Tax Accounting
On November 8, 2010, the IRS released Rev. Proc. 2010-44, which resolves some of the issues raised by Technical Advice Memorandum (TAM) 200736026. The TAM (described in more detail below) addressed numerous uniform capitalization (UNICAP) issues affecting automobile dealerships under Sec. 263A. The taxpayer in the TAM was a franchised automobile dealership that sold new and used vehicles as well as vehicle parts and accessories. The taxpayer repaired customer-owned vehicles and installed parts onto customer-owned and taxpayer-owned vehicles. The TAM specifically addressed whether the installation of parts on customer-owned vehicles, and on taxpayer-owned vehicles, would constitute “production” for purposes of the UNICAP regulations. The TAM concluded that the installation of parts on the taxpayer-owned vehicles constitutes production while the installation of parts on customer-owned vehicles does not constitute production.
The TAM also addressed whether an automobile dealership could continue to be treated as a retail sales facility in light of certain “off-site” sales that occurred at the dealership. The TAM caused a significant amount of concern because treating the automobile dealer’s installation activities as production activities and not treating the automobile dealership as a retail sales facility would both have a profound effect on an automobile dealership’s UNICAP calculation. Fortunately, Rev. Proc. 2010-44 provides two safe-harbor methods of accounting to deal with issues raised by the TAM and provides automatic procedures for taxpayers seeking to use those safe-harbor methods of accounting.
This item first summarizes the relevant rules of law—including the TAM and relevant IRS directives—and then describes Rev. Proc. 2010-44 in detail.
Rules of Law
Sec. 263A provides that the direct costs and indirect costs properly allocable to property that is inventory in the hands of the taxpayer must be included in inventory costs. Regs. Sec. 1.263A-1(e)(1) provides that taxpayers subject to Sec. 263A must capitalize all direct costs and certain indirect costs properly allocable to property produced or property acquired for resale.
Regs. Sec. 1.263A-3(c) provides certain favorable rules in connection with storage and handling costs incurred at a retail sales facility and at an on-site storage facility. Regs. Sec. 1.263A-3(c)(4)(i) provides that handling costs and storage costs incurred at retail sales facilities need not be capitalized. This rule (i.e., deduction of storage and handling at a retail sales facility) applies to producers that incur storage and handling costs as well as resellers. Regs. Secs. 1.263A-3(c)(5)(i) and (ii) also contain rules allowing the deduction of storage costs incurred in connection with an on-site storage facility.
A “retail sales facility” is defined as a facility where a taxpayer sells merchandise exclusively to retail customers (final purchasers of the merchandise) in on-site sales. For this purpose, the retail sales facility includes those portions of any specific retail site:
- That are customarily associated with and are an integral part of the operations of that retail site;
- That are generally open each business day exclusively to retail customers;
- On or in which retail customers normally and routinely shop to select specific items of merchandise; and
- That are adjacent to or in immediate proximity to the other portions of the specific retail site.
Regs. Sec. 1.263A-3(c)(5)(ii)(C) provides that a storage facility is an integral part of a retail facility when the storage facility is an essential and indispensible part of the retail sales facility.
It is important to be able to distinguish between storage and handling costs and production costs because production costs incurred at a retail sales facility would be capitalizable, while storage and handling costs would be deductible. Regs. Sec. 1.263A-3(c)(4) states that handling costs are defined as “costs attributable to processing, assembling, repackaging, transporting, and other similar activities with respect to property acquired for resale, providing the activities do not come within the meaning of the term produce as defined in § 1.263A-2(a)(1).” Further, Regs. Sec. 1.263A-3(c)(4)(ii) states that processing costs are “the costs a reseller incurs in making minor changes or alterations to the nature or form of a product acquired for resale. Minor changes to a product include, for example, monogramming a sweater, altering a pair of pants, and other similar activities.” Assembling costs are defined as “costs associated with incidental activities that are necessary in readying property for resale (e.g., attaching wheels and handlebars to a bicycle acquired for resale).”
Regs. Sec. 1.263A-3(a)(2) describes capitalization rules relating to resellers with production activities. Sec. 263A(g)(1) provides that the term “produce” includes construction, building, installation, manufacturing, developing, or improving of property. The IRS has interpreted “production” broadly in the context of Sec. 263A. Given the definitions of processing, assembling, and production, it is often difficult to determine whether a particular activity is a handling activity or a production activity.
The above definitions are extremely important because they will affect how particular costs will be treated for UNICAP purposes. For example, a taxpayer that incurred only storage and handling costs at its retail sales facility would not have to capitalize those costs. On the other hand, if those same activities were deemed to be production, the costs would be capitalized. In addition, if the facility at which the taxpayer operated was neither a retail sales facility nor on-site storage, inventory-related storage and handling costs incurred at that facility would be capitalized.
TAM 200736026
In TAM 200736026, the taxpayer was a franchised automobile dealership that sold new and used vehicles as well as vehicle parts and accessories. The taxpayer repaired customer-owned vehicles and installed parts onto customer-owned and taxpayer-owned vehicles. The TAM ruled on 12 issues, only two of which are discussed below.
One issue was whether the installation of parts (sold by the taxpayer) on either customer-owned vehicles or taxpayer-owned vehicles constituted production activities for purposes of Sec. 263A. The IRS concluded that the taxpayer engaged in production activities when it installed parts on the taxpayer-owned vehicles but that the taxpayer did not engage in production activities when it installed parts on customer-owned vehicles. The IRS stated that the installation of parts on customer-owned vehicles is not production because the taxpayer does not own the property that is being produced (which in the IRS’s view was the vehicle). The installation of parts on customer-owned vehicles would be considered handling costs. The IRS stated that production costs include the costs of those items that make the taxpayer-owned vehicles salable or more readily marketable. The IRS noted that while the cost of certain other activities, such as adding fluid to a vehicle, would not be production, those costs would be handling costs.
One of the other issues addressed in the TAM was whether certain sales that occurred at the automobile dealerships would preclude the taxpayer from treating the automobile dealership as a retail sales facility. Specifically, the TAM addressed whether the following sales would be on-site sales to retail customers:
- Vehicles taken in trade or purchased at auction and subsequently resold at wholesale;
- Vehicles sold to another dealership at cost;
- Vehicles leased;
- Vehicles sold as part of a fleet sale; and
- Wholesale sales of parts to purchasers who are, or are not, end users, where the parts are picked up at the taxpayer’s parts department by the purchaser or delivered to the purchaser by a driver from the taxpayer’s parts department.
The TAM held that vehicles resold at wholesale, vehicles sold to another dealership at cost, leased vehicles, and some parts sales were not on-site sales to retail customers. The IRS held that parts sales made to end users at its location are on-site sales to retail customers and, finally, that fleet sales are on-site sales to retail customers.
IRS Directives
After publishing the TAM, the IRS published two directives encouraging taxpayers to follow the rationale contained in the TAM. On September 15, 2009, the IRS announced in a field directive (LMSB-4-0909-035) that it was temporarily suspending the examination of Sec. 263A (UNICAP) issues involving automobile dealerships. The suspension began on September 15, 2009, and was to end on December 31, 2010. According to the directive, the suspension was done in order to allow affected taxpayers the opportunity to comply with legal analysis contained in the TAM. While the IRS acknowledged that a TAM is not authoritative guidance, it added that the legal reasoning in the TAM may be instructive in connection with automobile dealership examinations.
In August 2010, the IRS issued a second directive (LMSB-4-0810-021) that extended the suspension of examinations in this area until guidance was published by Treasury and the IRS.
Rev. Proc. 2010-44
Rev. Proc. 2010-44 addresses some of the issues raised by the TAM. Rev. Proc. 2010-44 applies to motor vehicle dealerships. It defines a motor vehicle dealership as a dealership that primarily purchases and resells to retail customers one or more of the following: automobiles, light-duty trucks, medium-duty trucks, heavy-duty trucks, recreational vehicles, motorcycles, boats, farm machinery and equipment, and construction machinery and equipment. The revenue procedure is effective as of November 9, 2010.
Rev. Proc. 2010-44 provides two safe-harbor methods of accounting for motor vehicle dealerships that relate to UNICAP: the retail sales facility safe-harbor method and the reseller without production activities safe-harbor method. The revenue procedure applies to motor vehicle dealerships, but it is important to note that the revenue procedure specifically provides that a motor vehicle dealership that removes Sec. 471 costs from ending inventory by treating those costs as negative amounts (negative additional Sec. 263A costs) in the numerator of either its simplified resale method or its simplified production method may not use either of the safe harbors.
The retail sales facility safe harbor provides that a motor vehicle dealership may treat its entire sales facility from which it normally and routinely conducts on-site sales to retail customers, including any lot that is an integral part of its sales facility and that is routinely visited by retail customers, as a retail sales facility under Regs. Sec. 1.263A-3(c)(5)(ii)(B). Therefore, a taxpayer using the retail sales facility safe harbor would not have to capitalize storage and handling costs incurred at the facility. Under the reseller without production activities safe harbor, a motor vehicle dealership may treat itself as a reseller without production activities for purposes of Regs. Sec. 1.263A-3. Specifically, Rev. Proc. 2010-44 provides that activities that a motor vehicle dealership, or a contractor, performs on dealership-owned vehicles and customer-owned vehicles are handling activities under Regs. Sec. 1.263A-3(c)(4), which would be deductible to the extent that they are incurred at a taxpayer’s retail sales facility. The cost of parts to make repairs to dealership-owned vehicles must still be capitalized as an acquisition cost of the vehicle. A motor vehicle dealership using the reseller without production activities safe-harbor method may use the simplified resale method under Regs. Sec. 1.263A-3(d) for its vehicles and other eligible property.
The revenue procedure provides processes for obtaining automatic consent to use either or both safe-harbor methods. Specifically, Rev. Proc. 2010-44 modifies Rev. Proc. 2008-52 to add new Section 11.07 to the appendix. The automatic procedures would allow a taxpayer to make a concurrent change to no longer include negative additional Sec. 263A costs in its simplified production method or simplified resale method calculation. The scope limitations contained in Rev. Proc. 2008-52 do not apply to this accounting method change for a taxpayer’s first or second tax year ending after November 9, 2010. Multiple automatic UNICAP changes may be made on one Form 3115, Application for Change in Accounting Method, as long as the taxpayer enters all applicable automatic change numbers and complies with all applicable terms and conditions.
EditorNotes
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or greg.fairbanks@gt.com.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.
