T administrative announcements dealing with tax cable to each - PDF document

C O R P O R A T E B U S I N E S S T A X A T I O N M O N T H L Y Tax Accounting BY JAMES E. SALLES his month’s column addresses four recent the specific changes covered and special rules appli- T administrative announcements dealing with tax cable to each appear in an appendix. In general, tax- accounting issues. The IRS has: payers can make changes subject to the automatic consent procedures until the return filing date. 1. Updated the procedure governing “automatic con- Modified Procedure sent” to accounting method changes, limiting some The IRS issued a new procedure in this accounting changes when the same taxpayer uses different procedure series in December, 1999 Revenue methods, Rev. Proc. 99-49, 1999-52 I.R.B. 1; Procedure 99-49, 1999-52 I.R.B. 1, which supersedes 2. Confirmed that expenditures to secure and main- Revenue Procedure 98-60, 1998-51 I.R.B. 16. Among tain ISO 9000 are currently deductible as ordinary other minor changes, Revenue Procedure 99-49 for the costs of conducting business, Rev. Rul. 2000-4, first time incorporates rules for making mark-to-market 2000-4 I.R.B. 1; elections under Code Section 475 and for revoking 3. Asserted that stock warrants granted to a major cus- elections to currently include market discount on debt tomer should be capitalized as leading to long-term instruments under Code Section 1278(b). benefits from the continuing relationship, F .S.A. 1999- 1166; and New Restriction Added 4. Reaffirmed its position that automatic expensing of One of the most common situations in which an auto- very small expenditures is not permitted, I.L.M. matic change is permitted has been that in which the 199952010 (Sept. 29, 1999). taxpayer wants to change from the cash method or a hybrid method to an accrual method. Revenue NEW AUTOMATIC CONSENT Procedure 99-49 continues to permit such a change, PROCEDURE with or without an election to apply the “recurring item Code Section 446(e) requires the Commissioner’s exception” in determining economic performance. The consent to a change in accounting methods. Under revenue procedure requires that all trades or business- recently liberalized rules, taxpayers can generally sub- es of the same taxpayer adopt the same overall accru- mit Form 3115 requesting consent at any time during al method for the change in method to be approved for the taxable year for which the change is sought to be one entity. made. 1 The normal procedures for requesting account- T axpayers are generally permitted to maintain differ- ing method changes appear in Revenue Procedure 97- ent accounting methods for different trades or busi- 27, 1997-1 C.B. 680. nesses that keep separate books and records. T reas. The IRS has long permitted taxpayers to make certain Reg. § 1.446-1(d). The IRS was probably concerned specific types of accounting method changes under about potential abuses. See T reas. Reg. § 1.446- special automatic consent procedures. In 1997, the IRS 1(d)(3), which states that businesses conducted by the began consolidating the relevant rules, formerly found same taxpayer will not be considered separate if “by in a hodgepodge of administrative pronouncements, reason of maintaining different methods of accounting, into one annual revenue procedure. General terms are there is a creation or shifting of profits or losses given in the body of the procedure and descriptions of between [them] so that income of the taxpayer is not clearly reflected.” Changes prohibited by this rule appear to be still pos- James E. Salles is a member of Caplin & Drysdale, Chartered, in Washington, DC. sible; however, the taxpayer would have to submit the M A R C H 2 0 0 0 1

C O R P O R A T E B U S I N E S S T A X A T I O N M O N T H L Y proposed change for individualized consideration Some commentators had doubted whether Briarcliff under the general method change procedures because remained good law, given its reliance on the absence of the change would fall outside the scope of Revenue a separate and distinct asset, 475 F .2d at 786, and a Procedure 99-49. disparaging footnote in INDOPCO , 503 U.S. at 83 n.3. Sun Microsystems, Inc. ISO 9000 EXPENDITURES Revenue Ruling 2000-4 cited Sun Microsystems, Inc. In early January 2000, the IRS issued the latest in a v. Commissioner , 66 T .C.M. (CCH) 997 (1993). In that series of revenue rulings in its continuing efforts to case the T ax Court held, contrary to the IRS’s position, impose order on capitalization doctrine in the aftermath that warrants granted as product discounts to a large of the Supreme Court’s decision in INDOPCO v. customer did not have to be capitalized based on Commissioner , 503 U.S. 79 (1992). Revenue Ruling amorphous considerations of “market development.” 2000-4, 2000-4 I.R.B. 1, holds that ISO 9000 compli- The ruling characterized the critical factor in Sun as ance expenditures are ordinary expenses and are cur- being the nature of the customer relationship. Any rently deductible. expected long-term benefits from development of a ISO 9000 refers to a series of quality standards devel- customer relationship were “softer” and more specula- oped by the International Standards Organization. tive than the immediate benefit from the sales to which Organizations that aspire to ISO 9000 certification may the warrants were tied. have to expend substantial sums to bring their process- Field Service Advice 199939035 was issued on es into compliance and then obtain a certificate of com- August 9, 1999. This field service advice signaled the pliance from an outside auditor. Certification generally IRS’s recognition that routine expenditures incurred to lasts from two to four years. Obtaining and maintaining maintain and even “grow,” in modern parlance, an ISO 9000 certification is not legally required, but is a existing business’s customer base need not be capi- prerequisite for dealing with many organizations in the talized on the basis of some speculative future benefit. United States and abroad and is of substantial help in The reinforcement of the same principle in a published marketing an organization’s products and services. ruling is welcome. INPOPCO Analysis WHEN CUSTOMERS RECEIVE The IRS performed what is now becoming a fairly famil- STOCK OPTIONS iar INDOPCO analysis as to ISO 9000 certification. ISO certification is not a “separate and distinct asset,” so the An increasingly common practice, especially in the issue was resolved on the basis of general considera- field of high technology, is for a supplier to issue stock tions of “future benefit” and “clear reflection.” The rev- warrants or options to its customers in connection with enue ruling concluded that the expenditures were princi- volume purchase contracts. Such arrangements have pally intended to benefit current sales and that the future been before the T ax Court several times. The value of the benefit was “incidental.” Consequently, these expendi- warrants is treated as a sales discount, reflected as a tures were not required to be capitalized. The only excep- reduction to gross sales by the supplier-issuer in Sun tion was for expenditures directly related to the creation Microsystems, Inc. v. Commissioner , 66 T .C.M. (CCH) or acquisition of a specific separate and distinct asset 997 (1993). The buyer treats the discount as a reduction with expected future utility, such as a quality manual. in purchase price in Computervision International Corp. New Life for Briarcliff Candy v. Commissioner , 71 T .C.M. (CCH) 2450, 2465–67 (1996). The T ax Court addressed related timing issues in The IRS relied on several cases holding that expendi- Convergent T echnologies v. Commissioner , 70 T .C.M. tures incurred in maintenance and expansion of an (CCH) 87, 94–95 (1995). Here the T ax Court held that the existing business are deductible. Interestingly, one value of the option is taken into account at issue if it has case the ruling cited was Briarcliff Candy Corp. v. “readily ascertainable market value.” Otherwise the tax- Commissioner , 475 F .2d 775 (2d Cir. 1973), which allowed current deductions for expenditures the tax- able event occurs when the option is exercised. This is payer incurred trying to open new distribution channels. in keeping with the traditional treatment of options issued 2 2 M A R C H 2 0 0 0