Software-license royalties qualify as domestic production receipts

Plain-English summary

A taxpayer developed unique computer software and licensed it to contracting parties that combined the software with their own data to provide services to end users. The question was whether the taxpayer's receipts were domestic production gross receipts from software licenses or nonqualifying receipts from services. The IRS treated the arrangements as two steps: the taxpayer produced and licensed software, then the contracting parties used it to serve customers. The agreements' royalty and payment terms supported finding that the contracting parties paid the taxpayer for software licenses, and limited end-user licenses protected intellectual property rather than showing that the taxpayer supplied the services. The receipts therefore qualified as domestic production gross receipts under section 199, although the memorandum did not decide whether embedded-service exceptions applied.

Ruling snapshot

• Question: Were the taxpayer's receipts derived from licensing domestically produced software or from providing services to end users?
• Outcome: Advice given: the receipts were DPGR from software licenses.
• Key authorities: IRC § 199; Treas. Reg. § 1.199-3(i).

Full text (IRS public release)

INTERNAL REVENUE SERVICE
NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                             July 10, 2014

                                                    Third Party Communication: None
                                                    Date of Communication: Not Applicable

Number: 201445010
Release Date: 11/7/2014
Index (UIL) No.: 199.00-00, 199.03-05
CASE-MIS No.: TAM-131376-13

RFTH, Industry Director, Field Operations West,

     Taxpayer's Name:                               ----------------------------------------------------
     Taxpayer's Address:                            --------------------------------------------------
                                                    ------------------------------
                                                     ----------------------------------
     Taxpayer's Identification No                   ---------------
     Year(s) Involved:                              ---------------------
     Date of Conference:                            ---------------------------

LEGEND:

Taxpayer = -----------------------------------------------------

Contracting Parties = ---------------------------------------------------------------------------------

Contracting Party A = ----------

Contracting Party B = ---------------

End Users = --------------------------------------------------------------------------------

Business A = ---------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

Results = -----------------
TAM-131376-13 -2-

Date 1 = --------------------------

Date 2 = -----------------

Date 3 = ------------------

Agreement X = --------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------

Master Agreement 1 = --------------------------------------------------------------------------------

----

Master Agreement 2 = --------------------------------------------------------------------------------

-----

Master Agreement 3 = --------------------------------------------------------------------------------

--

Computer Software = ------------------------------------------------------------

Year 1 = ------

Z= ------------

ISSUE:

For purposes of Taxpayer’s domestic production activities deduction under § 199 of the
Internal Revenue Code, did Taxpayer derive domestic production gross receipts
(DPGR) from the license of Computer Software to Contracting Parties, or non-DPGR
from providing services to End Users?

CONCLUSION:

Taxpayer derived DPGR from the license of Computer Software to Contracting Parties.
TAM-131376-13 -3-

FACTS:

Overview: Our Office was provided with representative agreements between Taxpayer
and Contracting Party A and Taxpayer and Contracting Party B. Our Office also
received a sample subscriber agreement between Taxpayer, Contracting Party B, and
End Users. Taxpayer and LB&I agree that Taxpayer’s relationship with each of the
Contracting Parties is generally similar. Taxpayer and LB&I also provided Agreement X
entered into by Taxpayer and Contracting Party A. This memorandum does not
address Agreement X because the gross receipts derived from it were nominal in the
years involved. Our Office’s analysis is further limited to analyzing the gross receipts
Taxpayer receives as a result of its agreements with the Contracting Parties, and does
not address any of Taxpayer’s other sources of gross receipts, including gross receipts
from ------------------.

Taxpayer, in Business A, develops and licenses ----------------------that calculate Results
used by End Users to ---------------------------------, such as -----------------------------------------
These proprietary --------- -----------are --------------------------- software developed, owned
and controlled by Taxpayer.

Many of the Business A products and services are distributed through the Contracting
Parties. Under master agreements with each of the Contracting Parties, Taxpayer
designs and develops unique Computer Software for each Contracting Party’s data, and
Taxpayer licenses the Computer Software to the Contracting Parties. An End User
subscribes to a product or service by entering into a subscriber agreement with both
Taxpayer and the respective Contracting Party. Under the subscriber agreement, the
End User submits a service request to the Contracting Party, and the Contracting Party
uses the licensed computer software and the Contracting Party’s data to perform the
service (generation and distribution of the Results) with the Results provided by the
Contracting Party to the End User. In some cases, Taxpayer grants the End User a
license to use the Results. Under the subscriber agreement, the Contracting Party
collects End User fees. The Contracting Party pays Taxpayer an amount as provided
under the respective master agreement.

Contracting Party A Master Agreement: Contracting Party A and Taxpayer entered into
an agreement (Master Agreement 1) on Date 1.

The recitals to Master Agreement 1 provide that “[Contracting Party A] and [Taxpayer]
desire to mutually create and market various products and services. This contract
specifies the nature of the overall business relationship…”

------------- provided that “Each product or service to be developed and offered under this
Agreement, the responsibilities of [Contracting Party A] and [Taxpayer] with respect
thereto, the fees to be charged for the use of such product or service by [Contracting
Party A’s] subscribers and the allocation of revenue between [Contracting Party A] and
[Taxpayer] will be set forth in detail in Addenda to this Master Agreement…”
TAM-131376-13 -4-

------------- provided that “It is anticipated that both [Contracting Party A] and [Taxpayer]
will generate revenues as a result of this Agreement. It is the intention that such
revenues, unless otherwise defined, will be pooled and shared in proportions set forth in
this Agreement and its addenda. It is likely that shared proportions will differ by product
or service depending on the relative contributions of [Taxpayer] and [Contracting Party
A].”

Under ------------ of Master Agreement 1, Contracting Party A’s monthly payment to
Taxpayer was based on End User fees invoiced, with subsequent adjustments for write-
offs of uncollected amounts. Taxpayer’s compensation under Addendums to Master
Agreement 1 is referred to as either “[Taxpayer’s] share” or “royalties.”

------------- states that “…[Taxpayer] shall use the data provided by [Contracting Party A]
to develop [Computer Software], to conduct ------------ analyses of Pooled Data Base
[Computer Software], to provide performance data for use in marketing the products
and services, and for research and development to the end of improving the jointly
developed products and services. Such [Computer Software] will be developed for the -
----- use of [Contracting Party A] in the Software Facility defined by this Agreement.”
---------------------(added by amendment) of Master Agreement 1 provides that
Contracting Party A is responsible for invoicing and collecting fees from End Users, and
it is authorized as Taxpayer’s agent for purposes of collecting fees.

In addition to other amendments, -----------amendment to Master Agreement 1 (Master
Agreement 2) was entered into with Contracting Party A, and was effective as of Date 2.

The recitals to Master Agreement 2 states “WHEREAS, the Parties desire to establish a
----------------------------------relationship that involves, among other things, each Party
treating the other Party as a ------------------------with respect to the activities
contemplated by this Agreement and the other agreements referenced below…” The
next recital provides “WHEREAS, under this [Master Agreement 2], the Parties are
amending [Master Agreement 1] for the purpose of modifying certain terms applicable to
-----------[Computer Software].”

Under ----------- of Master Agreement 2, ------------ of Master Agreement 1 was replaced.
The second agreement provides that “all fees, charges, royalties, rebates, revenue
shares and prices payable by [Contracting Party A] to [Taxpayer] for ---------- [Computer
Software] shall be replaced by the royalty payments set forth in this -----------. Taxpayer
is entitled to receive payment each month based on End User fees invoiced, regardless
of whether Contracting Party A collected the fees. -------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------.
TAM-131376-13 -5-

Contracting Party B Master Agreement: Contracting Party B and Taxpayer entered into
an agreement (Master Agreement 3) on Date 3.

------------------provides that “[Contracting Party B] is in the ----------------------------------------
business, having a --------------of ------- information --------------------------------------------------
--------.”

------------------provides that “[Taxpayer] is in the --------------------------------------, having the
capability to develop ------------------------------------------------------------------------ from ---------
----------- ------- data.”

------------------provides that [Contracting Party B] and [Taxpayer] desire to jointly
develop, produce, market, service and maintain services described herein, utilizing
[Contracting Party B’s] proprietary ------- information database and its data base
processing facilities and Taxpayer’s proprietary -------------------technology and its
expertise in -------------------design software. These services will be offered to --------------
-------------------- and other businesses (the “Subscribers”) within the United States to
provide them with ------------------------------(“[Results]”) of the information ----------------------
------------------------------- in the [Contracting Party B] data base…The services to be
jointly developed and produced pursuant to this Agreement are referred herein as the
“Services” or [Contracting Party B]/[Taxpayer] Services” or “Joint Services.”

------------------(added by addendum) provides that Contracting Party B is generally
responsible for collecting fees from End Users, and it is authorized as Taxpayer’s agent
for purposes of collecting fees.

------------------provides that “The initial schedule of fees and charges to [End Users], and
the allocations of such fees and charges between [Contracting Party B] and [Taxpayer]
are set forth in ------------------------------------attached hereto…There shall be no fee for
the development of the [Computer Software] by Taxpayer or for the information
provided by [Contracting Party B], or for any other service provided hereunder, except
as expressly stated herein. In all other respects, each party shall bear it [sic] own costs
and expenses.” -------------------------------------------------, Taxpayer’s compensation was
either a fixed amount per Result provided to End User, or a percentage if there was a
fixed fee arrangement with the End User.

------------------provides that any collection action against an End User is taken on behalf
of both Taxpayer and Contracting Party B if the parties subsequently agree to take
action. Taxpayer has never been a party to any collection action, and is unaware that
any such action has occurred.

------------------provides that “Both parties shall provide adequate staffing and resources
to facilitate the marketing and sale of the Joint Services covered by this Agreement.
[Taxpayer] shall provide said resources under the direction of a project director who
TAM-131376-13 -6-

shall aggressively pursue all mutually agreed upon marketing and publicity activities.
[Contracting Party B] shall name a lead marketing individual who shall have final
authority to coordinate the combined efforts.

----------------------provides that “[Contracting Party B] shall have primary responsibility for
sales. [Taxpayer] shall make good faith efforts to participate in joint sales calls, when
potential billings to the customer are large, and when technical expertise is needed to
close the sale.”

----------------------provides that “Marketing material shall from time to time be prepared by
[Taxpayer] and/or [Contracting Party B]…Any marketing materials, literature, or media
releases pertaining to products or services covered by this Agreement shall be prepared
jointly by ]Taxpayer] and [Contracting Party B] and shall not be disseminated without the
approval of both parties….”

Under Master Agreement 3, Taxpayer’s compensation is generally referred to as
“[Taxpayer’s] share,” although Year 1 amendments (after the years involved) use the
term “royalties” to refer to Taxpayer’s compensation. Under -----------------of Master
Agreement 3, Contracting Party B’s monthly payment to Taxpayer was contingent upon
receipt of payment from End Users. Under three Year 1 amendments (after the tax
years covered by this technical advice), Contracting Party B pays Taxpayer
compensation based on user fees invoiced, with subsequent adjustments for write-offs
of uncollected amounts.

Royalty Waivers: From time to time, a Contracting Party asks Taxpayer to waive its
fees relating to the Contracting Party’s services for certain End User projects.
Taxpayer’s agreement to waive its fees is documented in the form of a letter addressed
to the Contracting Party and is described as a “royalty waiver.”

Subscriber agreements: An End User subscribes to a product or service by entering
into a subscriber agreement. Master Agreement 3 imposes a number of requirements
and restrictions on the subscriber agreements. For example, -----------------of Master
Agreement 3 provides “Neither party shall provide any of the Joint Services to any third
party unless such third party has executed a Subscriber Contract therefor in a form
approved by both [Contracting Party B] and [Taxpayer]. Such contacts shall be in the
joint names of [Contracting Party B] and [Taxpayer] on one hand, and the Subscriber on
the other. [Contracting Party B] is authorized to execute such contracts in an approved
form on behalf of [Taxpayer].” Master Agreement 1 with Contracting Party A does not
require Taxpayer’s prior approval of the subscriber agreement.

In the representative subscriber agreement between Taxpayer, Contracting Party B,
and End User, Contracting Party B is solely responsible for distributing the products and
services to End Users. The subscriber agreement provides that Taxpayer owns the
Results, the End User places a request for services with Contracting Party B, and
TAM-131376-13 -7-

Contracting Party B delivers the services to the End User, with Taxpayer licensing the
right to use the Results of Contracting Party B’s services to End Users.

The subscriber agreement recitals state:

   “WHEREAS, [Contracting Party B] is in the business of providing Services to

clients…who have entered into one or more separate agreements with [Contracting
Party B] for such Services;

  WHEREAS, [Taxpayer] is in the -----------------------business with expertise in

developing -----------------------…which --------- are used to calculate…; and

     WHEREAS, Client…desires to license the [Results]…in connection with ------------

------------------------it is purchasing from [Contracting Party B], for the purposes permitted
by the agreement.”

---------------. provides that “From time to time, Client may request that [Contracting Party
B] deliver the [Results] to Client…[Contracting Party B] agrees to perform the Services
as reasonably practicable.”

-----------------of the subscriber agreement includes “a personal, non-exclusive, non-
transferrable, non-sublicensable, limited license to use, internally the [Results] solely for
the particular purpose…for which the [Results] were obtained, subject to the limitations
set forth in this Agreement…”

-----------------provides that “Under no circumstances will Client…(a) attempt in any
manner, directly or indirectly, to discover or reverse engineer any confidential and
proprietary information,…(b) alter, change, modify, adapt, translate or make derivative
works of the [Results]; (c) sublicense or request the [Result] Services or [Results] for
timesharing, rental, outsourcing, or service bureau operations, or to create or maintain a
database for itself or otherwise; (d) use the [Results] in any manner not permitted under
this Agreement, including, without limitation, for -----------------------------------------------------
---------------------------------------------------------------------or any other purpose that may
result ----------------------------------------------------------- [Results]…”

In ----------------------------, both Contracting Party B and Taxpayer provide limited
warranties under the subscriber agreements. In -----, Contracting Party B represents
and warrants that the services will be provided in a professional and workmanlike
manner consistent with industry standards. In ---------------, Taxpayer warrants the
software’s ------------- that it delivers to Contracting Party B. -----------------serves to limit
the parties’ warranties.

Under ---------------------------------------, Taxpayer and Contracting Party B have the power
to terminate the subscriber agreement, both must consent to any assignments or
TAM-131376-13 -8-

transfers of the agreement by the End User, and they must both consent to any
amendments of the agreement.

LAW:

Section 199(a)(1) allows a deduction equal to 9 percent (3 percent in the case of
taxable years beginning in 2005 or 2006, and 6 percent in the case of taxable years
beginning in 2007, 2008, or 2009) of the lesser of (A) the qualified production activities
income (QPAI) of the taxpayer for the taxable year, or (B) taxable income (determined
without regard to § 199) for the taxable year.

Section 199(c)(1) defines QPAI for any taxable year as an amount equal to the excess
(if any) of (A) the taxpayer’s DPGR for such taxable year, over (B) the sum of (i) the
CGS that are allocable to such receipts; and (ii) other expenses, losses, or deductions
(other than the deduction under § 199) that are properly allocable to such receipts.

Section 199(c)(4)(A)(i)(I) defines DPGR to mean the gross receipts of the taxpayer
which are derived from any lease, rental, license, sale, exchange, or other disposition of
qualifying production property (QPP) which was manufactured, produced, grown, or
extracted (MPGE) by the taxpayer in whole or in significant part within the United
States.

Section 199(c)(5) defines QPP as including computer software.

Section 1.199-3(i)(1)(i) of the Income Tax Regulations defines the term “derived from
the lease, rental, license, sale, exchange, or other disposition” as, and limited to, the
gross receipts directly derived from the lease, rental, license, sale, exchange, or other
disposition of QPP. Applicable Federal income tax principles apply to determine
whether a transaction is, in substance, a lease, rental, license, sale, exchange, or other
disposition, whether it is a service, or whether it is some combination thereof.

Section 1.199-3(i)(4)(i)(A) provides that, except as provided in § 1.199-3(i)(4)(i)(B),
gross receipts derived from the performance of services do not qualify as DPGR.

Section 1.199-3(i)(6)(i) provides that DPGR includes the gross receipts of the taxpayer
that are derived from the lease, rental, license, sale, exchange, or other disposition of
computer software MPGE by the taxpayer in whole or in significant part within the
United States. Such gross receipts qualify as DPGR even if the customer provides the
computer software to its employees or others over the Internet.

Section 1.199-3(i)(6)(ii) provides that gross receipts derived from customer and
technical support, telephone and other telecommunication services, online services
(such as Internet access services, online banking services, providing access to online
electronic books, newspapers, and journals), and other similar services do not
TAM-131376-13 -9-

constitute gross receipts derived from a lease, rental, license, sale, exchange, or other
disposition of computer software.

Section 1.199-3(i)(6)(v), Example 1, provides that L is a bank and produces computer
software within the United States that enables its customers to receive online banking
services for a fee. Under § 1.199-3(i)(6)(ii), gross receipts derived from online banking
services are attributable to a service and do not constitute gross receipts derived from a
lease, rental, license, sale, exchange, or other disposition of computer software.
Therefore, L’s gross receipts derived from the online banking services are non-DPGR.

Section 1.199-3(i)(6)(v), Example 2, provides that M is an Internet auction company that
produces computer software within the United States that enables its customers to
participate in Internet auctions for a fee. Under § 1.199-3(i)(6)(ii), gross receipts derived
from online auction services are attributable to a service and do not constitute gross
receipts derived from a lease, rental, license, sale, exchange, or other disposition of
computer software. M’s activities constitute the provision of online services. Therefore,
M’s gross receipts derived from the Internet auction services are non-DPGR.

Section 1.199-3(i)(6)(v), Example 3, provides that N provides telephone services,
voicemail services, and e-mail services. N produces computer software within the
United States that runs all of these services. Under § 1.199-3(i)(6)(ii), gross receipts
derived from telephone and related telecommunication services are attributable to a
service and do not constitute gross receipts derived from a lease, rental, license, sale,
exchange, or other disposition of computer software. Therefore, N’s gross receipts
derived from the telephone and other telecommunication services are non-DPGR.

ANALYSIS:

The issue in this technical advice is whether Taxpayer derived DPGR from the license
of Computer Software to Contracting Parties, or non-DPGR from providing services to
End Users. Section 1.199-3(i)(1)(i) defines the term “derived from the lease, rental,
license, sale, exchange, or other disposition” as, and limited to, the gross receipts
directly derived from the disposition of QPP. In this case, Taxpayer produced Computer
Software that qualifies as QPP (and satisfies the other requirements of § 199).
Taxpayer also made a qualifying disposition by licensing Computer Software to each of
the Contracting Parties. However, there is a question of whether Taxpayer derived
gross receipts from the license of Computer Software to the Contracting Parties. LB&I
maintains that Taxpayer derives its gross receipts directly from End Users as a result of
services provided by Taxpayer, and received no compensation from the Contracting
Parties for the license of Computer Software. Taxpayer’s position is that it derives
gross receipts directly from the license of Computer Software to the Contracting Parties.

In reviewing the agreements provided, our Office considered both the substance of the
Taxpayer’s relationships with the Contracting Parties and the End Users, and the form
of the agreements. Our Office concludes that Taxpayer derived DPGR from the license
TAM-131376-13 - 10 -

of Computer Software to the Contracting Parties in the years involved. Our conclusion
with respect to all Contracting Parties relies on LB&I’s agreement with Taxpayer that
Taxpayer’s relationship with other Contracting Parties is generally similar to the
relationship Taxpayer has with Contracting Party A and Contracting Party B.

LB&I and Taxpayer both agree a joint venture or partnership was not formed between
Taxpayer and any of the Contracting Parties. Our Office reviewed the agreements to
determine if we agreed because the provided agreements described the services as
“Joint Services,” and contained references to the relationship between Taxpayer and
Contracting Party B as ------------------------------Characterizing the relationships as a joint
venture or partnership could change the analysis and results for purposes of § 199. Our
Office concludes that Taxpayer’s relationships with Contracting Party A and Contracting
Party B were not joint ventures or partnerships. Based on LB&I’s agreement with
Taxpayer that the relationships between Taxpayer and the Contracting Parties are
generally similar, our Office concludes Taxpayer did not form a joint venture or
partnership with any of the Contracting Parties in the years involved.

Rather than viewing these agreements as joint ventures or partnerships, our Office
views them as transactions generally occurring in two steps, with each party performing
discrete activities. First, Taxpayer produces Computer Software for a Contracting Party
followed by a license of the Computer Software to the Contracting Party. Second, the
Contracting Parties use the Computer Software when providing services to End Users.
Our Office finds the agreed facts support this characterization.

The agreed facts support that the first step is Taxpayer producing the Computer
Software for a Contracting Party followed by a license to the Contracting Party. It is
agreed Taxpayer produces unique Computer Software for a Contracting Party. The
Contracting Party provides sample data in order for Taxpayer to develop appropriate
Computer Software. It is also agreed Taxpayer licenses the Computer Software to the
Contracting Parties.

The agreed facts support that the second step is the Contracting Parties using the
Computer Software to provide a service to End Users. It is agreed the Contracting
Parties license the Computer Software from Taxpayer. The facts show the Contracting
Parties then use the Computer Software to provide services (generation and distribution
of the Results) to End Users. A Contracting Party uses its own data in conjunction with
the licensed Computer Software to perform the service for End Users. This is important
as it shows the services to End Users require both Taxpayer’s Computer Software and
a Contracting Party’s data. Taxpayer only has access to the Computer Software,
whereas the Contracting Parties have access to both as a result of the license of the
Computer Software. The services that a Contracting Party performs also may be
included within a Contracting Party’s larger service contract with an End User.

Our view of the facts supports the conclusion Taxpayer derived gross receipts from the
license of Computer Software to the Contracting Parties, and not from providing
TAM-131376-13 - 11 -

services to End Users. In our view, the substance of Taxpayer’s relationship with the
Contracting Parties is that Taxpayer produces the Computer Software used by the
Contracting Parties to provide services to End Users. However, even though LB&I and
Taxpayer agree on the facts described above, the parties reach a different conclusion
as to which party is paying Taxpayer.

Our Office reviewed the language in the agreements and found some support for LB&I’s
position, but overall we find the language primarily supports concluding that Taxpayer
received royalty payments for licensing Computer Software to the Contracting Parties.
The clearest example of this is in the Master Agreement 2 between Taxpayer and
Contracting Party B, which is effective for the majority of the years involved. ---------------
-----------------------------------------------------------------, provides that any and all payments
(however previously described) are now covered by the royalty payment language. The
agreement also includes -----------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------. Beyond this
example, our Office does not agree that any of the other payment terms or the structure
of the payments prevent characterizing the payments as royalties from the license of
Computer Software. Thus, our Office finds Taxpayer is directly paid by the Contracting
Parties for the license of Computer Software.

Our Office disagrees that Taxpayer’s license to End Users in the representative
subscriber agreement between Contracting Party B, Taxpayer, and the End User
means Taxpayer is providing services to the End Users.1 Instead, this license indicates
the limits of the license provided by Taxpayer to the Contracting Parties. Essentially,
the master agreements allow the Contracting Parties to use the Computer Software to
provide the services to End Users only so as long as Taxpayer is able to restrict an End
Users rights with respect to the Results. For example, ---------------- of Master
Agreement 3 with Contracting Party B contains language allowing Taxpayer to approve
the “Subscriber Contract” before the services are provided. Taxpayer’s reason for this
license is protecting its intellectual property -----------------------------------------------------------

. This is consistent with our view that Taxpayer placed limits on the Contracting Parties
rights with respect to Taxpayer’s intellectual property, which limits are included in the
subscriber agreement. It also helps explain why Taxpayer is a party to the subscriber
agreement. Therefore, we conclude the license to End Users is not an indication of
Taxpayer providing services to End Users.

LB&I compared Taxpayer’s situation with those of the taxpayers described in Examples
1, 2, and 3 in § 1.199-3(i)(6)(v). These examples illustrate the rule in § 1.199-3(i)(6)(ii)
and describe situations where a taxpayer producing computer software does not lease,
rent, license, sell, exchange, or otherwise dispose of such computer software, but
instead uses the computer software to provide online services to customers. The gross
receipts are determined to be non-DPGR because the taxpayers are deriving gross

1. The facts indicate the license to End Users is only in “some” of the subscriber agreements, so the
   argument that the license represents Taxpayer services to End Users would not apply to all transactions.
   TAM-131376-13 - 12 -

receipts from providing services, not from the license of computer software. Taxpayer’s
facts are different from these examples. Here, Taxpayer licenses (disposes of) the
Computer Software to the Contracting Parties, and the Contracting Parties (not
Taxpayer) use the Computer Software to provide services to End Users. Thus, the
examples do not support the conclusion that Taxpayer’s gross receipts are derived from
services.

Our Office acknowledges the language discussing the Contracting Parties serving as
the collection agent for Taxpayer with respect to fees from End Users. While we think
this could serve to support a different characterization, our Office concludes it does not
necessarily, and even so, would not change our view in this context.

CAVEAT(S):

Our Office does not address whether or not Taxpayer meets any of the embedded
service exceptions in § 1.199-3(i)(4)(i)(B), particularly the computer software
maintenance agreement exception (§ 1.199-3(i)(4)(i)(B)(5)) and the de minimis
exception (§ 1.199-3(i)(4)(i)(B)(6)). LB&I states that Taxpayer did not include in DPGR
its revenue from ancillary services, and that the Service has not proposed that an
additional portion of Taxpayer’s revenue under the master agreements should be
allocated to embedded services. Further, to the extent our technical advice makes
these questions relevant, LB&I did not request legal advice as to these issues.

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.