                         T.C. Memo. 2009-9



                      UNITED STATES TAX COURT



   ROBINSON KNIFE MANUFACTURING COMPANY, INC. AND SUBSIDIARY,
   Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21514-06.              Filed January 14, 2009.



     Robert J. Lane, Jr. and Alice A. Joseffer, for petitioner.

     Jennifer McGinty and Grant Gabriel, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:   Respondent determined the following

deficiencies in the Federal income tax of Robinson Knife

Manufacturing Co. and Subsidiary:1


     1
      Robinson Knife Manufacturing Co., the parent corporation,
and a subsidiary corporation are an affiliated group
                                                   (continued...)
                                - 2 -

                     TYE                Deficiency

               Mar. 1, 2003              $123,902
               Feb. 28, 2004               16,419

     Robinson Knife Manufacturing Co. and Subsidiary, hereinafter

collectively referred to as petitioner, filed a petition to

redetermine the deficiencies.    After concessions,2 the issues we

must decide are:   (1) Whether petitioner must capitalize under

section 263A3 royalties incurred in connection with two trademark

licensing agreements and (2) if so, whether respondent properly

allocated the royalties to ending inventory using the simplified

production method.

                           FINDINGS OF FACT

     Some of the facts have been stipulated.         We incorporate the

stipulation of facts into our findings by this reference.        When

the petition was filed, petitioner’s principal place of business

was in the State of New York.




     1
      (...continued)
(petitioner) that filed consolidated returns for the periods at
issue.
     2
      Petitioner concedes that during the years at issue it
incurred and paid royalties, other than the royalties in dispute,
of $20,613 and $12,501 and that those royalties should be
capitalized under sec. 263A.
     3
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
                                - 3 -

Petitioner’s Operations

     Petitioner is a corporation engaged in the business of

designing, developing, manufacturing, marketing, and selling

kitchen tools and gadgets used in food preparation and service

(kitchen tools).4   Petitioner markets and sells the kitchen tools

to large retailers in the United States and Canada, including,

among others, Wal-Mart, Target, Bed Bath & Beyond, Kohl’s, and

Sears.

     Petitioner entered into licensing agreements for the right

to use well-known trademarks in connection with some of the

kitchen tools it produces and sells.    In return petitioner

generally pays the trademark licensors royalties based on a

percentage of net sales of the kitchen tools bearing the

licensors’ trademarks.    Petitioner also produces and sells

kitchen tools under its own brand names, including America Cooks

and Chip Clip, but it does not pay any royalties on the sale of

those kitchen tools.   Petitioner also produces and sells kitchen

tools to retailers in packaging bearing the retailers’ brand

names.

     Generally, the idea for a new line of kitchen tools

originates with petitioner.    Petitioner decides which licensed

trademark would be most appropriate for the new kitchen tools and

     4
      Examples of petitioner’s kitchen tools include spoons, soup
ladles, potato peelers, spatulas, turners, timers, pastry
brushes, and cooking thermometers.
                               - 4 -

then seeks a trademark license from either an existing licensor

or a new licensor.   Once petitioner has chosen a licensed

trademark for the new kitchen tools, it hires an industrial

designer to sketch the new kitchen tools.   The industrial

designer is also responsible for getting the trademark licensor’s

approval that a particular trademark is appropriate for the new

kitchen tools.   Petitioner owns the product designs it develops.

     After petitioner obtains a product design and the trademark

licensor’s approval, petitioner contracts with unrelated

manufacturers, generally in China, to manufacture the new kitchen

tools according to petitioner’s product design.   The

manufacturing contracts generally provide that the manufacturer

will deliver the finished kitchen tools, including the packaging.

The manufacturer either packages the manufactured kitchen tools

itself or outsources the packaging to a third party.5   Once the

manufacturer completes the kitchen tools, including the

packaging, petitioner purchases them from the manufacturer for

resale to retailers in the United States and Canada.

     For kitchen tools manufactured under a licensed trademark,

the licensed trademark appears on the front of the packaging of

each kitchen tool and sometimes in additional places.   The

licensed trademark sometimes appears on the kitchen tool itself.


     5
      Petitioner has occasionally packaged its kitchen tools
itself, but generally it does not.
                                - 5 -

Petitioner’s name sometimes appears on the back of the packaging

or inside an attached card.    On packaging with both the licensed

trademark and petitioner’s name, the licensed trademark is

featured more prominently than petitioner’s name.   Sometimes on

the back of the packaging petitioner includes a warranty against

breakage occurring during normal use.

     Petitioner does not advertise its branded kitchen tools

through magazines, newspapers, broadcast media, direct mailings,

or billboards.   Petitioner instead relies on the reputation of

the well-known trademarks to entice customers at the point of

sale to purchase its kitchen tools bearing the licensed

trademarks.   Petitioner uses the trademarks on point-of-sale

displays in retail outlets and on its Web site and exhibits its

kitchen tools bearing the licensed trademarks at trade shows and

at its facility in New York.

     During the years at issue petitioner had licensing

agreements for the use of trademarks from Corning, Inc.

(Corning), and Oneida, Ltd. (Oneida), and produced and sold

kitchen tools using trademarks owned by Corning and Oneida.6

Corning owns the Pyrex brand, a popular kitchen brand that

includes tempered clear-glass ovenware.   Oneida is a well-known

producer of glass, ceramic dinnerware, and metal tableware.     For

     6
      Petitioner also licensed trademarks from other licensors
but concedes that the royalties paid to other licensors are
required to be capitalized under sec. 263A.
                               - 6 -

over 80 years, Corning and Oneida have conducted substantial and

continuous advertising and marketing activities to develop

widespread awareness and goodwill with respect to their

trademarks.   Both trademarks are well known among retailers and

consumers of kitchen tools, and consumers purchasing kitchen

tools bearing the Pyrex or Oneida trademark likely expect a high-

quality product.

Corning License Agreement

     During the years at issue petitioner had a trademark license

agreement with Corning (Corning license agreement) for the

exclusive right to manufacture, distribute, and sell kitchen

tools using the Pyrex trademark (Pyrex-branded kitchen tools).

Under the Corning license agreement, petitioner had the right to

create its own advertising, packaging, and other promotional

materials using the Pyrex trademark in connection with the

manufacture, distribution, or sale of Pyrex-branded kitchen

tools.   In return petitioner agreed to pay Corning royalties

equal to 8 percent of the net wholesale billing price (less

returns from customers, certain taxes and other costs, and sales

commissions) of the Pyrex-branded kitchen tools sold.   The

royalties were due within 30 days following the end of each 3-

month period.

     The Corning license agreement imposed certain terms and

conditions of quality control over the Pyrex-branded kitchen
                               - 7 -

tools.   First, Corning required that petitioner provide samples

of the Pyrex-branded kitchen tools produced and any applicable

sales materials for inspection and testing.   If any Pyrex-branded

kitchen tool did not comply with Corning’s quality standards,

petitioner had to correct the deficiency or discontinue the

manufacture, distribution, and sale of the deficient Pyrex-

branded kitchen tool.   Second, petitioner could not engage in any

course of conduct that would damage the goodwill and reputation

or dilute the value or strength of the Pyrex trademark.   Third,

Corning had to approve all advertising, packaging, or other

promotional materials bearing the Pyrex trademark, and petitioner

could not use any material that violated the Corning license

agreement.

Oneida License Agreement

     During the years at issue petitioner also had a trademark

license agreement with Oneida (Oneida license agreement) for the

exclusive right to manufacture and sell kitchen tools using the

Oneida trademark (Oneida-branded kitchen tools).   Under the

Oneida license agreement, petitioner agreed to pay Oneida a

royalty of 11 percent on net sales up to $1 million and 8 percent

on net sales of $1 million or more of Oneida-branded kitchen

tools sold.   The royalties were due within 30 days after the end

of each 3-month period.
                                - 8 -

     The Oneida license agreement imposed certain terms and

conditions to ensure quality control over the Oneida-branded

kitchen tools.   First, Oneida requested samples of all Oneida-

branded kitchen tools so that it could decide whether to

authorize petitioner’s use of the Oneida trademark on or in

connection with the production of petitioner’s kitchen tools.      A

list of all approved Oneida-branded kitchen tools was

incorporated into a schedule attached to the Oneida license

agreement.   Petitioner could add to or delete from the schedule

in response to market conditions or new product development.

Second, petitioner agreed to submit to Oneida examples of any

packaging, promotional materials, displays, and advertisements

using the Oneida trademark.    Third, petitioner had to use its

best efforts to give Oneida’s representatives the opportunity to

visit any plant or office in which petitioner manufactured

kitchen tools to inspect manufacturing methods, advertising

materials, letterheads, and any other printed materials that may

bear the Oneida trademark.    Oneida reserved the right to

terminate the Oneida license agreement if the working conditions

in the manufacturing facilities violated certain laws or

otherwise embarrassed Oneida or diminished the goodwill of the

Oneida trademark.
                               - 9 -

Petitioner’s Tax Reporting

     Petitioner timely filed its Forms 1120, U.S. Corporation

Income Tax Return, for taxable years ending March 1, 2003, and

February 28, 2004 (tax returns).   Petitioner uses the accrual

method of accounting and the first-in, first-out inventory

method.   Petitioner uses the simplified production method, see

sec. 1.263A-2(b)(1), Income Tax Regs., for allocating warehouse

salaries and related fringe benefits, warehouse depreciation,

real estate taxes, warehouse building rental, and warehouse

utilities and repairs.

     For the taxable years ending March 1, 2003, and February 28,

2004, petitioner incurred and paid royalties to Corning and

Oneida for the use of the Pyrex and Oneida trademarks of

$2,184,252 and $1,741,415, respectively.   Petitioner deducted the

royalty payments as ordinary and necessary business expenses on

its tax returns.

     In a notice of deficiency, respondent determined that

petitioner must capitalize the royalties under section 263A.

Using the simplified production method, respondent determined

that $364,420 and $48,293 were allocable to petitioner’s ending

inventory for the taxable years ending March 1, 2003, and

February 28, 2004, respectively, and includable in petitioner’s

cost of inventory.
                               - 10 -

                               OPINION

     Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving its entitlement to the

deduction it claimed.7   Rule 142(a); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934); Welch v. Helvering, 290 U.S.

111, 115 (1933).    Section 162(a) permits a deduction for a

taxpayer’s ordinary and necessary business expenses paid or

incurred during the taxable year in carrying on a trade or

business.    Advertising and other selling expenses are examples of

deductible business expenses under section 162.    Sec. 1.162-1(a),

Income Tax Regs.    However, no item shall be included in

deductible business expenses to the extent that the item is used

by the taxpayer in computing the cost of property included in its

inventory.    Id.

     Section 263A was enacted as part of the Tax Reform Act of

1986, Pub. L. 99-514, sec. 803(a), 100 Stat. 2350.    In enacting

section 263A, Congress intended that a single, comprehensive set

     7
      Where a taxpayer produces credible evidence with respect to
any factual issue relevant to ascertaining the tax liability of
the taxpayer, the burden of proof shifts to the Commissioner, but
only if the taxpayer has complied with substantiation
requirements, has maintained all required records, and has
cooperated with reasonable requests by the Commissioner for
witnesses, information, documents, meetings, and interviews.
Sec. 7491(a). Although respondent concedes that he bears the
burden of proof under sec. 7491 as to any factual issue and we
assign the burden of proof to respondent in accordance with that
concession, our findings of fact are based on the preponderance
of the evidence and not on any allocation of the burden of proof.
See Knudsen v. Commissioner, 131 T.C. ___ (2008).
                              - 11 -

of rules generally should govern the capitalization of costs of

producing, acquiring, and holding property in order to more

accurately reflect income and make the tax system more neutral.

Suzy’s Zoo v. Commissioner, 273 F.3d 875, 879 (9th Cir. 2001),

affg. 114 T.C. 1 (2000); S. Rept. 99-313, at 140 (1986), 1986-3

C.B. (Vol. 3) 1, 140.   The term “produce” has been construed

broadly in order to give effect to legislative intent.8    E.g.,

Suzy’s Zoo v. Commissioner, supra at 879-880 (taxpayer was

“producer” of greeting cards manufactured by third-party

contractors); Von-Lusk v. Commissioner, 104 T.C. 207, 214-216

(1995) (taxpayer’s meetings with governmental officials,

obtaining building permits, and drafting architectural plans

constituted part of “production”).

     The capitalization rules of section 263A require that a

taxpayer’s direct costs and some indirect costs (including taxes)

of producing property9 that is inventory in the hands of the

taxpayer be included in inventory costs.   Sec. 263A(a)(1)(A) and

     8
      In general, sec. 263A(g)(1) defines the term “produce” to
include “construct, build, install, manufacture, develop, or
improve.”
     9
      For purposes of sec. 263A, property produced for the
taxpayer under a contract with another party is treated as
property produced by the taxpayer to the extent the taxpayer
makes payments or otherwise incurs costs with respect to the
property. Sec. 263A(g)(2); Suzy’s Zoo v. Commissioner, 273 F.3d
875, 879-880 (9th Cir. 2001), affg. 114 T.C. 1 (2000); sec.
1.263A-2(a)(1)(ii)(B), Income Tax Regs. The kitchen tools
manufactured by the unrelated manufacturers under contract with
petitioner are treated as property produced by petitioner.
                                   - 12 -

(2), (b)(1).        These costs must be capitalized10 under section

263A without regard to whether they are incurred before, during,

or after the production period.        Sec. 1.263A-2(a)(3), Income Tax

Regs.        Direct costs include direct labor costs and material

costs, including the costs of those materials that become an

integral part of specific property produced and those materials

that are consumed in the production process and that can be

identified or associated with particular units of property

produced.        Sec. 1.263A-1(e)(2)(A), Income Tax Regs.    Indirect

costs include all costs other than direct costs, and only some

indirect costs are required to be capitalized.        Sec. 1.263A-

1(e)(3)(i), Income Tax Regs.

     The regulations under section 263A provide a nonexclusive

list of indirect costs that must be capitalized to the extent the

costs are properly allocable to property produced.          See sec.

1.263A-1(e)(3)(ii), Income Tax Regs.        Included in the list are

licensing costs incurred in securing the contractual right to use

a trademark or other similar right associated with property

produced.        Sec. 1.263A-1(e)(3)(ii)(U), Income Tax Regs.

Specifically, section 1.263A-1(e)(3)(ii)(U), Income Tax Regs.,

provides:



        10
      To capitalize means, in the case of property that is
inventory in the hands of a taxpayer, to include in inventory
costs. Sec. 1.263A-1(c)(3), Income Tax Regs.
                               - 13 -

          (ii) Examples of indirect costs required to be
     capitalized.--The following are examples of indirect
     costs that must be capitalized to the extent they are
     properly allocable to property produced or property
     acquired for resale:

               *     *     *     *      *    *     *

               (U) Licensing and franchise costs.--
     Licensing and franchise costs include fees incurred in
     securing the contractual right to use a trademark,
     * * * or other similar right associated with property
     produced or property acquired for resale. These costs
     include the otherwise deductible portion (e.g.,
     amortization) of the initial fees incurred to obtain
     the license or franchise and any minimum annual
     payments and royalties that are incurred by a licensee
     or a franchisee.

On the other hand, some indirect costs are specifically excluded

from the capitalization rules.   See sec. 1.263A-1(e)(3)(iii),

Income Tax Regs.   Examples of those indirect costs include

marketing, selling, advertising, and distribution costs, sec.

1.263A-1(e)(3)(iii)(A), Income Tax Regs., which are generally

deductible business expenses under section 162, sec. 1.162-1(a),

Income Tax Regs.

     Respondent asserts that the royalties paid for the right to

use the Pyrex and Oneida trademarks in producing the Pyrex- and

Oneida-branded kitchen tools are indirect costs, i.e., licensing

costs, under section 1.263A-1(e)(3)(ii)(U), Income Tax Regs.     We

agree.   Petitioner incurred royalties for licensing the right to

use the Pyrex and Oneida trademarks in manufacturing the Pyrex-

and Oneida-branded kitchen tools it produced, and the regulations

under section 263A specifically require that those licensing
                              - 14 -

costs be capitalized to the extent they are properly allocable to

property produced.

     Indirect costs are properly allocable to property produced

when the costs directly benefit or are incurred by reason of the

performance of production activities.   Sec. 1.263A-1(e)(3)(i),

Income Tax Regs.   Whether petitioner’s royalties are properly

allocable to property produced is a question of fact.11

     Petitioner argues that the royalties did not directly

benefit its production activities and thus are not properly

allocable to property produced.   However, petitioner failed to

address whether the royalties were incurred by reason of

petitioner’s production activities.12   The Corning and Oneida

license agreements gave petitioner the right to manufacture the

Pyrex- and Oneida-branded kitchen tools, and without the license

agreements, petitioner could not have legally manufactured them.

In addition to securing the licenses for the trademarks,


     11
      Respondent argues that this case involves a legal issue;
i.e., whether the royalties are licensing fees capitalizable
under sec. 263A or whether they are deductible marketing and
advertising costs under sec. 162. Although the issue of whether
licensing fees, such as the royalties, are indirect costs
capitalizable under sec. 263A is a legal issue, the issue of
whether the royalties are properly allocable to property produced
by petitioner is a factual issue. See INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 86 (1992). In any event, it does not
appear that the characterization of the issue as one of law or of
fact or of mixed law and fact affects the outcome. See supra
note 6.
     12
      Although petitioner alludes to the “incurred by reason of”
test, it addresses only the “directly benefited” test.
                               - 15 -

obtaining approval from the licensors to use the Pyrex and Oneida

trademarks on new kitchen tools was also an integral part of

developing and producing the Pyrex- and Oneida-branded kitchen

tools.    For example, the industrial designers that petitioner

hired conferred with the licensors to ensure that the new kitchen

tools were appropriate for a particular trademark.    After the new

kitchen tools were manufactured, Corning and Oneida had the right

to inspect and approve the finished kitchen tools before

petitioner marketed and sold them to customers.    We conclude that

acquiring the right to use the Pyrex and Oneida trademarks was

part of petitioner’s production process.    Consequently, the

royalties paid to Corning and Oneida directly benefited

petitioner’s production activities and/or were incurred by reason

of petitioner’s producing the Pyrex- and Oneida-branded kitchen

tools and are therefore indirect costs properly allocable to the

Pyrex- and Oneida-branded kitchen tools petitioner produced.13

     Petitioner contends that the royalties paid to Corning and

Oneida for petitioner’s use of the licensed trademarks are

marketing expenses that are exempt from the capitalization rules



     13
      The fact that the amount of royalties petitioner owed
Corning and Oneida was calculated on the net sales of the Pyrex-
and Oneida-branded kitchen tools does not alter our conclusion.
We have held that a taxpayer must capitalize royalties incurred
for the right to use an intangible in a production process where
the amount of the royalties was calculated on the basis of net
sales. See Plastic Engg. & Technical Servs., Inc. v.
Commissioner, T.C. Memo. 2001-324.
                               - 16 -

of section 263A.   Specifically, petitioner argues that

expenditures to obtain a marketing advantage, to retain

customers, and to attract new customers are deductible marketing

expenses.    In support of its argument, petitioner relies on Rev.

Rul. 2000-4, 2000-1 C.B. 331, in which the Commissioner

determined that indirect costs incurred to obtain, maintain, and

renew ISO 9000 certification were not subject to capitalization

under section 263 or 263A.   ISO 9000 was a voluntary

certification comprising several specific requirements intended

to ensure a quality process in providing products or services.

Id.   In the revenue ruling, the Commissioner concluded that those

indirect costs were in connection with a quality control policy

and that such costs were specifically exempted from the

capitalization rules under the section 263A regulations.     Id.

      Petitioner’s reliance on Rev. Rul. 2000-4, supra, is

misplaced.   The royalties paid to Corning and Oneida were not in

connection with implementing a quality control policy but rather

were licensing costs for the right to use the Pyrex and Oneida

trademarks in connection with petitioner’s production of kitchen

tools, and the section 263A regulations specifically require that

such licensing costs be capitalized under section 263A.14




      14
      Petitioner does not contend that the sec. 263A regulations
are invalid.
                              - 17 -

     Although the Corning and Oneida license agreements permitted

petitioner to produce kitchen tools that were arguably more

marketable than petitioner’s other kitchen tools,15 the royalties

were licensing fees that enabled petitioner to use the Pyrex and

Oneida trademarks during the production process.    As such, the

royalties were properly allocable to the Pyrex- and Oneida-

branded kitchen tools produced by petitioner because the

royalties directly benefited and/or were incurred by reason of

petitioner’s production activities.    Sec. 1.263A-1(e)(3)(i),

Income Tax Regs.   Consequently, we conclude that respondent

properly determined that the royalties paid to Corning and Oneida

were indirect costs that petitioner was required to capitalize

under section 1.263A-1(e)(3)(i), Income Tax Regs.

     Petitioner contends that if we hold that the royalties must

be capitalized under section 263A, respondent erred in using the

simplified production method to allocate the royalties to

petitioner’s ending inventory.   Petitioner argues that the



     15
      Respondent properly distinguishes between costs incurred
for marketing, selling, or advertising and costs incurred to
produce a more marketable product and argues that the regulations
under sec. 263A reflect that distinction. Costs for marketing,
selling, and advertising a taxpayer’s products after they have
been produced are not required to be capitalized under sec. 263A.
See sec. 1.263A-1(e)(3)(iii)(A), (4)(ii)(B), (iv)(N), Income Tax
Regs. Licensing costs such as the royalties incurred by
petitioner to use the Pyrex and Oneida trademarks during its
production process are indirect costs that directly benefited
and/or were incurred by reason of petitioner’s production
activities. See sec. 1.263A-1(e)(3)(ii)(U), Income Tax Regs.
                                - 18 -

simplified production method is not appropriate for allocating

the royalties to ending inventory because it results in a

distortion of income and fails to match revenue with expenses.

     The simplified production method is an allocation method for

determining the additional section 263A costs properly allocable

to ending inventory of property produced and other property on

hand at the end of the taxable year.     Sec. 1.263A-2(b)(1), Income

Tax Regs.   Additional section 263A costs include the costs, other

than interest, that were not capitalized under the taxpayer’s

method of accounting immediately before the effective date of

section 263A but that are required to be capitalized under

section 263A.   Secs. 1.263A-2(b)(3)(ii)(A)(1), 1.263A-1(d)(3),

Income Tax Regs.

     The simplified production method was designed to relieve the

administrative burdens of complying with section 263A for

producers who engage in a mass production of products on a

repetitive and routine basis.    T.D. 8131, 1987-1 C.B. 98, 102.

The simplified production method differs from other cost

accounting allocation methods in that it allocates a pool of

costs between ending inventory and cost of goods sold using a

ratio prescribed by the regulations rather than allocating

individual costs to particular goods.    Compare sec. 1.263A-

2(b)(3), Income Tax Regs., with sec. 1.263A-1(f)(2), Income Tax

Regs.
                               - 19 -

     Petitioner uses the simplified production method for

allocating warehouse and administrative salaries and related

fringe benefits, warehouse depreciation, real estate taxes,

warehouse building rental, and warehouse utilities and repairs.

Because petitioner uses the simplified production method to

allocate other additional section 263A costs, respondent argues

that he properly allocated the royalties to ending inventory

using the simplified production method and that the simplified

production method does not create a distortion of income as

petitioner contends.16

     We agree that respondent properly applied the simplified

production method to allocate the royalties to petitioner’s

ending inventory.   The regulations under section 263A provide

that if a producer elects the simplified production method for

any trade or business, the producer generally must use it for all

production activities associated with inventory property to which

section 263A applies.17   Sec. 1.263A-2(b)(2)(i)(A), Income Tax


     16
      The parties do not dispute that the royalties that
petitioner paid to Corning and Oneida are additional sec. 263A
costs if we hold (as we do) that the royalties must be
capitalized.
     17
      A taxpayer may elect to exclude from the simplified
production method certain self-constructed assets. Sec. 1.263A-
2(b)(2)(ii), Income Tax Regs. Self-constructed assets include
assets produced by a taxpayer for use by the taxpayer in its
trade or business. Sec. 1.263A-1(d)(1), Income Tax Regs. The
Pyrex- and Oneida-branded kitchen tools were not self-constructed
assets. In addition, sec. 1.263A-1(d)(2)(iii), Income Tax Regs.,
                                                   (continued...)
                               - 20 -

Regs.18   Petitioner has elected the simplified production method

for allocating other additional section 263A costs, and

therefore, petitioner is required to use the simplified

production method to allocate the royalties.   Although the

simplified production method may allocate costs differently than

other accounting methods, such as the specific identification

method described in section 1.263A-1(f)(2), Income Tax Regs.,19

the simplified production method is intended to ease the

administrative burdens of section 263A and by its nature may

result in an allocation that is not as precise as other specific

cost allocation methods.   This does not suggest that the

simplified production method creates a distortion of income.    We

conclude that respondent appropriately allocated the royalties to




     17
      (...continued)
provides that a taxpayer may change its method of accounting used
in determining sec. 471 costs only with the consent of the
Commissioner as required under sec. 446(e) and the regulations
thereunder. Sec. 471 costs are generally costs capitalized to
inventory immediately before the enactment of sec. 263A. Sec.
1.263A-1(d)(2), Income Tax Regs. Petitioner has not requested
consent under sec. 446(e) to change its method of accounting with
respect to the royalties.
     18
      Congress directed the Secretary to prescribe regulations
as may be necessary or appropriate to carry out the purposes of
sec. 263A. Sec. 263A(i).
     19
      A specific identification method traces costs to a cost
objective, such as a function, department, activity, or product,
on the basis of a cause and effect or other reasonable
relationship between the costs and the cost objective. Sec.
1.263A-1(f)(2), Income Tax Regs.
                             - 21 -

petitioner’s ending inventory under the simplified production

method.

     We have considered all remaining arguments made by the

parties for results contrary to those expressed herein, and to

the extent not discussed above, we reject those arguments as

irrelevant, moot, or without merit.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.
