Guidance Regarding the Simplified Service Cost Method and the Simplified Production Method, 14675-14678 [E7-5732]

Download as PDF Federal Register / Vol. 72, No. 60 / Thursday, March 29, 2007 / Rules and Regulations DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9318] RIN 1545–BE57 Guidance Regarding the Simplified Service Cost Method and the Simplified Production Method Internal Revenue Service (IRS), Treasury. ACTION: Final regulations and removal of temporary regulations. AGENCY: SUMMARY: This document contains final regulations relating to the capitalization of costs under the simplified service cost method and the simplified production method provided by the Income Tax Regulations. For taxpayers that use the simplified service cost method or the simplified production method, the regulations clarify when self-constructed assets are produced on a routine and repetitive basis in the ordinary course of their businesses. DATES: Effective Date: These regulations are effective on March 29, 2007. Applicability Date: For dates of applicability, see §§ 1.263A–1(l) and 1.263A–2(f). FOR FURTHER INFORMATION CONTACT: Steven J. Gee or Donna M. Crawford, (202) 622–4970 (not a toll-free number). SUPPLEMENTARY INFORMATION: cprice-sewell on PROD1PC61 with RULES Background This document contains amendments to 26 CFR part 1. On August 2, 2005, the IRS and Treasury Department published in the Federal Register a notice of proposed rulemaking (REG–121584–05; 70 FR 44535) by cross reference to temporary regulations (TD 9217; 70 FR 44467) (collectively, the 2005 regulations) under section 263A of the Internal Revenue Code (Code). These regulations provide that self-constructed tangible personal property is considered produced on a routine and repetitive basis in the ordinary course of a taxpayer’s trade or business for purposes of the simplified service cost method or the simplified production method when units of tangible personal property are mass-produced, that is, numerous substantially identical assets are manufactured within a taxable year using standardized designs and assembly line techniques, and the applicable recovery period of such assets under section 168(c) is not longer than 3 years. The IRS and Treasury Department issued Rev. Proc. 2006–11 (2006–3 IRB VerDate Aug<31>2005 14:22 Mar 28, 2007 Jkt 211001 309), see § 601.601(d)(2)(ii)(b), which provides procedures by which a taxpayer changing its method of accounting to comply with § 1.263A–1T or § 1.263A–2T (issued under TD 9217) for its first taxable year ending on or after August 2, 2005, may request the consent of the Commissioner utilizing either the administrative procedures for requesting the advance consent of the Commissioner (for further guidance, for example, see Rev. Proc. 97–27 (1997–1 CB 680), as modified and amplified by Rev. Proc. 2002–19 (2002–1 CB 696), as amplified and clarified by Rev. Proc. 2002–54 (2002–2 CB 432), and § 601.601(d)(2)(ii)(b)), or the administrative procedures for obtaining the automatic consent of the Commissioner (for further guidance, for example, see Rev. Proc. 2002–9 (2002– 1 CB 327), as modified and clarified by Announcement 2002–17 (2002–1 CB 561), modified and amplified by Rev. Proc. 2002–19 (2002–1 CB 696), and amplified, clarified, and modified by Rev. Proc. 2002–54 (2002–2 CB 432), and § 601.601(d)(2)(ii)(b)). These final regulations have been revised to be consistent with the procedures provided in Rev. Proc. 2006–11. One written comment was received in response to the 2005 regulations. No requests to speak at a public hearing were received, and no hearing was held. After consideration of the comment, the proposed regulations under section 263A are adopted by this Treasury decision. Summary of Comments A commentator expressed the belief that the categories of property, as described in Notice 88–86 (1988–2 CB 401), see § 601.601(d)(2)(ii)(b), eligible for the simplified service cost method and the simplified production method represent a reasonable balance between technical accuracy and simplification. The commentator opposed the requirements in the 2005 regulations that, to qualify for the category of property ‘‘produced on a routine and repetitive basis,’’ the property must be mass-produced using standardized designs and assembly line techniques, and have an applicable recovery period of not longer than 3 years. The commentator argued that, with respect to electric utility companies, there is no sound tax policy to support limiting the application of the methods based on the manner in which self-constructed assets are produced or the number of years over which the self-constructed assets are depreciated. The commentator further stated that the preamble to the 2005 regulations did not explain why there may be a distortion of income PO 00000 Frm 00027 Fmt 4700 Sfmt 4700 14675 from the use of the simplified methods, and why such a distortion justified distinctions based on the method of manufacturing and the recovery lives of property. The simplified methods are less accurate and less precise than a facts and circumstances method and, thus, may capitalize more or less costs than a facts and circumstances method. Therefore, the simplified methods may cause distortions when compared to a more accurate facts and circumstances method. The amount of distortion may not be very large for assets that are mass produced, because the underlying assumption of the simplified methods that costs are incurred ratably across all the assets may be appropriate. Additionally, any distortion caused by the lack of precision quickly reverses if the assets to which the methods may be applied typically have a high turnover rate, that is, a short recovery period. Inventory production frequently meets one or both of these two criteria. The IRS and Treasury Department provided the simplified methods for inventory because the reduction in the burdens of complying with the uniform capitalization rules generally outweighed the possible distortion within the simplified methods. Under temporary regulations published in the Federal Register on March 30, 1987 (TD 8131, 1987–1 CB 98, [52 FR 10052]) (1987 regulations), the simplified methods were available only to inventory and non-inventory property held by a taxpayer primarily for sale to customers in the ordinary course of the taxpayer’s trade or business. The preamble to the 1987 regulations stated that the methods were ‘‘designed to alleviate the administrative burdens of complying with [section 263A] where mass production of assets occurs on a repetitive and routine basis, with a typically high ‘turnover’ rate for the produced assets.’’ The preamble to the 1987 regulations stated that the simplified methods could not be utilized with respect to self-constructed assets because the simplified methods were not appropriate for use ‘‘in accounting for casual or occasional production of property.’’ In response to comments suggesting that the categories of property eligible for the simplified service cost method and the simplified production method be expanded to include other categories of property with similar characteristics, Notice 88–86 expanded the availability of the methods, in relevant part, to ‘‘property constructed by a taxpayer for use in its trade or business if, in the ordinary course of its production activities, the taxpayer produces such E:\FR\FM\29MRR1.SGM 29MRR1 cprice-sewell on PROD1PC61 with RULES 14676 Federal Register / Vol. 72, No. 60 / Thursday, March 29, 2007 / Rules and Regulations property on a routine and repetitive basis (that is, the taxpayer produces numerous items of such property within a taxable year).’’ The final regulations published in the Federal Register on August 9, 1993 (TD 8482, 1993–2 CB 77, [58 FR 42198]) included the new category from Notice 88–86. The addition of certain self-constructed assets was merely intended to add another category of property with characteristics similar to inventory (mass produced or high turnover) and was not an indication that the application of the simplified methods to the production, whether or not casual or occasional, of all self-produced assets was considered appropriate. The IRS and Treasury Department continue to believe that to prevent distortion when applied to selfconstructed property, the simplified service cost method and simplified production method should be limited to property that is mass produced and has a typically high ‘‘turnover’’ rate. Accordingly, the final regulations do not incorporate the commentator’s suggestions. The regulations clarify, however, that property with a typically high ‘‘turnover’’ rate includes materials and supplies that are used and consumed within three years of being produced. The IRS and Treasury Department recognize that the application of the uniform capitalization requirements to self-constructed property can be burdensome, particularly to small taxpayers. The IRS and Treasury Department will consider proposing simplified methods for self-constructed property for small taxpayers in future guidance under section 263A. Additionally, a commentator indicated that for taxpayers that have both property that is eligible for the simplified methods and property that is ineligible for the simplified methods, the regulations do not provide specific procedures to determine how to allocate service costs and other indirect costs between the eligible property and the ineligible property. The IRS and Treasury Department agree that service costs and other indirect costs must be allocated to ineligible property as well as eligible property. However, prescribing specific procedures and methods for these allocations is beyond the scope of these regulations. The IRS and Treasury Department may address this issue in future guidance. Special Analyses It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a VerDate Aug<31>2005 14:22 Mar 28, 2007 Jkt 211001 regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking that preceded these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information The principal author of these regulations is Scott Rabinowitz of the Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows: I PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: I Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.263A–1 is amended by revising paragraphs (h)(2)(i)(D), (k) and (l) to read as follows: I § 1.263A–1 Uniform capitalization of costs. * * * * * (h) * * * (2) * * * (i) * * * (D) Self-constructed tangible personal property produced on a routine and repetitive basis—(1) In general. Selfconstructed tangible personal property produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer’s trade or business. Self-constructed tangible personal property is produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer’s trade or business when units of tangible personal property (as defined in § 1.263A–10(c)) are mass-produced, that is, numerous substantially identical assets are manufactured within a taxable year using standardized designs and assembly line techniques, and either the applicable recovery period of the property determined under section PO 00000 Frm 00028 Fmt 4700 Sfmt 4700 168(c) is not longer than 3 years or the property is a material or supply that will be used and consumed within 3 years of being produced. For purposes of this paragraph (h)(2)(i)(D), the applicable recovery period of the assets will be determined at the end of the taxable year in which the assets are placed in service for purposes of § 1.46–3(d). Subsequent changes to the applicable recovery period after the assets are placed in service will not affect the determination of whether the assets are produced on a routine and repetitive basis for purposes of this paragraph (h)(2)(i)(D). (2) Examples. The following examples illustrate this paragraph (h)(2)(i)(D): Example 1. Y is a manufacturer of automobiles. During the taxable year Y produces numerous substantially identical dies and molds using standardized designs and assembly line techniques. The dies and molds have a 3-year applicable recovery period for purposes of section 168(c). Y uses the dies and molds to produce or process particular automobile components and does not hold them for sale. The dies and molds are produced on a routine and repetitive basis in the ordinary course of Y’s business for purposes of this paragraph because the dies and molds are both mass-produced and have a recovery period of not longer than 3 years. Example 2. Z is an electric utility that regularly manufactures and installs identical poles that are used in transmitting and distributing electricity. The poles have a 20year applicable recovery period for purposes of section 168(c). The poles are not produced on a routine and repetitive basis in the ordinary course of Z’s business for purposes of this paragraph because the poles have an applicable recovery period that is longer than 3 years. * * * * * (k) Change in method of accounting— (1) In general. A change in a taxpayer’s treatment of mixed service costs to comply with paragraph (h)(2)(i)(D) of this section is a change in method of accounting to which the provisions of sections 446 and 481 and the regulations under those sections apply. See § 1.263A–7. For a taxpayer’s first taxable year ending on or after August 2, 2005, the taxpayer is granted the consent of the Commissioner to change its method of accounting to comply with paragraph (h)(2)(i)(D) of this section, provided the taxpayer follows the administrative procedures, as modified by paragraphs (k)(2) through (4) of this section, issued under § 1.446–1(e)(3)(ii) for obtaining the Commissioner’s automatic consent to a change in accounting method (for further guidance, for example, see Rev. Proc. 2002–9 (2002–1 CB 327), as modified and clarified by Announcement 2002– 17 (2002–1 CB 561), modified and E:\FR\FM\29MRR1.SGM 29MRR1 cprice-sewell on PROD1PC61 with RULES Federal Register / Vol. 72, No. 60 / Thursday, March 29, 2007 / Rules and Regulations amplified by Rev. Proc. 2002–19 (2002– 1 CB 696), and amplified, clarified, and modified by Rev. Proc. 2002–54 (2002– 2 CB 432), and § 601.601(d)(2)(ii)(b) of this chapter). For purposes of Form 3115, ‘‘Application for Change in Accounting Method,’’ the designated number for the automatic accounting method change authorized by this paragraph (k) is ‘‘95.’’ If Form 3115 is revised or renumbered, any reference in this section to that form is treated as a reference to the revised or renumbered form. Alternatively, notwithstanding the provisions of any administrative procedures that preclude a taxpayer from requesting the advance consent of the Commissioner to change a method of accounting that is required to be made pursuant to a published automatic change procedure, for its first taxable year ending on or after August 2, 2005, a taxpayer may request the advance consent of the Commissioner to change its method of accounting to comply with paragraph (h)(2)(i)(D) of this section, provided the taxpayer follows the administrative procedures, as modified by paragraphs (k)(2) through (5) of this section, for obtaining the advance consent of the Commissioner (for further guidance, for example, see Rev. Proc. 97–27 (1997–1 CB 680), as modified and amplified by Rev. Proc. 2002–19 (2002– 1 CB 696), as amplified and clarified by Rev. Proc. 2002–54 (2002–2 CB 432), and § 601.601(d)(2)(ii)(b) of this chapter). For the taxpayer’s second and subsequent taxable years ending on or after August 2, 2005, requests to secure the consent of the Commissioner must be made under the administrative procedures, as modified by paragraphs (k)(3) and (4) of this section, for obtaining the Commissioner’s advance consent to a change in accounting method. (2) Scope limitations. Any limitations on obtaining the automatic consent or advance consent of the Commissioner do not apply to a taxpayer seeking to change its method of accounting to comply with paragraph (h)(2)(i)(D) of this section for its first taxable year ending on or after August 2, 2005. (3) Audit protection. A taxpayer that changes its method of accounting in accordance with this paragraph (k) to comply with paragraph (h)(2)(i)(D) of this section does not receive audit protection if its method of accounting for mixed service costs is an issue under consideration at the time the application is filed with the national office. (4) Section 481(a) adjustment. A change in method of accounting to conform to paragraph (h)(2)(i)(D) of this section requires a section 481(a) adjustment. The section 481(a) VerDate Aug<31>2005 14:22 Mar 28, 2007 Jkt 211001 adjustment period is two taxable years for a net positive adjustment for an accounting method change that is made to conform to paragraph (h)(2)(i)(D) of this section. (5) Time for requesting change. Notwithstanding the provisions of § 1.446–1(e)(3)(i) and any contrary administrative procedure, a taxpayer may submit a request for advance consent to change its method of accounting to comply with paragraph (h)(2)(i)(D) of this section for its first taxable year ending on or after August 2, 2005, on or before the date that is 30 days after the end of the taxable year for which the change is requested. (l) Effective date. Paragraphs (h)(2)(i)(D), (k), and (l) of this section apply for taxable years ending on or after August 2, 2005. § 1.263A–1T [Removed] Par. 3. Section 1.263A–1T is removed. I Par. 4. Section 1.263A–2 is amended by revising paragraphs (b)(2)(i)(D), (e) and (f) to read as follows: I § 1.263A–2 Rules relating to property produced by the taxpayer. * * * * * (b) * * * (2) * * * (i) * * * (D) Self-constructed tangible personal property produced on a routine and repetitive basis—(1) In general. Selfconstructed tangible personal property produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer’s trade or business. Self-constructed tangible personal property is produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer’s trade or business when units of tangible personal property (as defined in § 1.263A–10(c)) are mass-produced, that is, numerous substantially identical assets are manufactured within a taxable year using standardized designs and assembly line techniques, and either the applicable recovery period of the property determined under section 168(c) is not longer than 3 years or the property is a material or supply that will be used and consumed within 3 years of being produced. For purposes of this paragraph (b)(2)(i)(D), the applicable recovery period of the assets will be determined at the end of the taxable year in which the assets are placed in service for purposes of § 1.46–3(d). Subsequent changes to the applicable recovery period after the assets are placed in service will not affect the determination of whether the assets are produced on a routine and repetitive PO 00000 Frm 00029 Fmt 4700 Sfmt 4700 14677 basis for purposes of this paragraph (b)(2)(i)(D). (2) Examples. The following examples illustrate this paragraph (b)(2)(i)(D): Example 1. Y is a manufacturer of automobiles. During the taxable year Y produces numerous substantially identical dies and molds using standardized designs and assembly line techniques. The dies and molds have a 3-year applicable recovery period for purposes of section 168(c). Y uses the dies and molds to produce or process particular automobile components and does not hold them for sale. The dies and molds are produced on a routine and repetitive basis in the ordinary course of Y’s business for purposes of this paragraph because the dies and molds are both mass-produced and have a recovery period of not longer than 3 years. Example 2. Z is an electric utility that regularly manufactures and installs identical poles that are used in transmitting and distributing electricity. The poles have a 20year applicable recovery period for purposes of section 168(c). The poles are not produced on a routine and repetitive basis in the ordinary course of Z’s business for purposes of this paragraph because the poles have an applicable recovery period that is longer than 3 years. * * * * * (e) Change in method of accounting— (1) In general. A change in a taxpayer’s treatment of additional section 263A costs to comply with paragraph (b)(2)(i)(D) of this section is a change in method of accounting to which the provisions of sections 446 and 481 and the regulations under those sections apply. See § 1.263A–7. For a taxpayer’s first taxable year ending on or after August 2, 2005, the taxpayer is granted the consent of the Commissioner to change its method of accounting to comply with paragraph (b)(2)(i)(D) of this section, provided the taxpayer follows the administrative procedures, as modified by paragraphs (e)(2) through (4) of this section, issued under § 1.446– 1(e)(3)(ii) for obtaining the Commissioner’s automatic consent to a change in accounting method (for further guidance, for example, see Rev. Proc. 2002–9 (2002–1 CB 327), as modified and clarified by Announcement 2002–17 (2002–1 CB 561), modified and amplified by Rev. Proc. 2002–19 (2002–1 CB 696), and amplified, clarified, and modified by Rev. Proc. 2002–54 (2002–2 CB 432), and § 601.601(d)(2)(ii)(b) of this chapter). For purposes of Form 3115, ‘‘Application for Change in Accounting Method,’’ the designated number for the automatic accounting method change authorized by this paragraph (e) is ‘‘95.’’ If Form 3115 is revised or renumbered, any reference in this section to that form is treated as a reference to the revised or renumbered form. Alternatively, E:\FR\FM\29MRR1.SGM 29MRR1 cprice-sewell on PROD1PC61 with RULES 14678 Federal Register / Vol. 72, No. 60 / Thursday, March 29, 2007 / Rules and Regulations notwithstanding the provisions of any administrative procedures that preclude a taxpayer from requesting the advance consent of the Commissioner to change a method of accounting that is required to be made pursuant to a published automatic change procedure, for its first taxable year ending on or after August 2, 2005, a taxpayer may request the advance consent of the Commissioner to change its method of accounting to comply with paragraph (b)(2)(i)(D) of this section, provided the taxpayer follows the administrative procedures, as modified by paragraphs (e)(2) through (5) of this section, for obtaining the advance consent of the Commissioner (for further guidance, for example, see Rev. Proc. 97–27 (1997–1 CB 680), as modified and amplified by Rev. Proc. 2002–19 (2002–1 CB 696), as amplified and clarified by Rev. Proc. 2002–54 (2002–2 CB 432), and § 601.601(d)(2)(ii)(b) of this chapter). For the taxpayer’s second and subsequent taxable years ending on or after August 2, 2005, requests to secure the consent of the Commissioner must be made under the administrative procedures, as modified by paragraphs (e)(3) and (4) of this section, for obtaining the Commissioner’s advance consent to a change in accounting method. (2) Scope limitations. Any limitations on obtaining the automatic consent or advance consent of the Commissioner do not apply to a taxpayer seeking to change its method of accounting to comply with paragraph (b)(2)(i)(D) of this section for its first taxable year ending on or after August 2, 2005. (3) Audit protection. A taxpayer that changes its method of accounting in accordance with this paragraph (e) to comply with paragraph (b)(2)(i)(D) of this section does not receive audit protection if its method of accounting for additional section 263A costs is an issue under consideration at the time the application is filed with the national office. (4) Section 481(a) adjustment. A change in method of accounting to conform to paragraph (b)(2)(i)(D) of this section requires a section 481(a) adjustment. The section 481(a) adjustment period is two taxable years for a net positive adjustment for an accounting method change that is made to conform to paragraph (b)(2)(i)(D) of this section. (5) Time for requesting change. Notwithstanding the provisions of § 1.446–1(e)(3)(i) and any contrary administrative procedure, a taxpayer may submit a request for advance consent to change its method of accounting to comply with paragraph VerDate Aug<31>2005 14:22 Mar 28, 2007 Jkt 211001 (b)(2)(i)D) of this section for its first taxable year ending on or after August 2, 2005, on or before the date that is 30 days after the end of the taxable year for which the change is requested. (f) Effective date. Paragraphs (b)(2)(i)(D), (e), and (f) of this section apply for taxable years ending on or after August 2, 2005. § 1.263A–2T I [Removed] Par. 5. Section 1.263A–2T is removed. Kevin M. Brown, Deputy Commissioner for Services and Enforcement. Approved: March 20, 2007. Eric Solomon, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. E7–5732 Filed 3–28–07; 8:45 am] prove to be misleading and is in need of clarification. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Correction of Publication Accordingly, 26 CFR part 1 is corrected by making the following amendments: I PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read, in part, as follows: I Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.368–2T is amended by revising paragraph (l)(2)(iv) to read as follows: I BILLING CODE 4830–01–P § 1.368–2T DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9313] RIN 1545–BG29 Corporate Reorganizations; Additional Guidance on Distributions Under Sections 368(a)(1)(D) and 354(b)(1)(B); Correction Internal Revenue Service (IRS), Treasury. ACTION: Correcting amendment. AGENCY: SUMMARY: This document contains correction to temporary regulations (TD 9313) that were published in the Federal Register on Thursday, March 1, 2007 (72 FR 9262) providing guidance regarding the qualification of certain transactions as reorganizations described in section 368(a)(1)(D) where no stock and/or securities of the acquiring corporation are issued and distributed in the transaction. DATES: This amendment is effective March 29, 2007. FOR FURTHER INFORMATION CONTACT: Bruce A. Decker at (202) 622–7550 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background The temporary regulations that are the subjects of this correction are under section 368 of the Internal Revenue Code. Need for Correction As published, temporary regulations (TD 9313) contain an error that may PO 00000 Frm 00030 Fmt 4700 Sfmt 4700 Definition of terms (temporary). * * * * * (l) * * * (2) * * * (iv) Exception. This paragraph (l)(2) of this section does not apply to a transaction otherwise described in § 1.358–6(b)(2) or section 368(a)(1)(G) by reason of section 368(a)(2)(D). * * * * * LaNita Van Dyke, Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel, (Procedure and Administration). [FR Doc. E7–5603 Filed 3–28–07; 8:45 am] BILLING CODE 4830–01–P ENVIRONMENTAL PROTECTION AGENCY 40 CFR Part 52 [EPA–R05–OAR–2006–0774; FRL–8284–5] Approval and Promulgation of Air Quality Implementation Plans; Indiana Environmental Protection Agency (EPA). ACTION: Direct final rule. AGENCY: SUMMARY: The EPA is approving revisions to Indiana’s State Implementation Plan (SIP) submitted on August 25, 2006, revising its existing emission reporting rule to be consistent with the emission statement program requirements for stationary sources in the Clean Air Act (CAA). The rationale for approval and other information are provided in this rulemaking action. DATES: This direct final rule will be effective May 29, 2007, unless EPA receives adverse comments by April 30, 2007. If adverse comments are received, EPA will publish a timely withdrawal of E:\FR\FM\29MRR1.SGM 29MRR1

Agencies

[Federal Register Volume 72, Number 60 (Thursday, March 29, 2007)]
[Rules and Regulations]
[Pages 14675-14678]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-5732]



[[Page 14675]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9318]
RIN 1545-BE57


Guidance Regarding the Simplified Service Cost Method and the 
Simplified Production Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations relating to the 
capitalization of costs under the simplified service cost method and 
the simplified production method provided by the Income Tax 
Regulations. For taxpayers that use the simplified service cost method 
or the simplified production method, the regulations clarify when self-
constructed assets are produced on a routine and repetitive basis in 
the ordinary course of their businesses.

DATES: Effective Date: These regulations are effective on March 29, 
2007.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.263A-1(l) and 1.263A-2(f).

FOR FURTHER INFORMATION CONTACT: Steven J. Gee or Donna M. Crawford, 
(202) 622-4970 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1. On August 2, 
2005, the IRS and Treasury Department published in the Federal Register 
a notice of proposed rulemaking (REG-121584-05; 70 FR 44535) by cross 
reference to temporary regulations (TD 9217; 70 FR 44467) 
(collectively, the 2005 regulations) under section 263A of the Internal 
Revenue Code (Code). These regulations provide that self-constructed 
tangible personal property is considered produced on a routine and 
repetitive basis in the ordinary course of a taxpayer's trade or 
business for purposes of the simplified service cost method or the 
simplified production method when units of tangible personal property 
are mass-produced, that is, numerous substantially identical assets are 
manufactured within a taxable year using standardized designs and 
assembly line techniques, and the applicable recovery period of such 
assets under section 168(c) is not longer than 3 years.
    The IRS and Treasury Department issued Rev. Proc. 2006-11 (2006-3 
IRB 309), see Sec.  601.601(d)(2)(ii)(b), which provides procedures by 
which a taxpayer changing its method of accounting to comply with Sec.  
1.263A-1T or Sec.  1.263A-2T (issued under TD 9217) for its first 
taxable year ending on or after August 2, 2005, may request the consent 
of the Commissioner utilizing either the administrative procedures for 
requesting the advance consent of the Commissioner (for further 
guidance, for example, see Rev. Proc. 97-27 (1997-1 CB 680), as 
modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), as 
amplified and clarified by Rev. Proc. 2002-54 (2002-2 CB 432), and 
Sec.  601.601(d)(2)(ii)(b)), or the administrative procedures for 
obtaining the automatic consent of the Commissioner (for further 
guidance, for example, see Rev. Proc. 2002-9 (2002-1 CB 327), as 
modified and clarified by Announcement 2002-17 (2002-1 CB 561), 
modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), and 
amplified, clarified, and modified by Rev. Proc. 2002-54 (2002-2 CB 
432), and Sec.  601.601(d)(2)(ii)(b)). These final regulations have 
been revised to be consistent with the procedures provided in Rev. 
Proc. 2006-11.
    One written comment was received in response to the 2005 
regulations. No requests to speak at a public hearing were received, 
and no hearing was held. After consideration of the comment, the 
proposed regulations under section 263A are adopted by this Treasury 
decision.

Summary of Comments

    A commentator expressed the belief that the categories of property, 
as described in Notice 88-86 (1988-2 CB 401), see Sec.  
601.601(d)(2)(ii)(b), eligible for the simplified service cost method 
and the simplified production method represent a reasonable balance 
between technical accuracy and simplification. The commentator opposed 
the requirements in the 2005 regulations that, to qualify for the 
category of property ``produced on a routine and repetitive basis,'' 
the property must be mass-produced using standardized designs and 
assembly line techniques, and have an applicable recovery period of not 
longer than 3 years. The commentator argued that, with respect to 
electric utility companies, there is no sound tax policy to support 
limiting the application of the methods based on the manner in which 
self-constructed assets are produced or the number of years over which 
the self-constructed assets are depreciated. The commentator further 
stated that the preamble to the 2005 regulations did not explain why 
there may be a distortion of income from the use of the simplified 
methods, and why such a distortion justified distinctions based on the 
method of manufacturing and the recovery lives of property.
    The simplified methods are less accurate and less precise than a 
facts and circumstances method and, thus, may capitalize more or less 
costs than a facts and circumstances method. Therefore, the simplified 
methods may cause distortions when compared to a more accurate facts 
and circumstances method. The amount of distortion may not be very 
large for assets that are mass produced, because the underlying 
assumption of the simplified methods that costs are incurred ratably 
across all the assets may be appropriate. Additionally, any distortion 
caused by the lack of precision quickly reverses if the assets to which 
the methods may be applied typically have a high turnover rate, that 
is, a short recovery period. Inventory production frequently meets one 
or both of these two criteria. The IRS and Treasury Department provided 
the simplified methods for inventory because the reduction in the 
burdens of complying with the uniform capitalization rules generally 
outweighed the possible distortion within the simplified methods.
    Under temporary regulations published in the Federal Register on 
March 30, 1987 (TD 8131, 1987-1 CB 98, [52 FR 10052]) (1987 
regulations), the simplified methods were available only to inventory 
and non-inventory property held by a taxpayer primarily for sale to 
customers in the ordinary course of the taxpayer's trade or business. 
The preamble to the 1987 regulations stated that the methods were 
``designed to alleviate the administrative burdens of complying with 
[section 263A] where mass production of assets occurs on a repetitive 
and routine basis, with a typically high `turnover' rate for the 
produced assets.'' The preamble to the 1987 regulations stated that the 
simplified methods could not be utilized with respect to self-
constructed assets because the simplified methods were not appropriate 
for use ``in accounting for casual or occasional production of 
property.''
    In response to comments suggesting that the categories of property 
eligible for the simplified service cost method and the simplified 
production method be expanded to include other categories of property 
with similar characteristics, Notice 88-86 expanded the availability of 
the methods, in relevant part, to ``property constructed by a taxpayer 
for use in its trade or business if, in the ordinary course of its 
production activities, the taxpayer produces such

[[Page 14676]]

property on a routine and repetitive basis (that is, the taxpayer 
produces numerous items of such property within a taxable year).'' The 
final regulations published in the Federal Register on August 9, 1993 
(TD 8482, 1993-2 CB 77, [58 FR 42198]) included the new category from 
Notice 88-86. The addition of certain self-constructed assets was 
merely intended to add another category of property with 
characteristics similar to inventory (mass produced or high turnover) 
and was not an indication that the application of the simplified 
methods to the production, whether or not casual or occasional, of all 
self-produced assets was considered appropriate.
    The IRS and Treasury Department continue to believe that to prevent 
distortion when applied to self-constructed property, the simplified 
service cost method and simplified production method should be limited 
to property that is mass produced and has a typically high ``turnover'' 
rate. Accordingly, the final regulations do not incorporate the 
commentator's suggestions. The regulations clarify, however, that 
property with a typically high ``turnover'' rate includes materials and 
supplies that are used and consumed within three years of being 
produced. ?>
    The IRS and Treasury Department recognize that the application of 
the uniform capitalization requirements to self-constructed property 
can be burdensome, particularly to small taxpayers. The IRS and 
Treasury Department will consider proposing simplified methods for 
self-constructed property for small taxpayers in future guidance under 
section 263A.
    Additionally, a commentator indicated that for taxpayers that have 
both property that is eligible for the simplified methods and property 
that is ineligible for the simplified methods, the regulations do not 
provide specific procedures to determine how to allocate service costs 
and other indirect costs between the eligible property and the 
ineligible property. The IRS and Treasury Department agree that service 
costs and other indirect costs must be allocated to ineligible property 
as well as eligible property. However, prescribing specific procedures 
and methods for these allocations is beyond the scope of these 
regulations. The IRS and Treasury Department may address this issue in 
future guidance.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking that preceded these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is Scott Rabinowitz of 
the Office of Associate Chief Counsel (Income Tax and Accounting). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

     Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.263A-1 is amended by revising paragraphs 
(h)(2)(i)(D), (k) and (l) to read as follows:


Sec.  1.263A-1  Uniform capitalization of costs.

* * * * *
    (h) * * *
    (2) * * *
    (i) * * *
    (D) Self-constructed tangible personal property produced on a 
routine and repetitive basis--(1) In general. Self-constructed tangible 
personal property produced by the taxpayer on a routine and repetitive 
basis in the ordinary course of the taxpayer's trade or business. Self-
constructed tangible personal property is produced by the taxpayer on a 
routine and repetitive basis in the ordinary course of the taxpayer's 
trade or business when units of tangible personal property (as defined 
in Sec.  1.263A-10(c)) are mass-produced, that is, numerous 
substantially identical assets are manufactured within a taxable year 
using standardized designs and assembly line techniques, and either the 
applicable recovery period of the property determined under section 
168(c) is not longer than 3 years or the property is a material or 
supply that will be used and consumed within 3 years of being produced. 
For purposes of this paragraph (h)(2)(i)(D), the applicable recovery 
period of the assets will be determined at the end of the taxable year 
in which the assets are placed in service for purposes of Sec.  1.46-
3(d). Subsequent changes to the applicable recovery period after the 
assets are placed in service will not affect the determination of 
whether the assets are produced on a routine and repetitive basis for 
purposes of this paragraph (h)(2)(i)(D).
    (2) Examples. The following examples illustrate this paragraph 
(h)(2)(i)(D):

    Example 1. Y is a manufacturer of automobiles. During the 
taxable year Y produces numerous substantially identical dies and 
molds using standardized designs and assembly line techniques. The 
dies and molds have a 3-year applicable recovery period for purposes 
of section 168(c). Y uses the dies and molds to produce or process 
particular automobile components and does not hold them for sale. 
The dies and molds are produced on a routine and repetitive basis in 
the ordinary course of Y's business for purposes of this paragraph 
because the dies and molds are both mass-produced and have a 
recovery period of not longer than 3 years.
    Example 2. Z is an electric utility that regularly manufactures 
and installs identical poles that are used in transmitting and 
distributing electricity. The poles have a 20-year applicable 
recovery period for purposes of section 168(c). The poles are not 
produced on a routine and repetitive basis in the ordinary course of 
Z's business for purposes of this paragraph because the poles have 
an applicable recovery period that is longer than 3 years.
* * * * *
    (k) Change in method of accounting--(1) In general. A change in a 
taxpayer's treatment of mixed service costs to comply with paragraph 
(h)(2)(i)(D) of this section is a change in method of accounting to 
which the provisions of sections 446 and 481 and the regulations under 
those sections apply. See Sec.  1.263A-7. For a taxpayer's first 
taxable year ending on or after August 2, 2005, the taxpayer is granted 
the consent of the Commissioner to change its method of accounting to 
comply with paragraph (h)(2)(i)(D) of this section, provided the 
taxpayer follows the administrative procedures, as modified by 
paragraphs (k)(2) through (4) of this section, issued under Sec.  
1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic consent to 
a change in accounting method (for further guidance, for example, see 
Rev. Proc. 2002-9 (2002-1 CB 327), as modified and clarified by 
Announcement 2002-17 (2002-1 CB 561), modified and

[[Page 14677]]

amplified by Rev. Proc. 2002-19 (2002-1 CB 696), and amplified, 
clarified, and modified by Rev. Proc. 2002-54 (2002-2 CB 432), and 
Sec.  601.601(d)(2)(ii)(b) of this chapter). For purposes of Form 3115, 
``Application for Change in Accounting Method,'' the designated number 
for the automatic accounting method change authorized by this paragraph 
(k) is ``95.'' If Form 3115 is revised or renumbered, any reference in 
this section to that form is treated as a reference to the revised or 
renumbered form. Alternatively, notwithstanding the provisions of any 
administrative procedures that preclude a taxpayer from requesting the 
advance consent of the Commissioner to change a method of accounting 
that is required to be made pursuant to a published automatic change 
procedure, for its first taxable year ending on or after August 2, 
2005, a taxpayer may request the advance consent of the Commissioner to 
change its method of accounting to comply with paragraph (h)(2)(i)(D) 
of this section, provided the taxpayer follows the administrative 
procedures, as modified by paragraphs (k)(2) through (5) of this 
section, for obtaining the advance consent of the Commissioner (for 
further guidance, for example, see Rev. Proc. 97-27 (1997-1 CB 680), as 
modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), as 
amplified and clarified by Rev. Proc. 2002-54 (2002-2 CB 432), and 
Sec.  601.601(d)(2)(ii)(b) of this chapter). For the taxpayer's second 
and subsequent taxable years ending on or after August 2, 2005, 
requests to secure the consent of the Commissioner must be made under 
the administrative procedures, as modified by paragraphs (k)(3) and (4) 
of this section, for obtaining the Commissioner's advance consent to a 
change in accounting method.
    (2) Scope limitations. Any limitations on obtaining the automatic 
consent or advance consent of the Commissioner do not apply to a 
taxpayer seeking to change its method of accounting to comply with 
paragraph (h)(2)(i)(D) of this section for its first taxable year 
ending on or after August 2, 2005.
    (3) Audit protection. A taxpayer that changes its method of 
accounting in accordance with this paragraph (k) to comply with 
paragraph (h)(2)(i)(D) of this section does not receive audit 
protection if its method of accounting for mixed service costs is an 
issue under consideration at the time the application is filed with the 
national office.
    (4) Section 481(a) adjustment. A change in method of accounting to 
conform to paragraph (h)(2)(i)(D) of this section requires a section 
481(a) adjustment. The section 481(a) adjustment period is two taxable 
years for a net positive adjustment for an accounting method change 
that is made to conform to paragraph (h)(2)(i)(D) of this section.
    (5) Time for requesting change. Notwithstanding the provisions of 
Sec.  1.446-1(e)(3)(i) and any contrary administrative procedure, a 
taxpayer may submit a request for advance consent to change its method 
of accounting to comply with paragraph (h)(2)(i)(D) of this section for 
its first taxable year ending on or after August 2, 2005, on or before 
the date that is 30 days after the end of the taxable year for which 
the change is requested.
    (l) Effective date. Paragraphs (h)(2)(i)(D), (k), and (l) of this 
section apply for taxable years ending on or after August 2, 2005.


Sec.  1.263A-1T  [Removed]

0
Par. 3. Section 1.263A-1T is removed.
0
Par. 4. Section 1.263A-2 is amended by revising paragraphs 
(b)(2)(i)(D), (e) and (f) to read as follows:


Sec.  1.263A-2  Rules relating to property produced by the taxpayer.

* * * * *
    (b) * * *
    (2) * * *
    (i) * * *
    (D) Self-constructed tangible personal property produced on a 
routine and repetitive basis--(1) In general. Self-constructed tangible 
personal property produced by the taxpayer on a routine and repetitive 
basis in the ordinary course of the taxpayer's trade or business. Self-
constructed tangible personal property is produced by the taxpayer on a 
routine and repetitive basis in the ordinary course of the taxpayer's 
trade or business when units of tangible personal property (as defined 
in Sec.  1.263A-10(c)) are mass-produced, that is, numerous 
substantially identical assets are manufactured within a taxable year 
using standardized designs and assembly line techniques, and either the 
applicable recovery period of the property determined under section 
168(c) is not longer than 3 years or the property is a material or 
supply that will be used and consumed within 3 years of being produced. 
For purposes of this paragraph (b)(2)(i)(D), the applicable recovery 
period of the assets will be determined at the end of the taxable year 
in which the assets are placed in service for purposes of Sec.  1.46-
3(d). Subsequent changes to the applicable recovery period after the 
assets are placed in service will not affect the determination of 
whether the assets are produced on a routine and repetitive basis for 
purposes of this paragraph (b)(2)(i)(D).
    (2) Examples. The following examples illustrate this paragraph 
(b)(2)(i)(D):

    Example 1. Y is a manufacturer of automobiles. During the 
taxable year Y produces numerous substantially identical dies and 
molds using standardized designs and assembly line techniques. The 
dies and molds have a 3-year applicable recovery period for purposes 
of section 168(c). Y uses the dies and molds to produce or process 
particular automobile components and does not hold them for sale. 
The dies and molds are produced on a routine and repetitive basis in 
the ordinary course of Y's business for purposes of this paragraph 
because the dies and molds are both mass-produced and have a 
recovery period of not longer than 3 years.
    Example 2. Z is an electric utility that regularly manufactures 
and installs identical poles that are used in transmitting and 
distributing electricity. The poles have a 20-year applicable 
recovery period for purposes of section 168(c). The poles are not 
produced on a routine and repetitive basis in the ordinary course of 
Z's business for purposes of this paragraph because the poles have 
an applicable recovery period that is longer than 3 years.
* * * * *
    (e) Change in method of accounting--(1) In general. A change in a 
taxpayer's treatment of additional section 263A costs to comply with 
paragraph (b)(2)(i)(D) of this section is a change in method of 
accounting to which the provisions of sections 446 and 481 and the 
regulations under those sections apply. See Sec.  1.263A-7. For a 
taxpayer's first taxable year ending on or after August 2, 2005, the 
taxpayer is granted the consent of the Commissioner to change its 
method of accounting to comply with paragraph (b)(2)(i)(D) of this 
section, provided the taxpayer follows the administrative procedures, 
as modified by paragraphs (e)(2) through (4) of this section, issued 
under Sec.  1.446-1(e)(3)(ii) for obtaining the Commissioner's 
automatic consent to a change in accounting method (for further 
guidance, for example, see Rev. Proc. 2002-9 (2002-1 CB 327), as 
modified and clarified by Announcement 2002-17 (2002-1 CB 561), 
modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), and 
amplified, clarified, and modified by Rev. Proc. 2002-54 (2002-2 CB 
432), and Sec.  601.601(d)(2)(ii)(b) of this chapter). For purposes of 
Form 3115, ``Application for Change in Accounting Method,'' the 
designated number for the automatic accounting method change authorized 
by this paragraph (e) is ``95.'' If Form 3115 is revised or renumbered, 
any reference in this section to that form is treated as a reference to 
the revised or renumbered form. Alternatively,

[[Page 14678]]

notwithstanding the provisions of any administrative procedures that 
preclude a taxpayer from requesting the advance consent of the 
Commissioner to change a method of accounting that is required to be 
made pursuant to a published automatic change procedure, for its first 
taxable year ending on or after August 2, 2005, a taxpayer may request 
the advance consent of the Commissioner to change its method of 
accounting to comply with paragraph (b)(2)(i)(D) of this section, 
provided the taxpayer follows the administrative procedures, as 
modified by paragraphs (e)(2) through (5) of this section, for 
obtaining the advance consent of the Commissioner (for further 
guidance, for example, see Rev. Proc. 97-27 (1997-1 CB 680), as 
modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), as 
amplified and clarified by Rev. Proc. 2002-54 (2002-2 CB 432), and 
Sec.  601.601(d)(2)(ii)(b) of this chapter). For the taxpayer's second 
and subsequent taxable years ending on or after August 2, 2005, 
requests to secure the consent of the Commissioner must be made under 
the administrative procedures, as modified by paragraphs (e)(3) and (4) 
of this section, for obtaining the Commissioner's advance consent to a 
change in accounting method.
    (2) Scope limitations. Any limitations on obtaining the automatic 
consent or advance consent of the Commissioner do not apply to a 
taxpayer seeking to change its method of accounting to comply with 
paragraph (b)(2)(i)(D) of this section for its first taxable year 
ending on or after August 2, 2005.
    (3) Audit protection. A taxpayer that changes its method of 
accounting in accordance with this paragraph (e) to comply with 
paragraph (b)(2)(i)(D) of this section does not receive audit 
protection if its method of accounting for additional section 263A 
costs is an issue under consideration at the time the application is 
filed with the national office.
    (4) Section 481(a) adjustment. A change in method of accounting to 
conform to paragraph (b)(2)(i)(D) of this section requires a section 
481(a) adjustment. The section 481(a) adjustment period is two taxable 
years for a net positive adjustment for an accounting method change 
that is made to conform to paragraph (b)(2)(i)(D) of this section.
    (5) Time for requesting change. Notwithstanding the provisions of 
Sec.  1.446-1(e)(3)(i) and any contrary administrative procedure, a 
taxpayer may submit a request for advance consent to change its method 
of accounting to comply with paragraph (b)(2)(i)D) of this section for 
its first taxable year ending on or after August 2, 2005, on or before 
the date that is 30 days after the end of the taxable year for which 
the change is requested.
    (f) Effective date. Paragraphs (b)(2)(i)(D), (e), and (f) of this 
section apply for taxable years ending on or after August 2, 2005.


Sec.  1.263A-2T  [Removed]

0
Par. 5. Section 1.263A-2T is removed.

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: March 20, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E7-5732 Filed 3-28-07; 8:45 am]
BILLING CODE 4830-01-P

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