Fishing-reel designer is not the manufacturer for excise-tax purposes

Plain-English summary

A company designed and marketed fishing reels, owned the relevant patents and know-how, and paid for specialized tooling used by an unrelated domestic fabricator. The fabricator supplied the raw materials, owned its other equipment, chose how many reels to make, could reject the company's purchase orders, and bore production-cost risk between price negotiations. It could also use the licensed intellectual property and specialized tooling to sell unbranded reels to third parties if it paid license and user fees. The company had neither an exclusive nor a first right to the fabricator's output. Based on control, ownership, sales freedom, and risk-of-loss factors, the IRS ruled that the company was not the manufacturer, producer, or importer liable for the Section 4161 sporting-goods excise tax on the reels.

Ruling snapshot

• Question: Is the company that owns the reel designs, patents, and specialized tooling treated as the manufacturer for the Section 4161 excise tax?
• Outcome: Approved, the company is not the manufacturer, producer, or importer
• Key authorities: IRC §§ 4161(a) and 4162(a)(2); Treas. Reg. §§ 48.0-2(a)(4) and 48.4161-1(c); Rev. Ruls. 58-134, 60-42, 76-181, and 78-34

Full text (IRS public release)

 Internal Revenue Service                                  Department of the Treasury
                                                           Washington, DC 20224

 Number: 202140004
 Release Date: 10/8/2021
 Index Number: 4161.00-00, 4161.01-00

                                                           Person To Contact:
 ------------                                              ------------------------- ID No. -----------------
 --------------------------------                          Telephone Number:
 ---------------------------                               ----------------------
                                                           Refer Reply To:
                                                           CC:PSI:B07 – PLR-101061-21
                                                           Date:
                                                           July 14, 2021




LEGEND

        X                           =   ---------------------------------------

        Fabricator                  =   -------------------------------------

        License Agreement =             --------------------------------------------------------

        Supply Agreement =              -------------------------------------------------------

        Period                      =   --------------


Dear ------------------:

       This letter responds to a letter ruling request dated January 9, 2021, submitted
on your behalf by your authorized representative, requesting a ruling under § 4161(a) of
the Internal Revenue Code (the Code).

FACTS

       According to the facts submitted, X designs, markets, and sells fishing reels
(“Reels”). X owns intellectual property relating to the mechanical architecture and
manufacture of Reels, including issued utility patents, pending utility patent applications,
and certain know-how owned by X (collectively, “X Intellectual Property”).

       X has entered into License Agreement and Supply Agreement with Fabricator
pursuant to which Fabricator fabricates Reels based on X’s specifications. Fabricator
and X are unrelated entities and the arrangement between them is the result of arm's
length negotiations.
PLR-101061-21                                 2

        Under the terms of License Agreement, X grants Fabricator a license to use X
Intellectual Property to fabricate and sell Reels in the United States. Fabricator may
use X Intellectual Property to fabricate and sell Reels to third-party customers in the
United States, but only if such Reels do not contain X’s logo, trademark, tradenames, or
aesthetic design elements (“X Identifiers”). For each Reel sold by Fabricator to third-
party customers, Fabricator must pay X a license fee. Fabricator can only use X
Identifiers on Reels it fabricates and sells to X, and only if it has X’s permission to do so.
During the term of License Agreement, the intellectual property license is irrevocable.

       Supply Agreement outlines the terms pursuant to which Fabricator fabricates
Reels for sale to X and may fabricate Reels for sale to third-party customers. Under the
terms of Supply Agreement, Fabricator must obtain materials required to fabricate and
package Reels, including all raw materials, programmable logic controllers and
associated programming, Fabricator tools, components, and packaging materials. The
fabrication of Reels requires special tools and molds that are expensive. Supply
Agreement requires X to purchase such special tooling and molds (collectively “X
Tooling”) and permits Fabricator to use X Tooling to fabricate Reels for X and third-party
customers pursuant to the terms of License Agreement. For each Reel that Fabricator
fabricates using X Tooling but sells to third-party customers, Fabricator must pay X a
user fee. Fabricator owns all other tools, equipment, and molds it needs to fabricate
Reels. Pursuant to Supply Agreement, Fabricator will fabricate all Reels at its facility in
the United States.

       The price at which Fabricator sells Reels to X is determined by X and Fabricator
every Period. Once the price is determined, it is not adjusted based on the fabrication
cost of Fabricator. Accordingly, Fabricator bears the risk of loss if the production costs
go up and keeps the profits if the production costs go down during that time. Fabricator
decides, in its sole discretion, how many Reels it fabricates each year and to whom it
sells Reels. X does not have the exclusive or first right to purchase Reels fabricated by
Fabricator. After X issues a purchase order for Reels, Fabricator decides whether to
accept the purchase order at Fabricator’s sole discretion.

RULING REQUESTED

      X is not the manufacturer, producer, or importer of Reels for purposes of the tax
imposed by § 4161(a) of the Code.

LAW

        Section 4161(a)(1) of the Code imposes a 10 percent tax on the sale of any
article of sport fishing equipment by the manufacturer, producer, or importer.

       Section 4162(a)(2) provides that the term “sport fishing equipment” includes
fishing reels.
PLR-101061-21                               3


      Section 48.4161-1(c) of the Manufacturers and Retailers Excise Taxes
Regulations provides that the tax imposed by § 4161(a) is payable by the manufacturer,
producer, or importer making the sale.

      Section 48.0-2(a)(4)(i) provides that the term “manufacturer” includes any person
who produces a taxable article from scrap, salvage, or junk material or from new or raw
material, by processing, manipulating, or changing the form of an article or by
combining or assembling two or more articles. The term also includes a “producer” and
an “importer.”

          Section 48.0-2(a)(4)(ii) provides that under certain circumstances, as where a
person manufactures or produces a taxable article for another person who furnishes
materials under an agreement whereby the person who furnished the materials retains
title thereto and to the finished article, the person for whom the taxable article is
manufactured or produced, and not the person who actually manufactures or produces
it, will be considered the manufacturer.

      Rev. Rul. 58-134, 1958-1 C.B. 395, holds that a company that owns the patents
under which a taxable article is fabricated by another company, exercises control as to
the amounts to be fabricated, has exclusive rights or first rights to the output, and
designates territories where the fabricator may sell the article is considered to be the
manufacturer for purposes of the manufacturers excise tax on those articles the
company sells.

        Rev. Rul. 60-42, 1960-1 C.B. 474, holds that among the factors to be considered
in determining whether a fabricator or the vendee is liable for the manufacturers excise
tax are (1) the ownership of the raw materials used in producing the articles, and (2) the
right to control the production and sale of the articles.

       Rev. Rul. 76-181, 1976-1 C.B. 341, holds that where (1) a fabricator owns the
materials, tools, dies, machinery, and equipment used to manufacture a product and
can produce and sell the articles anywhere (except that articles with the trademark or
trade name of the customer can only be sold to the customer), (2) the fabricator has an
unlimited, nonexclusive, and irrevocable license to use the customer's patents in the
production process, and (3) the customer does not have the exclusive or first right to the
output of the fabricator's products under the patent license, the fabricator is the
manufacturer liable for the excise tax on all sales of the article produced by fabricator.

       Rev. Rul. 78-34, 1978-1 C.B. 355, holds, generally, that where a company not
only owns the patents under which a taxable article is fabricated by another company,
but also exercises control as to the amounts to be so fabricated and has exclusive rights
to the output so that the fabricator is not free to sell elsewhere, the company owning the
patents is the manufacturer for purposes of the manufacturers excise tax.
PLR-101061-21                                4


       In Polaroid Corp. v. U.S., 235 F.2d 276 (1st Cir. 1956), cert. denied, 352 U.S.
953 (1956), a taxpayer contracted with a fabricator to produce taxable cameras for
which the taxpayer had a patent. The appellate court held that the taxpayer was the
manufacturer of the cameras because the taxpayer bought the fabricator's entire output,
dictated the amount of the output, prohibited the fabricator from selling the cameras to
anyone but the taxpayer, bore the risk of a production cost increase, benefitted if
production costs dropped, and owned specialized tools. Additionally, the fabricator did
not pay the taxpayer royalties for the patented cameras, which both the appellate court
and the trial court found to be of particular significance.

ANALYSIS & CONCLUSION

      At issue is whether X is the manufacturer, producer, or importer of Reels for
purposes of the tax imposed by § 4161(a).

       Fabricator fabricates Reels in the United States. Fabricator owns all raw
materials, tools (other than X Tooling), machinery, and equipment used to fabricate
Reels. Fabricator decides at its sole discretion how many Reels it fabricates each year
and whether it wants to sell any Reels to X. X does not have the exclusive or first right
to purchase Reels produced by Fabricator. Further, Fabricator bears the risk of loss if
its production costs go up and keeps the profits if its production costs go down during
the period between price determinations.

        In addition, Fabricator can, without seeking any permission from X, use X
Intellectual Property and X Tooling to fabricate and sell Reels to anyone in the United
States as long as Fabricator pays X a license fee for the use of X Intellectual Property
and a user fee for the use of X Tooling, and otherwise satisfies the requirements of
License Agreement and Supply Agreement.

       Based on the foregoing, we conclude that X is not the manufacturer, producer, or
importer of the Reels for purposes of the tax imposed by § 4161(a). See Polaroid, Rev.
Rul. 58-134, Rev. Rul. 60-42, and Rev. Rul. 78-34.

       Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

        This ruling is directed only to the party requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

      This private letter ruling is based upon information and representations submitted
by X and accompanied by a penalty of perjury statement executed by an appropriate
PLR-101061-21                                    5

party. While this office has not verified any of the material submitted in support of the
request for a ruling, the supporting material is subject to verification or examination.

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.

                                           Sincerely,

                                           /s/

                                           Stephanie Bland
                                           Branch Chief, Branch 7
                                           Office of Associate Chief Counsel
                                           (Passthroughs & Special Industries)


Enclosures (2)
      Copy of this letter
      Copy for § 6110 purposes



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