| Treasury Decision 9217 |
September 12, 2005 |
Guidance Regarding the Simplified Service Cost Method
and the Simplified Production Method
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
This document contains final and temporary regulations relating to the
capitalization of costs under the simplified service cost method and the simplified
production method provided by the Income Tax Regulations. The regulations
affect taxpayers that use the simplified service cost method or the simplified
production method for self-constructed assets that are produced on a routine
and repetitive basis in the ordinary course of their businesses. The text
of the temporary regulations also serves as the text of the proposed regulations
set forth in the notice of proposed rulemaking (REG-121584-05) on this subject
in this issue of the Bulletin. The portions of this rule that are final regulations
provide necessary cross-references to the temporary regulations.
Effective Date: These regulations are effective
August 2, 2005.
Applicability Date: These regulations apply to
taxable years ending on or after August 2, 2005. See §§1.263A-1T(l)
and 1.263A-2T(f).
FOR FURTHER INFORMATION CONTACT:
Scott Rabinowitz, (202) 622-4970 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Under section 263A of the Internal Revenue Code (Code), producers of
real or tangible personal property and resellers of real or personal property
must capitalize the direct costs and a proper share of the indirect costs
of such property. Indirect costs include indirect labor costs, overhead, and
service costs. Service costs are indirect costs that can be identified specifically
with an administrative or support department. Service costs consist of capitalizable
service costs, deductible service costs, and mixed service costs. Capitalizable
service costs are service costs that directly benefit, or are incurred by
reason of, a production or resale activity. Deductible service costs are service
costs that do not directly benefit, or are not incurred by reason of, a production
or resale activity. Mixed service costs are service costs that are partially
allocable to production or resale activities and partially allocable to non-production
or non-resale activities.
Although section 263A requires capitalization of indirect costs, the
statute generally does not set forth methods for allocating indirect costs,
including mixed service costs. Instead, in accordance with the legislative
history of the section, the regulations under section 263A generally provide
that indirect costs are to be allocated to property using detailed or specific
(facts-and-circumstances) cost allocation methods, including a specific identification
method, the standard cost method, and methods using burden rates. The regulations
further provide that allocations of mixed service costs are to be made on
the basis of a factor or relationship that reasonably relates such costs with
the benefit provided. To alleviate the administrative burdens of using these
detailed or specific methods, the Treasury Department and the Internal Revenue
Service developed simplified methods. In particular, the simplified production
method provided by §1.263A-2(b) determines aggregate amounts of additional
section 263A costs allocable to produced “eligible property.”
Additional section 263A costs are those costs, other than interest, that were
not capitalized under a taxpayer’s method of accounting immediately
prior to the effective date of section 263A, but that are required to be capitalized
under section 263A. In addition, the final regulations provide a simplified
method, the simplified service cost method provided by §1.263A-1(h),
for determining capitalizable mixed service costs incurred during the taxable
year with respect to “eligible property.”
On March 30, 1987, temporary regulations under section 263A were published
in the Federal Register (T.D. 8131, 1987-1
C.B. 98 [52 FR 10052]). The temporary regulations limited the availability
of the simplified production method and the simplified service cost method
to two types of “eligible property”: stock in trade or other property
properly includible in the inventory of the taxpayer 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 temporary regulations
indicates that this limitation was prescribed because the simplified production
method is not appropriate to account for the casual or occasional production
of property (i.e., property that is not mass-produced
on a repetitive and routine basis and that does not have a high “turnover”
rate.) Similarly, the simplified service cost method is not appropriate to
account for the casual or occasional production of property.
On August 22, 1988, the IRS published Notice 88-86, 1988-2 C.B. 401.
Notice 88-86 states that forthcoming regulations will expand the categories
of property eligible for the simplified production method and simplified service
cost method to other types of property that share characteristics that are
appropriate for application of the methods. In particular, the notice indicates
that the regulations will provide that the simplified production method and
the simplified service cost method are available to (1) self-constructed assets
substantially identical in nature to, and produced in the same manner as,
inventory property or other property held primarily for sale to customers
in the ordinary course of the taxpayer’s trade or business, and (2)
self-constructed assets produced by the taxpayer on a routine and repetitive
basis in the ordinary course of the taxpayer’s production activities.
On August 9, 1993, final regulations under section 263A were published
in the Federal Register (T.D. 8482, 1993-2
C.B. 77 [58 FR 42198]). The final regulations follow Notice 88-86 and expand
the categories of eligible property for the simplified production method and
the simplified service cost method.
Notice 2003-36, 2003-1 C.B. 992, as modified by Notice 2003-59, 2003-2
C.B. 429, indicates that the Treasury Department and the IRS are aware that
uncertainty exists as to what types of property constitute “eligible
property” under §§1.263A-1(h)(2)(i)(D) and 1.263A-2(b)(2)(i)(D)
for purposes of the simplified service cost method and the simplified production
method. These sections provide that self-constructed assets produced by a
taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer’s
trade or business are “eligible property.”
To provide guidance as to what types of property constitute “eligible
property” under the final regulations, Rev. Rul. 2005-53, 2005-35 I.R.B.
425 (dated August 29, 2005), holds that a taxpayer’s production of property
will be considered “routine and repetitive” for purposes of §§1.263A-1(h)(2)(i)(D)
and 1.263A-2(b)(2)(i)(D) only if the property is mass-produced (i.e.,
numerous identical goods are manufactured using standardized designs and assembly
line techniques) or the produced property has a high
degree of turnover (i.e., the costs of production are
recovered over a relatively short amount of time).
Explanation of Provisions
Upon further consideration of the simplified service cost method and
the simplified production method under §§1.263A-1(h)(2)(i)(D) and
1.263A-2(b)(2)(i)(D), the Treasury Department and the IRS believe that, to
minimize the distortion of income that may arise from the use of those methods,
a taxpayer’s production of property is considered “routine and
repetitive” for purposes of those sections only if the property is mass-produced
and has a high degree of turnover. Accordingly, the temporary regulations
provide that self-constructed property is considered produced on a routine
and repetitive basis for purposes of the simplified service cost method and
the simplified production method only if numerous substantially identical
units of tangible personal property are produced within a taxable year using
standardized designs and assembly line techniques and the
applicable recovery period of the assets under §168(c) is not longer
than 3 years.
A change in a taxpayer’s treatment of mixed service costs or additional
section 263A costs to comply with these temporary regulations is a change
in method of accounting to which the provisions of sections 446 and 481 and
the regulations thereunder apply. For the 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 these temporary
regulations, provided the taxpayer follows the applicable administrative procedures
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 C.B.
327, as modified and clarified by Announcement 2002-17, 2002-1 C.B. 561, modified
and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, and amplified, clarified,
and modified by Rev. Proc. 2002-54, 2002-2 C.B. 432). For purposes of Form
3115, “Application for Change in Accounting Method”,
the designated number for the automatic accounting method change authorized
by this regulation 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. 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 for obtaining
the Commissioner’s advance consent to a change in accounting method
(for further guidance, for example, see Rev. Proc. 97-27, 1997-1 C.B. 680,
as modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, as amplified
and clarified by Rev. Proc. 2002-54, 2002-2 C.B. 432). However, notwithstanding
section 5.04(1) of Rev. Proc. 2002-9 and section 5.02(3)(a) of Rev. Proc.
97-27, 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 these temporary regulations.
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. Please refer to the cross-reference notice of proposed
rulemaking published elsewhere in this issue of the Bulletin for applicability
of the Regulatory Flexibility Act (5 U.S.C. chapter 6). Pursuant to section
7805(f) of the Code, these temporary regulations will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for comment
on their impact on small business.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.263A-1 is amended by revising paragraph (h)(2)(i)(D)
and adding paragraphs (k) and (l) to read as follows:
§1.263A-1 Uniform capitalization of costs.
* * * * *
(h) * * *
(2) * * *
(i) * * *
(D) [Reserved]. For further guidance, see §1.263A-1T(h)(2)(i)(D).
* * * * *
(k) and (l) [Reserved]. For further guidance, see §1.263A-1T(k)
and (l).
Par 3. Section 1.263A-1T is added to read as follows:
§1.263A-1T Uniform capitalization of costs (temporary).
(a) through (h)(2)(i)(C) [Reserved]. For further guidance, see §1.263A-1(a)
through (h)(2)(i)(C).
(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 §1.263A-10(c)) are mass-produced, i.e.,
numerous substantially identical assets are manufactured within a taxable
year using standardized designs and assembly line techniques, and the applicable
recovery period of the property determined under section 168(c) is not longer
than 3 years. For purposes of this paragraph, 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.
(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.
(h)(2)(ii) through (j) [Reserved]. For further guidance, see §1.263A-1(h)(2)(ii)
through (j).
(k) Change in method of accounting—(1) In
general. A change in a taxpayer’s treatment of mixed service
costs to comply with these temporary regulations is a change in method of
accounting to which the provisions of sections 446 and 481 and the regulations
thereunder 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
these temporary regulations, 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 C.B. 327, as modified and clarified
by Announcement 2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc.
2002-19, 2002-1 C.B. 696, and amplified, clarified, and modified by Rev. Proc.
2002-54, 2002-2 C.B. 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. 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)(2) through (4) of this section, for obtaining the Commissioner’s
advance consent to a change in accounting method (for further guidance, for
example, see Rev. Proc. 97-27, 1997-1 C.B. 680, as modified and amplified
by Rev. Proc. 2002-19, 2002-1 C.B. 696, as amplified and clarified by Rev.
Proc. 2002-54, 2002-2 C.B. 432, and §601.601(d)(2)(ii)(b) of this chapter).
(2) Scope limitations. Any limitations on obtaining
the automatic consent of the Commissioner do not apply to a taxpayer seeking
to change its method of accounting to comply with 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
these temporary regulations 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 these temporary regulations 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 these temporary regulations.
(l) Effective date. This section applies for taxable
years ending on or after August 2, 2005.
Par. 4. Section 1.263A-2 is amended by revising paragraph (b)(2)(i)(D)
and adding paragraphs (e) and (f) to read as follows:
§1.263A-2 Rules relating to property produced by the
taxpayer.
* * * * *
(b) * * *
(2) * * *
(i) * * *
(D) [Reserved]. For further guidance, see §1.263A-2T(b)(2)(i)(D).
* * * * *
(e) and (f) [Reserved]. For further guidance, see §1.263A-2T(e)
and (f).
Par. 5. Section 1.263A-2T is added to read as follows:
§263A-2T Rules relating to property produced by the
taxpayer (temporary).
(a) through (b)(2)(i)(C) [Reserved]. For further guidance, see §1.263A-2(a)
through (b)(2)(i)(C).
(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 §1.263A-10(c)) are mass-produced, i.e.,
numerous substantially identical assets are manufactured within a taxable
year using standardized designs and assembly line techniques, and the applicable
recovery period of the property determined under section 168(c) is not longer
than 3 years. For purposes of this paragraph, 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.
(2) Examples. The following examples illustrate
this paragraph (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
an applicable 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(a). 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.
(b)(2)(ii) through (d) [Reserved]. For further guidance, see §1.263A-2(b)(2)(ii)
through (d).
(e) Change in method of accounting—(1) In
general. A change in a taxpayer’s treatment of additional
section 263A costs to comply with these temporary regulations is a change
in method of accounting to which the provisions of sections 446 and 481 and
the regulations thereunder 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 these temporary regulations, 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 C.B. 327, as modified and clarified
by Announcement 2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc.
2002-19, 2002-1 C.B. 696, and amplified, clarified, and modified by Rev. Proc.
2002-54, 2002-2 C.B. 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. 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)(2) through (4) of this section,
for obtaining the Commissioner’s advance consent to a change in accounting
method (for further guidance, for example, see Rev. Proc. 97-27, 1997-1 C.B.
680, as modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, as
amplified and clarified by Rev. Proc. 2002-54, 2002-2 C.B. 432, and §601.601(d)(2)(ii)(b)
of this chapter).
(2) Scope limitations. Any limitations on obtaining
the automatic consent of the Commissioner do not apply to a taxpayer seeking
to change its method of accounting to comply with 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
these temporary regulations 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 these temporary regulations 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 these temporary regulations.
(f) Effective date. This section applies for taxable
years ending on or after August 2, 2005.
Mark E. Matthews,
Deputy
Commissioner for
Services and Enforcement.
Approved July 14, 2005.
Eric Solomon,
Acting
Deputy Assistant Secretary of the Treasury.
Note
(Filed by the Office of the Federal Register on August 2, 2005, 8:45
a.m., and published in the issue of the Federal Register for August 3, 2005,
70 F.R. 44467)
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 the Treasury Department participated in their development.
* * * * *
Internal Revenue Bulletin 2005-37
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