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Company's Production of Unit Doses of Medicine Qualifies for Section 199 Deduction.

(Parker Tax Publishing October 19, 2015)

A company's business of selling unit doses of medicines involved the sale of qualifying production property which was manufactured, produced, grown, or extracted and the company thus qualified for the Code Sec. 199 domestic production activities deduction. Precision Dose, Inc. v. U.S., 2015 PTC 345 (W.D. Ill. 2015).


Precision Dose, Inc. sells unit doses of medications. A unit dose is a drug in a non-reusable container intended for administration as a single dose to a patient. The specific unit doses that Precision sells are different liquid, oral drugs sealed in various size cups and syringes. The company buys, in bulk, certain drugs it deems marketable in unit doses and suitable for sale in unit doses.

In producing unit doses, Precision engages in a process that runs the gamut from deciding what drugs to consider for possible unit doses; testing to determine their suitability and marketability; preparing specifications and documentation for the materials to be used and standard operating procedures for all processes and equipment to be used; developing cups and syringes (and the molds from which they will be made); working with the vendors that will make the containers; buying cups and syringes; contracting with laboratories to conduct stability studies to insure the drug remains within specifications when put into a unit dose and to establish expiration dates; running validation batches; setting up and conducting fill operations; conducting in process testing; conducting post-fill processing; performing release testing to determine if the unit doses are ready for release to customers; and batch record reviews to confirm no anomalies occurred during production.

Precision claimed a domestic production deduction under Code Sec. 199 on its 2007 and 2008 tax returns, resulting in tax refund requests of approximately $73,000 and $74,000, respectively.

Under Code Sec. 199(a)(1), a taxpayer can deduct a portion of its qualified production activities income, which is determined from the taxpayer's domestic production gross receipts. Domestic production gross receipts are defined, in part, as proceeds from the sale 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.

Reg. Sec. 1.199-3(e)(1) defines MPGE generally as including, among other things, manufacturing, producing, growing, extracting, installing, developing, improving, and creating QPP; making QPP out of scrap, salvage, or junk material as well as from new or raw material by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles. The regulation also provides that if a taxpayer packages, repackages, labels, or performs minor assembly of QPP and the taxpayer engages in no other MPGE activity with respect to the QPP, such actions do not qualify as MPGE with respect to that QPP.

The IRS disallowed Precision's refund claim because it said that Precision only engaged in repackaging of materials. Precision argued that its activities did not fall within the repackaging exception and that it engaged in MPGE with respect to QPP and, thus, income received from its sales "qualified production activities income" entitling it to the Code Sec. 199 deduction.


A district court rejected the IRS's argument and granted Precision's refund request. Precision, the court noted, produces unit doses and the dictionary defines the transitive verb "produce" as "to cause to have existence or to happen." There was no doubt in the court's mind that Precision causes the unit doses to come into existence. According to the court, without Precision doing what it does with the drugs, cups and syringes, they are simply drugs, cups and syringes. It is Precision's activities, its application of its processes to the drugs, cups, and syringes, that produce a unit dose.

The court then looked at the exception to the definition of MPGE for packaging, repackaging, labeling, and minor assembly. Even if Precision's activities otherwise meet the definition of MPGE, the court observed, those activities are not MPGE if those activities are only packaging, repackaging, labeling or minor assembly with respect to the unit doses which are the QPP at issue.

The court noted that Precision looks for drugs it believes it can successfully process into and sell as unit doses. Drug manufacturers, the court said, do not seek bids from companies to repackage their drugs into small packages. Precision engaged in market research to determine which drugs to buy to turn into unit doses, and worked with potential customers to identify needs for new unit dose products. The court drew an analogy between Precision's activities and those in U.S. v. Dean, 945 F. Supp. 2d 1110 (C.D. Cal. 2013), where the taxpayer's S corporation designed gift baskets, outsourced the production of the baskets, and then filled the baskets with various items, like chocolate and wine. The court in Dean observed that the S corporation's production process changed the form and function of individual items by creating distinct gifts and that the company's complex production process was similar to purchasing various automobile parts from suppliers and assembling them to create the car itself. The Dean court said that, while come of the company's activities might have constituted packaging or repackaging, that "subassembly process" was only part of the complex production process that resulted in a distinct final product.

OBSERVATION: Proposed regulations (REG-136459-09) under Code Sec. 199 add an example based on the facts in U.S. v Dean, but reaches the opposite conclusion. In the example, the taxpayer is not considered to have engaged in the MPGE of QPP. The propose regs are not effective until finalized.

The district court rejected the IRS's argument that Dean was wrongly decided because the court failed to understand that all the corporation's activities were just part of the repackaging process. According to the court, the products assembled in Dean were each a unique product, similar to the way the unit dose is a unique product.

For a discussion of the activities that constitute MPGE for purposes of the Code Sec. 199 deduction, see Parker Tax ¶96,110. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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