Rev. Rul. 81-66

1981-1 C.B. 19, 1981-9 I.R.B. 7.

                       Internal Revenue Service
                                 Revenue Ruling

                         INVESTMENT CREDIT; CAFETERIAS

                            Published: March 2, 1981

26 CFR 1.48-1: Definition of section 38 property

  Investment credit; cafeterias. The operation of cafeterias is a retail activity, not a manufacturing activity within the meaning of section 48(a)(1)(B)(i) of the Code, and leasehold improvements to the cafeteria facility that are not tangible personal property do not qualify as section 38 property.

ISSUE

  Is the preparation of food and drink by cafeteria employees for direct sale to the public a manufacturing activity within the meaning of section 48(a)(1)(B)(i) of the Internal Revenue Code?

FACTS

  The taxpayer is a corporation that operates a number of cafeterias and is engaged in the business of selling prepared food and drink to the public primarily for consumption on the premises of these cafeterias.  Most of the food items sold to customers are prepared by cafeteria employees on the site. In 1977, the taxpayer opened several new cafeterias on leased premises.

  The leases are generally for a term of 20 years. Each of these cafeterias contains approximately 12,000 square feet of floor space and seats about 300 customers.  The leases provide that the lessor will furnish the building and certain unfinished interior improvements and that the lessee will finish all unfinished improvements and add certain other leasehold improvements required for the operation of a cafeteria.  The leasehold improvements made by the lessee, with the exception of trade fixtures and signs, will become the property of the lessor upon termination of the lease. The leasehold improvements in issue are outside the cafeteria buildings, are depreciable property, and have useful lives of 3 years or more.

LAW AND ANALYSIS

  Section 38 of the Code allows a credit against federal income tax for qualified investment in 'section 38 property.'  The determination of what property qualifies as section 38 property is made in accordance with the rules provided in section 48.

  Section 48(a)(1) of the Code provides that the term 'section 38 property' means (a) tangible personal property or (b) other tangible property (not including a building and its structural components) used as an integral part of certain specified activities such as manufacturing.

  Section 1.48-1(d)(2) of the Income Tax Regulations provides that for purposes of the credit allowed by section 38 of the Code the term 'manufacturing' includes the construction, reconstruction, or making of property out of scrap, salvage, or junk material, as well as from new or raw material, by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles.

  If the activities associated with the operation of a cafeteria are manufacturing within the meaning of section 48(a)(1)(B) of the Code, property that is determined to be other tangible property (except for a building and its structural components) used as an integral part of such activity may qualify as section 38 property.

  The Committee Reports for the Revenue Act of 1962 [Pub. L. 87-834, 1962-3 C.B. 111] (H.R. Rep. No. 1447, 87th Cong., 2nd Sess. (1962), 1962-3 C.B. 405, 516; S. Rep. No. 1881, 87th Cong., 2nd Sess. (1962), 1962-3 C.B. 707, 859) state that the term 'manufacturing' is to be given its commonly accepted meaning.

  Activities involving the sale of merchandise, food and other items to the general public for personal or household consumption, and the rendering of services incidental to the sale of goods are considered to be retail activities rather than manufacturing within the commonly accepted meaning of the term. Processing incidental or subordinate to selling is often conducted at retail stores.  For example, drug stores prepare prescriptions, restaurants prepare meals, and meat markets cut meat.

  The operation of a cafeteria, like the operation of a restaurant or cafe, is considered in the trade to be a retail activity rather than a manufacturing activity.  The food and drink prepared by the cafeteria employees is for direct sale to and for the consumption by the general public.  The food preparation activity is incidental or subordinate to the selling of the prepared meals and is not considered to be similar to any of the activities encompassed by the definition of manufacturing provided by section 1.48-1(d)(2) of the regulations.

HOLDING

  The operation of cafeterias is a retail activity and not a manufacturing activity within the meaning of section 48(a)(1)(B)(i) of the Code. Therefore, leasehold improvements to the cafeteria facility that are not tangible personal property as defined in section 1.48-1(c) of the regulations do not qualify as section 38 property.

Rev. Rul. 81-66, 1981-1 C.B. 19, 1981-9 I.R.B. 7.