TAM 200631029, 8/4/2006 1

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

Technical Advise Memorandum 200631029,

8/4/2006Presented by Antonia Kwan

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FactsTaxpayerDesign & Select Samples

Outside Vendor

(Samples)In-House

(Samples)

Samples

DesignSamples

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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.

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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.

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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.

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Main Issue:

Does Taxpayer qualify to use the simplified resale method pursuant to § 1.263A-3(a)(4)?

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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.

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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.

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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.

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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).

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Law

De Minimis:GR from sale of property < 10% of total GR of the trade or businessANDLabor costs allocable to production activities < 10% of total labor costs allocable to its trade or business.

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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.

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Analysis 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

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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.

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Thank you