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Wednesday, January 21, 2009


The uniform capitalization rules require a manufacturer to capitalize various costs into its produced inventory. Licensing costs incurred in securing the contractual right to use a trademark or other similar right associated with property produced are indirect costs that must be capitalized (to the extent the costs are properly allocable to property produced) under Treas. Regs. Section 1.263A-1(e)(3)(ii). However, marketing, selling, advertising, and distribution costs are indirect costs that are specifically excluded from the Section 263A rules.

A recent Tax Court case landed at the intersection of these two rules, when a kitchen product manufacturer paid royalties under a trademark licensing agreement, and claimed that the payments for the use of the trademark on its products did not need to be capitalized.

On the one hand, clearly the right to put a trademark on produced goods enhances the marketing, selling, advertising and distribution of the product. This is what the taxpayer asserted. The IRS asserted that capitalization applies because the acquired trademark related to goods that the taxpayer was producing. The Tax Court sided with the IRS.

The taxpayer’s argument seemed strong – common sense indicates that the use of the trademark enhances sales and distribution of the produced product. What appears to have swayed the court to the IRS side was that the license agreements granted the taxpayer the right to manufacture the branded knives and tools – without the license it would not not have had the legal right to produce them. Thus, the license was an integral part of production and the license fees had to be capitalized.

However, nothing in the case indicates that the taxpayer acquired any trade secrets or manufacturing process licenses – instead, it appears that while the licensors did exercise quality control over the taxpayer, there was no license of intellectual property that was needed by the taxpayer to produce its products – the license appears to have been needed solely to affix the trademarks. Most licensors will exercise quality control over the licensees to protect their trademark, so this oversight does not seem to be enough to make the trademark part of the manufacturing process. If the taxpayer-manufacturer could have produced the products without the consent of the licensors by leaving off the trademarks (as appears to be the case), then it is difficult to see how the trademark is part of the production process and why the fees had to be capitalized.

Robinson Knife Manufacturing Company, Inc., et al., TC Memo 2009-9

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