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issue.7 See secs. 1.263A-1(e)(3)(i), (f)(4), (g)(3), 1.451-
3(d)(6)(ii), (8)(iv), Income Tax Regs.8
The first-level allocations are governed by sections 1.263A-
1(e)(3)(i) and 1.451-3(d)(6)(ii), Income Tax Regs. In his
motion, respondent focuses only on one sentence of section
1.263A-1(e)(3)(i), Income Tax Regs.: “Indirect costs are
properly allocable to property produced or property acquired for
resale when the costs directly benefit or are incurred by reason
of the performance of production or resale activities.”
Respondent’s interpretation of this sentence, resulting in the
creation of a “directly benefits” test and an “incurred by reason
of” test, would render meaningless the remainder of section
1.263A-1(e)(3)(i), Income Tax Regs., and would create an
unjustifiable contradiction between sections 1.263A-1(e)(3)(i)
and 1.451-3(d)(6)(ii), Income Tax Regs.
If we were to apply the “directly benefits” test advocated
by respondent, all indirect costs that directly benefit taxpayer-
7 The regulations under secs. 460 and 263A do not use the
terminology “first level” and “second level” allocations.
However, the effect of those regulations is to break the
allocations into two distinct steps. For purposes of clarity, we
refer to these steps as “first level” and “second level”.
8 Sec. 460(c)(1) provides that costs are allocated to long-
term contracts in the same manner as costs are allocated to
extended period long-term contracts under sec. 451 and the
accompanying regulations. Sec. 451 directs us to the regulations
at sec. 1.451-3(d)(6), Income Tax Regs., to allocate costs to
long-term contracts.
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