That’s what BATS Global Markets Holdings, Inc. and Subsidiaries, 158 T. C.5, filed 3/31/22, did with its stock-trading software, that it developed and used to propel itself to the world’s third largest stock exchange. What got it to Tax Court was its claimed deductions from Domestic Production Gross Receipts (Section 199) arising out of said software.

But Ch J I W (Chief Judge In Waiting) Kathleen (“TBS = The Big Shillelagh”) Kerrigan will none of it.

If you’re interested in creating an online stock exchange but haven’t age-appropriate offspring or descendants handy to teen-‘splain IP/TCP ports, order matching software, “physical” and “logical” connectivity, and latency, read Judge Kerrigan’s treatise at pp. 2-18. Then go out and make billions, and you won’t have to read blogs about Tax Court.

The BATS did and didn’t.

To participate in the BATS exchange, one had to be a broker-dealer as defined in the securities laws. One also had to pay the laundry list of Fees charged by BATS to play in their schoolyard. BATS claimed the Fees were DPGR. IRS says no.

Key to BATS’ claim is Reg. Section “199 -3(i)(6)(iii)(B): first, that they [receipts] were derived from providing customers access to computer software for the customers’ direct use while connected to the internet or any other public or private communications network, id. subdiv. (iii); and second, that a third party derived gross receipts from the lease, rental, license, sale, exchange, or other disposition of substantially identical software, id. subdiv. (iii)(B).” 158 T. C. 5, at p. 20.

But the property (and that includes computer software) has to be disposed of, that is, leased, licensed, sold, exchanged, not used to provide services for a fee. And the software has to be distributed by download or tangible medium (CD or flashdrive) as well as online only. And the download or tangible has to be substantially the same as the online. This is the so-called “self-comparable” exception, but BATS doesn’t claim that.

BATS does claim Reg. Section 1.199-3(i)(6)(iii)(B) third-party comparable status, that is, that other unrelated parties are disposing of like software.

The idea is that merely offering your software for online use, without letting the customer buy or lease or download it for their own use, isn’t domestic production. It’s selling a service, and only architects and engineers doing that onshore qualify.

The Logical Port Fees aren’t DPGR; they only allowed the customer to log into BATS’ exchanges, no different from any e-mail service.

The Routing Fees were paid to send the customers’ orders to specified exchanges. This is again a service, not a disposition of software.

Transaction Fees varied widely. Some transactions never happened, so no fee was charged. Some fees depended upon how much liquidity the customer was providing or taking from the exchange. In short, another fee-for-service.

“Petitioner is an operator of securities exchanges. The fact that the Exchanges use software to operate does not convert petitioner’s trade execution services into the provision of software for customers’ direct use.” 158 T. C. 5, at p. 28.

The BATS claim they’re like TurboTax, providing software to customers. But you can buy TurboTax software, or download it. The BATS stuff you can’t.

And while customers can submit orders to BATS, they cannot themselves execute the orders. Only BATS can do that, and their user agreement says it’s a service.

BATS claims the safe harbor afforded computer games, where all computer games are deemed to satisfy third-party comparability. But BATS is not providing games, and their proposed reading eviscerates the statute and regs.

Other stock market software can be used to operate a market; BATS’ cannot.

Reminder: Post-1/1/2018, the domestic production break is off the table. Repealed by Tax Cuts and Jobs Act of 2017, Pub. L. 115–97, title I, § 13305(a).