IRS Campaign Focuses on Definition of “Qualified Film” Under Section 199

By and on March 9, 2017

On January 31, the Internal Revenue Service (IRS) announced 13 Large Business & International (LB&I) “campaigns.”  One campaign targets deductions claimed by multi-channel video programming distributors (MVPDs) and TV broadcasters under section 199 of the Internal Revenue Code (IRC).  According to the IRS’s campaign announcement, these taxpayers make several erroneous claims, including that (1) groups of channels or programs constitute “qualified films” eligible for the section 199 domestic production activities deduction, and (2) MVPDs and TV broadcasters are producers of a qualified film when they distribute channels and subscription packages that include third-party content.

IRC section 199(a) provides for a deduction equal to 9 percent of the lesser of a taxpayer’s “qualified production activities income” (QPAI) for a taxable year and its taxable income for that year.  A taxpayer’s QPAI is the excess of its “domestic production gross receipts” (DPGR) over the sum of the cost of goods sold and other expenses, losses or deductions allocable to such receipts.  IRC section 199(c)(1).  DPGR includes 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.”  IRC section 199(c)(4)(A)(i)(II).  A “qualified film” is “any property described in section 168(f)(3) if not less than 50 percent of the total compensation relating to the production of such property is compensation for services performed in the United States by actors, production personnel, directors and producers.”  IRC section 199(c)(6).  However, “qualified film” does not include property with respect to which records are required to be maintained under 18 U.S.C. § 2257 (i.e., sexually explicit materials).  Id.  Under regulations issued in 2006, “qualified film” also includes “live or delayed television programming.”  Treas. Reg. § 1.199-3(k)(1); see also Notice 2005-14, 2005-1 C.B. 498, §§ 3.04(9)(a), 4.04(9)(a). “Qualified film” includes “any copyrights, trademarks, or other intangibles with respect to such film.”  IRC section 199(c)(6).  The “methods and means of distributing a qualified film” have no effect on the availability of the section 199 deduction.  Id.  IRC section 168(f)(3), entitled “Films and Video Tape,” provides an exclusion from accelerated depreciation for “[a]ny motion picture film or video tape.”

Though the January 31 announcement did not explain the IRS’s position on these issues in detail, the IRS rejected both claims in two Technical Advice Memoranda (TAMs) issued in late 2016.  The IRS determined in TAM 201646004 (Nov.10, 2016) and TAM 201647007 (Nov.18, 2016) (the 2016 TAMs) that a subscription package of multiple channels of video programming transmitted by an MVPD to its customers via signal is not a “qualified film” as defined in IRC section 199(c)(6) and Treas. Reg. § 1.199-3(k)(1).  It also determined that an MVPD’s gross receipts from its subscription package are not from the disposition of a qualified film produced by the MVPD and are therefore not DPRG included in calculating a section 199 deduction.  The MVPD would only have DPRG from the subscription package to the extent its gross receipts are derived from an individual film or episode within the subscription package that is a qualified film produced by the MVPD.

The new LB&I campaign will likely incorporate the IRS’s arguments from the 2016 TAMs.  In those TAMs, the IRS argued that the definition of “qualified film” is limited to individual films and episodes.  The IRS pointed to the statutory and regulatory language defining qualified film as “any motion picture film or video tape” or “live or delayed television programming (film)” that meets the statute’s compensation requirement as evidence that the term “qualified film” is limited to individual films.  The IRS stated that the plain meaning of the terms “motion picture film,” “video tape,” and “television programming” refers to individual films and does not include the subscription packages sold by an MVPD.  Thus, according to the IRS, eligibility for a deduction under IRC section 199 must be determined on a film-by-film basis.  Lastly, it argued that Congress intended section 199 to incentivize movie production in the United States, and that there is no indication that Congress also wanted to incentivize domestic movie distribution.

The IRS therefore determined in the 2016 TAMs that an MVPD could not treat its subscription package of multiple television channels as a qualified film.  The IRS noted that the MVPD was being inconsistent by attempting to analyze an entire subscription package as a qualified film, but excluding content described in 18 U.S.C. §2257 (sexually explicit materials) on an individual, film-by-film basis.  The IRS rejected the MVPD’s application of Treas. Reg. §1.199-3(d)(1)’s “item rule.”  The item rule provides that a taxpayer should determine whether gross receipts qualify as DPGR on an “item-by-item” basis, where “item” means the property offered by the taxpayer for disposition to customers in the normal course of its business.  The MVPD had argued that the entire subscription package should be analyzed as a qualified film because the subscription package is the “item” sold to customers in the normal course of its business.  The IRS held that the item rule is merely a way to determine DPGR; it does not change the definition of “qualified film,” which applies only to individual films.

This analysis of an MVPD in the 2016 TAMs contrasts starkly with the analysis of a network content provider in TAM 201049029 (Dec.10, 2010) (the 2010 TAM).  There, the taxpayer provided taxpayer-produced programs, third-party-produced programs, commercials, and interstitials (the programming package) to MVPDs and television stations for distribution to their customers.  The IRS ruled that the entire programming package offered by the taxpayer should be tested as a single qualified film because, under the “item” rule, property that consists of multiple properties is tested as a single property for purposes of section 199.  The 2010 TAM was not addressed in either of the 2016 TAMs.

Practice Point:  The IRS’s new campaign specifically identifies MVPDs and TV broadcasters that claim a section 199 deduction as producers of qualified films.  Those taxpayers should anticipate additional IRS guidance in this area, as well as challenges from the IRS on the definition of “qualified film” and whether gross receipts from distributing channels and subscription packages to customers qualify as DPGR.  It remains to be seen how the campaign will affect other taxpayers within the industry, including the companies that provide original and third-party programming to MVPDs and TV broadcasters.

Elizabeth Chao
Elizabeth Chao focuses her practice on US and international tax matters. Read Elizabeth Chao's full bio.


Roger J. Jones
    Roger J. Jones represents clients in tax controversy and litigation matters at all levels of the federal court system, before the Internal Revenue Service (IRS), and before various state courts and tax agencies. He has represented taxpayers, including numerous Fortune 500 companies, in more than 80 docketed cases before the US Supreme Court, most of the US courts of appeals, federal district courts, the US Court of Federal Claims and the US Tax Court. Read Roger Jones' full bio.

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