In a notable opinion issued in December 2024, the Tax Court held, in part, in Bloomberg's favor, concluding that a significant portion of its gross receipts derived from online software qualified as domestic production gross receipts (DPGR) for purposes of the former section 199 deduction for domestic production activities. See Bloomberg, L.P. v. Commissioner, T.C. Memo. 2024-108. In prior cases addressing the section 199 deduction for online software, the Tax Court and two appellate courts consistently rejected taxpayers' claims. See Direct Supply, Inc. v. United States, 635 F. Supp. 3d 685 (E.D. Wis. 2022), aff'd, 96 F.4th 1031 (7th Cir. 2024); BATS Glob. Mkts. Holdings, Inc. v. Commissioner, 158 T.C. 118 (2022), aff'd, No. 22-9002, 2023 U.S. App. LEXIS 17608 (10th Cir. July 12, 2023) (covered here and here). In Bloomberg, the Tax Court distinguished those prior cases, finding that a portion of the gross receipts Bloomberg derived from the software was DPGR, notwithstanding the fact that the software also enabled the provision of services, which did not give rise to DPGR.

Former section 199 provided a deduction for taxpayers involved in the domestic production of qualifying property, which included computer software. See § 199(c)(5)(B). While the statute did not distinguish between online software and software provided on a tangible medium (e.g., a disk), the regulations imposed certain requirements for online software to qualify for the deduction. In general, the regulations excluded from DPGR gross receipts derived from the provision of "online services (such as Internet access services, online banking services, providing access to online electronic books, newspapers, and journals), and other similar services." Treas. Reg. § 1.199-3(i)(6)(ii). The regulations provided a narrow exception to this general rule, allowing the deduction when the taxpayer derived gross receipts from providing customers access to online software for the customers' direct use (referred to as the "threshold requirement" in the case law) if either (1) the taxpayer also sold the same software on a tangible medium or via download, or (2) a third party sold "substantially identical software" on a tangible medium or via download (the "third-party comparable exception"). Treas. Reg. § 1.199-3(i)(6)(iii). These regulatory provisions were at the center of the disputes in BATS Global and Direct Supply, and likewise, in Bloomberg.

In Bloomberg, the Tax Court noted that the regulations applicable to computer software under section 199 were ambiguous and inadequate, "often read[ing] more as a collection of parts forced together than as a seamless whole." The court remarked that some examples and provisions were imprecisely written, the computer software provisions were poorly incorporated with the rest of the regulatory scheme, and some descriptions and definitions were inadequate. T.C. Memo. 2024-108, at 42. The court also took issue with the IRS's interpretation of the regulation, finding that it was "extremely restrictive" and would effectively eliminate the deduction for almost any complex software, which would contravene congressional intent. Interestingly, in reaching its conclusion the court noted that it was unnecessary to invalidate any portion of Treas. Reg. § 1.199-3. Instead, the court independently interpreted the regulation, landing on a reading that represented "the best interpretation of both section 199 and the regulation text itself." Id. at 43.

There were two software programs at issue in the case. The Bloomberg Professional Service (BPS) software had several functions: (1) enabling BPS to collect, categorize, and store financial information and allowing users to access and search that information; (2)  an email and instant messaging feature; and (3) enabling users "to analyze, manipulate, and model the financial information that was available through BPS." Id. at 53. The second software program, the Order Management System (OMS), was used in connection with the BPS software and data, but was subject to a separate subscription. OMS allowed customers to track transactions and investments for performance and accounting purposes and to comply with regulatory and other requirements.

As a threshold matter for the BPS software, the Tax Court held that Bloomberg did not derive DPGR from the software that enabled the first two functions of BPS (i.e., data collection and search and communication). It concluded that users did not pay Bloomberg for access to the software in those cases. Rather, similar to the software at issue in BATS Global and Direct Supply, those aspects of the BPS software merely enabled the provision of services (namely, financial information and communication services). 

By contrast, the court held that the analytical and graphing portion of the BPS software did not facilitate the provision of any service. Instead, that software allowed users to manipulate the data and draw their own conclusions from the financial information. The court was unpersuaded by the government's attempt to deny the deduction for this portion of the software on the basis that it was integrated with, and relied upon, the financial data in BPS. The court concluded that nothing in the regulation precluded software from qualifying because it operated in conjunction with a service. The court found that the BPS analytical and graphing software met the other elements of the threshold requirement and, therefore, Bloomberg derived gross receipts from the provision of access to software. The Tax Court then concluded that Bloomberg satisfied the third-party comparable exception based on substantially identical software provided by Thomson Reuters. The court also agreed with Bloomberg that the subscription fee received for the software could be divided into qualifying and nonqualifying portions for purposes of section 199.
 
For the OMS software, the court found that most of the subscription fees were paid for access to the software and satisfied the threshold requirement. In addition, the court found that the OMS software met the third-party comparable exception because it was substantially identical to the IMS software program sold by Charles River. 

After finding that the software at issue qualified for the deduction in part, the court analyzed the parties' competing positions with respect to the allocation of fees Bloomberg received (and related expenses it incurred) between DPGR and non-DPGR. Allocation issues were particularly complex with respect to BPS and the court did not embrace either party's position in full. The court ultimately concluded that Bloomberg had DPGR (from both BPS and OMS) for the years at issue totaling roughly $4 billion, which was approximately 40 percent of the amount Bloomberg had claimed.

Although repealed in the 2017 Tax Cuts and Jobs Act (TCJA), the section 199 deduction continues to be a source of controversy. Bloomberg is a taxpayer-favorable development that has the potential to shift the landscape and how pending controversies are resolved. As illustrated by the Bloomberg opinion, however, section 199 online software cases are fact-intensive, and the outcomes will ultimately turn on the specific facts and circumstances of each case.

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