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Court Ruling’s Effect on Taxpayers Operating in the Repackaging of Products

Illinois District Court Sides with Producer of “Unit-Dose” Pharmaceutical Products in Dispute with IRS

The Illinois Northern District Court recently decided in favor of the taxpayer where the taxpayer sued the IRS for refunds relating to disallowed domestic production deductions.  The domestic production deduction is allowed for certain taxpayers in the amount of the lesser of 9 percent of “qualified production activities income” or taxable income.  A taxpayer’s qualified production activities income is determined by a mechanical calculation set forth in the tax law, the most important component being “domestic production gross receipts.”  As relevant here, domestic production gross receipts is defined as gross receipts from “…qualifying production property which was manufactured, produced, grown, or extracted by the taxpayer in whole or significant part within the United States…”  Packaging, repackaging, labeling or other minor assembly activities without engaging in other production activity does not qualify as domestic receipts and therefore disqualifies a taxpayer from the domestic production deduction.

In Precision Dose, Inc. v. United States of America, the issue at hand was whether Precision Dose’s (Precision) production activities rose to the level of qualified production activities or was simply packaging or repackaging, as the IRS contended.  Precision is engaged in the development and sale of “unit doses” of various medications.  The IRS argued that Precision was engaged only in repackaging activities and therefore denied its domestic production deductions in 2007 and 2008.  Precision argued that although repackaging was part of its production process, it also engages in other significant production activities, including market research, acquiring and testing samples, preparing specifications for vendors, conducting studies, etc.  The Court found in favor of Precision, noting that although Precision does not develop or manufacture the drugs it sells, it does engage in a complex production process which results in creating an entirely new and unique product, the “unit dose.”

Although the ruling is not binding outside of its district, it is not without precedent.  The Illinois District Court referenced another taxpayer win with respect to a similar domestic production deduction dispute heard by the California Central District Court.  In that case, the taxpayer was engaged in the assembly, arrangement and sale of gift baskets.  The California Central District Court held in favor of the taxpayer, noting that the domestic taxpayer’s production process changed the form and function of various individual products to create a “distinct gift.” The IRS still disagrees with the Illinois and California District Court’s interpretation of the domestic production deduction rules and has therefore proposed adding an example to the proposed regulations in direct contrast to the court decisions, discussed above.  In light of the above, taxpayers engaged in the repackaging of products should consider carefully whether the requirements to take the domestic production deduction can be met.

If you have questions or comments regarding this article, please contact Tax Partner, Chris Colyer at or 973.994.9400.

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