[Federal Register Volume 72, Number 53 (Tuesday, March 20, 2007)]
[Rules and Regulations]
[Pages 12969-12974]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-1354]



[[Page 12969]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9317]
RIN 1545-BF56


Computer Software Under Section 199(c)(5)(B)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations concerning the 
application of section 199 of the Internal Revenue Code, which provides 
a deduction for income attributable to domestic production activities. 
The final regulations are necessary to provide guidance regarding 
certain transactions involving online software and to clarify the rules 
regarding the application of section 199 to certain cooperatives. The 
regulations will affect taxpayers engaged in certain domestic 
production activities involving computer software and taxpayers engaged 
in certain domestic production activities in cooperative form.

DATES: Effective Date: These regulations are effective March 20, 2007.
    Applicability Date: For dates of applicability, see Sec.  1.199-
8(i)(4) and (i)(7).

FOR FURTHER INFORMATION CONTACT: Paul Handleman or Lauren Ross Taylor, 
(202) 622-3040 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document amends 26 CFR part 1 to provide rules relating to the 
deduction for income attributable to domestic production activities 
under section 199 of the Internal Revenue Code (Code). Section 199 was 
added to the Code by section 102 of the American Jobs Creation Act of 
2004 (Pub. L. 108-357, 118 Stat. 1418), and amended by section 403(a) 
of the Gulf Opportunity Zone Act of 2005 (Pub. L. 109-135, 119 Stat. 
25) and section 514 of the Tax Increase Prevention and Reconciliation 
Act of 2005 (Pub. L. 109-222, 120 Stat. 345). On June 1, 2006, the IRS 
and Treasury Department published in the Federal Register final 
regulations under section 199 (71 FR 31268). Also on June 1, 2006, the 
IRS and Treasury Department published in the Federal Register temporary 
and proposed regulations under section 199 providing guidance on 
certain transactions involving computer software (71 FR 31074 and 71 FR 
31128, respectively). Written and electronic comments responding to the 
temporary and proposed regulations were received. After consideration 
of the comments, the proposed regulations are adopted as amended by 
this Treasury decision.

General Overview

    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 section 199) for the taxable year (or, in the case of 
an individual, adjusted gross income (AGI)).

Qualified Production Activities Income

    Section 199(c)(1) defines QPAI for any taxable year as an amount 
equal to the excess (if any) of (A) the taxpayer's domestic production 
gross receipts (DPGR) for such taxable year, over (B) the sum of (i) 
the cost of goods sold (CGS) that are allocable to such receipts; and 
(ii) other expenses, losses, or deductions (other than the deduction 
under section 199) that are properly allocable to such receipts.
    Section 199(c)(4)(A)(i) defines DPGR, in part, to mean the 
taxpayer's gross receipts that are derived from any lease, rental, 
license, sale, exchange, or other disposition of qualifying production 
property (QPP) that 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 to mean: (A) Tangible 
personal property; (B) any computer software; and (C) any property 
described in section 168(f)(4) (certain sound recordings).

Patrons of Certain Cooperatives

    Section 199(d)(3)(A) provides that any person who receives a 
qualified payment from a specified agricultural or horticultural 
cooperative shall be allowed for the taxable year in which such payment 
is received a deduction under section 199(a) equal to the portion of 
the deduction allowed under section 199(a) to such cooperative which is 
(i) allowed with respect to the portion of the QPAI to which such 
payment is attributable, and (ii) identified by such cooperative in a 
written notice mailed to such person during the payment period 
described in section 1382(d).
    Section 199(d)(3)(B) provides that the taxable income of a 
specified agricultural or horticultural cooperative shall not be 
reduced under section 1382 by reason of that portion of any qualified 
payment as does not exceed the deduction allowable under section 
199(d)(3)(A) with respect to such payment.
    Section 199(d)(3)(C) provides that, for purposes of section 199, 
the taxable income of a specified agricultural or horticultural 
cooperative shall be computed without regard to any deduction allowable 
under section 1382(b) or (c) (relating to patronage dividends, per-unit 
retain allocations, and nonpatronage distributions).
    Section 199(d)(3)(E) provides that, for purposes of section 
199(d)(3), the term qualified payment means, with respect to any 
person, any amount that (i) is described in section 1385(a)(1) or (3), 
(ii) is received by such person from a specified agricultural or 
horticultural cooperative, and (iii) is attributable to QPAI with 
respect to which a deduction is allowed to such cooperative under 
section 199(a).

Authority To Prescribe Regulations

    Section 199(d)(8) authorizes the Secretary to prescribe such 
regulations as are necessary to carry out the purposes of section 199, 
including regulations that prevent more than one taxpayer from being 
allowed a deduction under section 199 with respect to any activity 
described in section 199(c)(4)(A)(i).

Temporary Regulations

    Section 1.199-3T(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 constitute gross receipts derived from a lease, rental, license, 
sale, exchange, or other disposition of computer software.
    However, Sec.  1.199-3T(i)(6)(iii) provides two exceptions under 
which gross receipts derived by a taxpayer from providing computer 
software to customers for the customers' direct use while connected to 
the Internet will be treated as being derived from the lease, rental, 
license, sale, exchange, or other disposition of such computer 
software. Such gross receipts will be treated as DPGR if all the other 
requirements of section 199 are met (for example, the taxpayer MPGE 
computer software in whole or in significant part within the United 
States).

[[Page 12970]]

    The exception in Sec.  1.199-3T(i)(6)(iii)(A) applies to a taxpayer 
that derives gross receipts from providing computer software to 
customers for the customers' direct use while connected to the Internet 
(online software) and also derives gross receipts from customers that 
are unrelated to the taxpayer from the lease, rental, license, sale, 
exchange, or other disposition of computer software affixed to a 
tangible medium or downloaded from the Internet. The exception in Sec.  
1.199-3T(i)(6)(iii)(B) applies if a taxpayer derives gross receipts 
from providing online software and an unrelated person derives, on a 
regular and ongoing basis in the unrelated person's business, gross 
receipts from the lease, rental, license, sale, exchange, or other 
disposition of substantially identical software to its customers 
affixed to a tangible medium or by allowing its customers to download 
the substantially identical computer software from the Internet.
    Section 1.199-3T(i)(6)(iv) defines substantially identical software 
as computer software that, from a customer's perspective, has the same 
functional result as the online software and has a significant overlap 
of features or purpose with the online software. Section 1.199-
3T(i)(6)(iv)(B) provides a safe harbor under which all computer 
software games are deemed to be substantially identical software.
    The exceptions outlined in Sec.  1.199-3T(i)(6)(iii) permit gross 
receipts derived from providing online software to be treated as gross 
receipts derived from the lease, rental, license, sale, exchange, or 
other disposition of software. However, because the rules for online 
software are exceptions, all other provisions of the temporary and 
final regulations do not necessarily apply to online software. 
Specifically, Sec.  1.199-3T(i)(6)(iv)(E) provides that the computer 
software maintenance agreement exception provided in Sec.  1.199-
3(i)(4)(i)(B)(5) does not apply to online software. Section 1.199-
3(i)(4)(i)(B)(5) provides that a taxpayer may include in DPGR, the 
gross receipts derived from services performed pursuant to a qualified 
computer software maintenance agreement.

Summary of Comments and Explanation of Provisions

    A commentator suggested that the online software exceptions should 
apply to transactions where access to computer software is provided 
over any public or private communications network and not just the 
Internet. The final regulations adopt this suggestion.
    A commentator suggested that the final regulations provide an 
example where computer software would not be considered substantially 
identical software. This suggestion has been adopted.
    Commentators noted that, in the future, some computer software will 
only be available over the Internet. In addition, newly developed 
computer software provided over the Internet may not have a 
substantially identical counterpart. The IRS and Treasury Department 
recognize that the computer software industry is evolving and current 
industry trends may result in a more limited applicability of the 
online software exceptions provided in the final regulation. However, 
there are significant differences between transactions which provide 
customers with access to online software and transactions involving the 
transfer of software to customers affixed to a tangible medium or by 
download. Accordingly, in order to give meaning to the statutory 
language requiring a lease, rental, license, sale, exchange, or other 
disposition, the online software exceptions have been narrowly tailored 
and are intended to apply only to gross receipts derived from providing 
customers access to computer software for the customers' direct use 
while connected to the Internet and only when the taxpayer (or another 
person) also derives gross receipts from the lease, rental, license, 
sale, exchange, or other disposition of the computer software (or 
substantially identical software) affixed to a tangible medium or by 
download. The final regulations clarify that, with respect to online 
software, taxpayers are providing customers with access to the 
taxpayers' software as opposed to actually transferring the software to 
customers either affixed to a tangible medium or by allowing them to 
download the computer software from the Internet.
    Commentators suggested that the rule in Sec.  1.199-
3T(i)(6)(iv)(E), precluding the application of the qualified computer 
software maintenance provision to online software, be deleted because 
it places taxpayers providing access to online software at a 
competitive disadvantage with taxpayers providing computer software to 
customers either affixed to a tangible medium or by allowing them to 
download the computer software from the Internet. In addition, 
commentators suggest that the advertising exception in Sec.  1.199-
3(i)(5) should be extended to include online software. The final 
regulations do not adopt these suggestions. As previously noted, the 
online software exceptions have been narrowly tailored and the IRS and 
Treasury Department do not believe the exceptions should be extended 
beyond gross receipts derived from providing customers access to 
computer software for the customers' direct use. Therefore, the final 
regulations do not extend the exception for qualified computer software 
maintenance agreements in Sec.  1.199-3(i)(4)(i)(B)(5) or the 
advertising exception in Sec.  1.199-3(i)(5) to online software.
    The final regulations in Sec.  1.199-3(i)(5)(ii)(B) do, however, 
extend the advertising exception to computer software that is provided 
to customers either affixed to a tangible medium (for example, a disk 
or DVD) or by allowing them to download the computer software from the 
Internet. However, the advertising exception only applies to 
advertising placed or integrated into software that is either affixed 
to a tangible medium or provided through download and does not apply to 
advertising incorporated into online software. In addition, the IRS and 
Treasury Department have clarified that, except as otherwise provided 
in Sec.  1.199-3(i)(5)(ii), gross receipts derived from the lease, 
rental, license, sale, exchange, or other disposition of QPP, a 
qualified film, or utilities do not include advertising income or 
product-placement income.
    A commentator expressed concern that the exception for qualified 
computer software maintenance agreements in Sec.  1.199-
3(i)(4)(i)(B)(5) does not apply if the taxpayer separately offers 
maintenance in subsequent years. The mere fact that a taxpayer 
separately offers maintenance in subsequent years does not preclude 
eligibility for the exception.
    A commentator interpreted the rule in Sec.  1.199-3T(i)(6)(iii)(E) 
as possibly treating gross receipts derived from the lease, rental, 
license, sale, exchange, or other disposition of future updates, 
cyclical releases, and rewrites of the underlying software as non-DPGR 
if the underlying software is online software. The rule in Sec.  1.199-
3T(i)(6)(iii)(E) only provides that the qualified computer software 
maintenance agreement exception does not apply to online software. 
Therefore, to the extent a taxpayer providing online software derives 
gross receipts from the lease, rental, license, sale, exchange, or 
other disposition of future updates, cyclical releases, and rewrites of 
the underlying software, the gross receipts are DPGR assuming all the 
other requirements of Sec.  1.199-3 are met.
    A commentator noted that Example 6 in the temporary regulations 
concludes that the gross receipts derived from storage of customers' 
data and telephone support are non-DPGR. Example 6 is silent as to the 
amount of gross receipts

[[Page 12971]]

derived from the storage of customers' data and telephone support and 
does not address whether the de minimis exception in Sec.  1.199-
3(i)(4)(i)(B)(6) is available. Numerous examples in the final 
regulations under section 199 also conclude that gross receipts are 
non-DPGR without reference to the de minimis exception in Sec.  1.199-
3(i)(4)(i)(B)(6). However, assuming all the requirements are met, the 
de minimis exception in Sec.  1.199-3(i)(4)(i)(B)(6) can apply when an 
example concludes the gross receipts are non-DPGR.
    The IRS and Treasury Department received a comment letter on the 
application of section 199 to agricultural and horticultural 
cooperatives under Sec.  1.199-6 of the final regulations (71 FR 31312) 
published on June 1, 2006. The commentator noted that the sentence in 
Sec.  1.199-6(h) stating that the cooperative may not apply section 
199(d)(3) and Sec.  1.199-6 to any portion of the section 199 deduction 
that is not passed through to its patrons is inconsistent with section 
199(d)(3) which has no such limitation. These final regulations amend 
Sec.  1.199-6(h) to remove the sentence.
    In addition, consistent with the change to Sec.  1.199-6(h), these 
final regulations amend Sec.  1.199-6(l) to remove the phrase, ``To the 
extent a cooperative passes through the section 199 deduction to a 
patron'' and add the phrase, ``by the patron.''
    The final regulations also amend Sec.  1.199-6(c) to clarify that a 
cooperative's QPAI is computed without taking into account any 
deduction allowable under section 1382(b) or (c) (relating to patronage 
dividends, per-unit retain allocations, and nonpatronage 
distributions).

Effective Date

    Section 199 applies to taxable years beginning after December 31, 
2004. These final regulations are applicable for taxable years 
beginning on or after March 20, 2007. In addition, Sec.  1.199-8(i)(1) 
provides that, in certain circumstances, a taxpayer may rely on the 
guidance in Notice 2005-14 (2005-7 IRB 498), see Sec.  601.602(d)(2), 
the proposed regulations under section 199 that were published in the 
Federal Register on November 4, 2005 (70 FR 67220), or the final 
regulations under section 199 that were published in the Federal 
Register on June 1, 2006 (71 FR 31268). Regardless of which guidance a 
taxpayer applies, the taxpayer may apply these final regulations to 
taxable years beginning after December 31, 2004, and before March 20, 
2007.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to this regulation, and because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding this regulation was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal authors of these regulations are Paul Handleman and 
Lauren Ross Taylor, Office of the Associate Chief Counsel (Passthroughs 
and Special Industries), IRS. However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.199-0 is amended by:
0
1. Revising the entries for Sec. Sec.  1.199-3(i)(5)(i) and (ii), 
1.199-3(i)(6)(ii) through (v), 1.199-6(c), and 1.199-8(i)(4).
0
2. Adding a new entry for Sec.  1.199-8(i)(7).
    The revisions and addition read as follows:


Sec.  1.199-0  Table of contents.

* * * * *

Sec.  1.199-3 Domestic production gross receipts.

* * * * *
    (i) * * *
    (5) * * *
    (i) In general.
    (ii) Exceptions.
    (A) Tangible personal property.
    (B) Computer software.
    (C) Qualified film.
* * * * *
    (6) * * *
    (ii) Gross receipts derived from services.
    (iii) Exceptions.
    (iv) Definitions and special rules.
    (A) Substantially identical software.
    (B) Safe harbor for computer software games.
    (C) Regular and ongoing basis.
    (D) Attribution.
    (E) Qualified computer software maintenance agreements.
    (F) Advertising income and product-placement income.
    (v) Examples.
* * * * *

Sec.  1.199-6 Agricultural and horticultural cooperatives.

* * * * *
    (c) Determining cooperative's qualified production activities 
income and taxable income.
* * * * *

Sec.  1.199-8 Other rules.

* * * * *
    (i) * * *
    (4) Computer software.
* * * * *
    (7) Agricultural and horticultural cooperatives.
* * * * *

0
Par. 3. Section 1.199-3 is amended by:
0
1. Revising paragraphs (i)(5)(i) and (i)(5)(ii).
0
2. Removing the language ``(i)(5)(ii)'' each place it appears in 
paragraph (i)(5)(iii) and adding the language ``(i)(5)(ii)(C)'' in its 
place.
0
3. Revising paragraphs (i)(6)(ii), (i)(6)(iii), (i)(6)(iv), and 
(i)(6)(v).
    The revisions read as follows:


Sec.  1.199-3  Domestic production gross receipts.

* * * * *
    (i) * * *
    (5) * * *
    (i) In general. Except as provided in paragraph (i)(5)(ii) of this 
section, gross receipts derived from the lease, rental, license, sale, 
exchange, or other disposition of QPP, a qualified film, or utilities 
do not include advertising income and product-placement income.
    (ii) Exceptions--(A) Tangible personal property. A taxpayer's gross 
receipts that are derived from the lease, rental, license, sale, 
exchange, or other disposition of newspapers, magazines, telephone 
directories, periodicals, and other similar printed publications that 
are MPGE in whole or in significant part within the United States 
include advertising income from advertisements placed in those media, 
but only if the gross receipts, if any, derived from the

[[Page 12972]]

lease, rental, license, sale, exchange, or other disposition of the 
newspapers, magazines, telephone directories, or periodicals are (or 
would be) DPGR.
    (B) Computer software. A taxpayer's gross receipts that are derived 
from the lease, rental, license, sale, exchange, or other disposition 
of computer software that is MPGE in whole or in significant part 
within the United States include advertising income and product-
placement income with respect to that computer software, but only if 
the gross receipts, if any, derived from the lease, rental, license, 
sale, exchange, or other disposition of computer software are (or would 
be) DPGR. For this purpose, advertising income and product-placement 
income mean compensation for placing or integrating advertising or a 
product into the computer software. This paragraph (i)(5)(ii)(B) does 
not extend to the exceptions provided in paragraph (i)(6)(iii) of this 
section. See paragraph (i)(6)(iv)(F) of this section.
    (C) Qualified film. A taxpayer's gross receipts that are derived 
from the lease, rental, license, sale, exchange, or other disposition 
of a qualified film include advertising income and product-placement 
income with respect to that qualified film, but only if the gross 
receipts, if any, derived from the lease, rental, license, sale, 
exchange, or other disposition of a qualified film are (or would be) 
DPGR. For this purpose, advertising income and product-placement income 
mean compensation for placing or integrating advertising or a product 
into the qualified film.
* * * * *
    (6) * * *
    (ii) Gross receipts derived from services. 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 constitute gross receipts derived from a lease, rental, license, 
sale, exchange, or other disposition of computer software.
    (iii) Exceptions. Notwithstanding paragraph (i)(6)(ii) of this 
section, if a taxpayer derives gross receipts from providing customers 
access to computer software MPGE in whole or in significant part by the 
taxpayer within the United States for the customers' direct use while 
connected to the Internet or any other public or private communications 
network (online software), then such gross receipts will be treated as 
being derived from the lease, rental, license, sale, exchange, or other 
disposition of computer software only if--
    (A) The taxpayer also derives, on a regular and ongoing basis in 
the taxpayer's business, gross receipts from the lease, rental, 
license, sale, exchange, or other disposition to customers that are not 
related persons (as defined in paragraph (b)(1) of this section) of 
computer software that--
    (1) Has only minor or immaterial differences from the online 
software;
    (2) Has been MPGE by the taxpayer in whole or in significant part 
within the United States; and
    (3) Has been provided to such customers either affixed to a 
tangible medium (for example, a disk or DVD) or by allowing them to 
download the computer software from the Internet; or
    (B) Another person derives, on a regular and ongoing basis in its 
business, gross receipts from the lease, rental, license, sale, 
exchange, or other disposition of substantially identical software (as 
described in paragraph (i)(6)(iv)(A) of this section) (as compared to 
the taxpayer's online software) to its customers pursuant to an 
activity described in paragraph (i)(6)(iii)(A)(3) of this section.
    (iv) Definitions and special rules--(A) Substantially identical 
software. For purposes of paragraph (i)(6)(iii)(B) of this section, 
substantially identical software is computer software that--
    (1) From a customer's perspective, has the same functional result 
as the online software described in paragraph (i)(6)(iii) of this 
section; and
    (2) Has a significant overlap of features or purpose with the 
online software described in paragraph (i)(6)(iii) of this section.
    (B) Safe harbor for computer software games. For purposes of 
paragraph (i)(6)(iv)(A) of this section, all computer software games 
are deemed to be substantially identical software. For example, 
computer software sports games are deemed to be substantially identical 
to computer software card games.
    (C) Regular and ongoing basis. For purposes of paragraph 
(i)(6)(iii) of this section, in the case of a newly-formed trade or 
business or a taxpayer in its first taxable year, the taxpayer is 
considered to be engaged in an activity described in paragraph 
(i)(6)(iii) of this section on a regular and ongoing basis if the 
taxpayer reasonably expects that it will engage in the activity on a 
regular and ongoing basis.
    (D) Attribution. For purposes of paragraph (i)(6)(iii)(A) of this 
section--
    (1) All members of an expanded affiliated group (as defined in 
Sec.  1.199-7(a)(1)) are treated as a single taxpayer; and
    (2) In the case of an EAG partnership (as defined in Sec.  1.199-
3T(i)(8)), the EAG partnership and all members of the EAG to which the 
EAG partnership's partners belong are treated as a single taxpayer.
    (E) Qualified computer software maintenance agreements. Paragraph 
(i)(4)(i)(B)(5) of this section does not apply if the computer software 
is online software under paragraph (i)(6)(iii) of this section.
    (F) Advertising income and product-placement income. Paragraph 
(i)(5)(ii)(B) of this section does not apply if the computer software 
is online software under paragraph (i)(6)(iii) of this section. If a 
taxpayer provides a customer with access to online software in 
conjunction with providing computer software to such customer either 
affixed to a tangible medium or by download, paragraph (i)(5)(ii)(B) of 
this section will only apply to compensation for the placement or 
integration of advertising or a product into the computer software 
transferred to such customer either affixed to the tangible medium or 
by download.
    (v) Examples. The following examples illustrate the application of 
this paragraph (i)(6):

    Example 1. 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 paragraph (i)(6)(ii) of this section, 
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.
    Example 2. 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 
paragraph (i)(6)(ii) of this section, 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.
    Example 3. 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 paragraph (i)(6)(ii) 
of this section, 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.

[[Page 12973]]

    Example 4. O produces tax preparation computer software within 
the United States. O derives, on a regular and ongoing basis in its 
business, gross receipts from both the sale to customers that are 
unrelated persons of O's computer software that has been affixed to 
a compact disc as well as from the sale to customers of O's computer 
software that customers have downloaded from the Internet. O also 
derives gross receipts from providing customers access to the 
computer software for the customers' direct use while connected to 
the Internet. The computer software sold on compact disc or by 
download has only minor or immaterial differences from the online 
software, and O does not provide any other goods or services in 
connection with the online software. Under paragraph (i)(6)(iii)(A) 
of this section, O's gross receipts derived from providing access to 
the online software will be treated as derived from the lease, 
rental, license, sale, exchange, or other disposition of computer 
software and are DPGR (assuming all the other requirements of this 
section are met).
    Example 5. The facts are the same as in Example 4, except that O 
does not sell the tax preparation computer software to customers 
affixed to a compact disc or by download. In addition, one of O's 
competitors, P, derives, on a regular and ongoing basis in its 
business, gross receipts from the sale to customers of P's 
substantially identical tax preparation computer software that has 
been affixed to a compact disc as well as from the sale to customers 
of P's substantially identical tax preparation computer software 
that customers have downloaded from the Internet. Under paragraph 
(i)(6)(iii)(B) of this section, O's gross receipts derived from 
providing access to its tax preparation online software will be 
treated as derived from the lease, rental, license, sale, exchange, 
or other disposition of computer software and are DPGR (assuming all 
the other requirements of this section are met).
    Example 6. Q produces payroll management computer software 
within the United States. For a fee, Q provides customers access to 
the payroll management computer software for the customers' direct 
use while connected to the Internet. This is Q's sole method of 
providing access to its payroll management computer software to 
customers. In conjunction with the payroll management computer 
software, Q provides storage of customers' data and telephone 
support. One of Q's competitors, R, derives, on a regular and 
ongoing basis in its business, gross receipts from the sale to 
customers of R's substantially identical payroll management software 
that has been affixed to a compact disc as well as from the sale to 
customers of R's substantially identical payroll management software 
that customers have downloaded from the Internet. Under paragraph 
(i)(6)(iii)(B) of this section, Q's gross receipts derived from 
providing access to its payroll management online software will be 
treated as derived from the lease, rental, license, sale, exchange, 
or other disposition of computer software and are DPGR (assuming all 
the other requirements of this section are met). However, Q's gross 
receipts derived from the fees that are properly allocable to the 
storage of customers' data and telephone support are non-DPGR.
    Example 7. The facts are the same as in Example 6, except that R 
produces inventory computer software, not payroll management 
computer software. R's inventory computer software is not 
substantially identical software as defined in paragraph 
(i)(6)(iv)(A) of this section because R's inventory software, from a 
customer's perspective, does not have the same functional result as 
Q's payroll management computer software and does not have 
significant overlap of features or purpose with Q's payroll 
management computer software. No other person provides substantially 
identical software to customers affixed to a compact disc or by 
download. Under paragraph (i)(6)(ii) of this section, gross receipts 
derived from providing access to Q's payroll online software do not 
constitute gross receipts derived from a lease, rental, license, 
sale, exchange or other disposition of payroll computer software. 
Therefore, Q's gross receipts derived from the payroll management 
computer software are non-DPGR.
    Example 8. S produces computer software games within the United 
States. S derives, on a regular and ongoing basis in its business, 
gross receipts from both the sale to customers that are not related 
to S of S's computer software games that have been affixed to a 
compact disc as well as from the sale to customers of S's computer 
software games that customers have downloaded from the Internet. S 
also derives gross receipts from providing customers access to the 
computer software games for the customers' direct use while 
connected to the Internet (online software games). The computer 
software games sold on compact disc or by download have only minor 
or immaterial differences from the online software games, and S does 
not provide any other goods or services in connection with the 
online software games. Under paragraph (i)(6)(iii)(A) of this 
section, S's gross receipts derived from providing customers access 
to its online software games will be treated as derived from the 
lease, rental, license, sale, exchange, or other disposition of 
computer software and are DPGR (assuming all the other requirements 
of this section are met).
    Example 9. The facts are the same as in Example 8, except S's 
gross receipts also include advertising income from integrating 
advertisers' logos into the computer software games. Under paragraph 
(i)(5)(ii)(B) of this section, for S's computer software games sold 
affixed to a compact disc or by download, S's advertising income is 
treated as gross receipts derived from the sale of the computer 
software games and, therefore, is DPGR (assuming all the other 
requirements of this section are met). However, under paragraphs 
(i)(5)(i) and (i)(6)(iv)(F) of this section, for S's online software 
games, S's advertising income is not derived from the lease, rental, 
license, sale, exchange, or other disposition of computer software 
and, therefore, is non-DPGR.

0
Par. 4. Section 1.199-3T is amended by revising paragraphs (i)(1), 
(i)(2), (i)(3), (i)(4), (i)(5), and (i)(6) to read as follows:


Sec.  1.199-3T  Domestic production gross receipts (temporary).

* * * * *
    (i) Derived from the lease, rental, license, sale, exchange or 
other disposition.
    (1) through (6) [Reserved]. For further guidance, see Sec.  1.199-
3(i)(1) through (6).
* * * * *

0
Par. 5. Section 1.199-6 is amended by:
0
1. Revising paragraphs (c) and (l).
0
2. Removing the language ``qualified production activities income 
(QPAI) (as defined in Sec.  1.199-1(c))'' from paragraph (e) and adding 
``QPAI'' in its place.
0
3. Removing the language ``However, the cooperative may not apply 
section 199(d)(3) and this section to any portion of the section 199 
deduction that is not passed through to its patrons.'' from paragraph 
(h).
    The revisions read as follows:


Sec.  1.199-6  Agricultural and horticultural cooperatives.

* * * * *
    (c) Determining cooperative's qualified production activities 
income and taxable income. For purposes of determining its section 199 
deduction, the cooperative's qualified production activities income 
(QPAI) (as defined in Sec.  1.199-1(c)) and taxable income are computed 
without taking into account any deduction allowable under section 
1382(b) or (c) (relating to patronage dividends, per-unit retain 
allocations, and nonpatronage distributions).
* * * * *
    (l) No double counting. A qualified payment received by a patron of 
a cooperative is not taken into account by the patron for purposes of 
section 199.

0
Par. 6. Section 1.199-8 is amended by:
0
1. Revising paragraph (i)(4).
0
2. Adding new paragraph (i)(7).
    The revision and addition read as follows:


Sec.  1.199-8  Other rules.

* * * * *
    (i) * * *
    (4) Computer software. Section 1.199-3(i)(5)(ii)(B) and (i)(6)(ii) 
through (v) are applicable for taxable years beginning on or after 
March 20, 2007. A taxpayer may apply Sec.  1.199-3(i)(5)(ii)(B) and 
(i)(6)(ii) through (v) to taxable years beginning after December 31, 
2004, and before March 20, 2007.
* * * * *
    (7) Agricultural and horticultural cooperatives. Section 1.199-6(c) 
is

[[Page 12974]]

applicable for taxable years beginning on or after March 20, 2007. A 
taxpayer may apply Sec.  1.199-(6)(c) to taxable years beginning after 
December 31, 2004, and before March 20, 2007.

0
Par. 7. Section 1.199-8T is amended by revising paragraphs (i)(1), 
(i)(2), (i)(3), and (i)(4) to read as follows:


Sec.  1.199-8T  Other rules (temporary).

* * * * *
    (i) Effective dates. (1) through (4) [Reserved]. For further 
guidance, see Sec.  1.199-8(i)(1) through (4).
* * * * *

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: March 14, 2007.
Eric Solomon,
Assistant Secretary of the Treasury.
[FR Doc. 07-1354 Filed 3-19-07; 8:45 am]
BILLING CODE 4830-01-P