Tax

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7^th Circuit Court of Appeals

Case Name: Direct Supply, Inc. v. United States of America

Case No.: 23-1936

Officials: Easterbrook, St. Eve, and Jackson-Akiwumi, Circuit Judges.

Focus: Tax

Direct Supply, a company specializing in aiding nursing homes with equipment, medical supplies, and furniture procurement through its “Direct Supply DSSI” (DSSI) system, sought tax deductions under §199 of the Internal Revenue Code. This section permitted deductions based on revenues from the “disposition” of “qualifying production property,” which includes software. However, the Internal Revenue Service (IRS) rejected these deductions, leading Direct Supply to file a lawsuit seeking a refund.

Direct Supply contended that DSSI constituted the “disposition” of the software powering the system. Nonetheless, both the IRS and the district court regarded DSSI as a service facilitated by software rather than a disposition of software itself. Notably, the court observed that Direct Supply’s customers did not hold the software code or a license to utilize any of DSSI’s software. Moreover, the bulk of Direct Supply’s revenue stemmed from fees based on a percentage of vendors’ sales, rather than from any valuation of the software.

The Seventh Circuit concurred with the district court and the IRS. The court acknowledged DSSI’s reliance on software but concluded that it did not constitute the “disposition” of said software. Additionally, the court highlighted that Direct Supply’s income was not “directly derived” from the software, as mandated by the governing regulation, but rather from the goods sold by vendors to customers. Consequently, the court upheld the district court’s ruling that Direct Supply’s deductions under §199 of the Internal Revenue Code were rightfully disallowed.

Affirmed.

Decided 03/22/24

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