Will treat Taxpayer’s trade secrets or information as confidential. • Will remove all reference to its tradenames or trademark on goods when Taxpayer cannot accept the goods and authorize their transfer to a third party. TAM 200631029, 8/4/2006

5. Facts • Date 2: Taxpayer filed Form 3115 to request the Commissioner’s consent to use the simplified resale method. • Date 3: IRS National Office issued a ruling to grant the change. • Examination team: Taxpayer is ineligible to use the simplified resale method and the consent to use that method should be revoked. TAM 200631029, 8/4/2006

6. Main Issue: • Does Taxpayer qualify to use the simplified resale method pursuant to § 1.263A-3(a)(4)? TAM 200631029, 8/4/2006

7. Law • § 1.263A-2(a)(1)(ii)(B) • Property produced for the taxpayer under a contract with another party is treated as property produced by the taxpayer except in the case of a routine purchase order for fungible property if the agreement is entered into before the production of the property to be delivered under the contract is completed. TAM 200631029, 8/4/2006

8. Law • § 1.263A-2(b)(1) • Producers may elect to use the simplified production method if engaged in both production and resale activities with respect to items of eligible property. TAM 200631029, 8/4/2006

9. Law • § 1.263A-3(d) • Resellers may elect to use the simplified resale method that is only available to a trade or business exclusively engaged in resale activities. TAM 200631029, 8/4/2006

10. Law • § 1.263A-3(a)(4) – Two Exceptions • 1st Exception: Reseller may use simplified resale method if its production activities with respect to the items of eligible property are de minimis and incident to its resale of personal property described in § 1221(1). TAM 200631029, 8/4/2006

11. Law • De Minimis: GR from sale of property < 10% of total GR of the trade or business AND Labor costs allocable to production activities < 10% of total labor costs allocable to its trade or business. TAM 200631029, 8/4/2006

12. Law • 2nd Exception: A reseller may use the simplified resale method even though it has personal property produced for it under a contract with an unrelated person if the contract is entered into incident to its resale activities and the property is sold to its customers. TAM 200631029, 8/4/2006

13. Taxpayer: Reseller Subject to 2nd exception IRS: Producer Agreement does not qualify as a routine purchase order for fungible goods Taxpayer controls the manufacturing process Does not qualify for the exceptions Analysis TAM 200631029, 8/4/2006

14. Conclusion • Taxpayer does not qualify to use the simplified resale method pursuant to § 1.263A-3 because Taxpayer is a producer and does not qualify for the exceptions. TAM 200631029, 8/4/2006

15. Thank you TAM 200631029, 8/4/2006