Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42051

objection. Three copies of all documents

shall be submitted and shall be

identified with the docket number

found in brackets in the heading of this

document. Any objections received in

response to the regulation may be seen

in the Dockets Management Branch

between 9 a.m. and 4 p.m., Monday

through Friday.

List of Subjects in 21 CFR Part 178

Food additives, Food packaging.

Therefore, under the Federal Food,

Drug, and Cosmetic Act and under

authority delegated to the Commissioner

of Food and Drugs and redelegated to

the Director, Center for Food Safety and

Applied Nutrition, 21 CFR part 178 is

amended as follows:

PART 178—INDIRECT FOOD

ADDITIVES: ADJUVANTS,

PRODUCTION AIDS, AND SANITIZERS

1. The authority citation for 21 CFR

part 178 continues to read as follows:

Authority: Secs. 201, 402, 409, 721 of the

Federal Food, Drug, and Cosmetic Act (21

U.S.C. 321, 342, 348, 379e).

2. Section 178.3400 is amended in the

table in paragraph (c) by alphabetically

adding a new entry under the headings

‘‘List of substances’’ and ‘‘Limitations’’

to read as follows:

§ 178.3400 Emulsifiers and/or surface

active agents.

* * * * *

(c) * * *

List of substances Limitations

* * * * * * *

Disodium 4-isodecyl sulfosuccinate (CAS Reg. No. 37294–49–8). For use only as an emulsifier at levels not to exceed

5 percent by weight of polymers intended for use

in coatings.

* * * * * * *

* * * * *

Dated: July 23, 1997.

Janice F. Oliver,

Acting Director, Center for Food Safety and

Applied Nutrition.

[FR Doc. 97–20498 Filed 8-4-97; 8:45 am]

BILLING CODE 4160–01–F

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8728]

RIN 1545–AQ94

Procedure for Changing a Method of

Accounting Under Section 263A

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final and temporary

regulations.

SUMMARY: This document contains final

regulations relating to the requirements

for changing a method of accounting for

costs subject to section 263A. The

regulations provide guidance regarding

changes in method of accounting for

costs incurred in producing property

and acquiring property for resale. The

regulations affect taxpayers changing

their method of accounting for costs

subject to section 263A.

DATES: These regulations are effective

August 5, 1997.

FOR FURTHER INFORMATION CONTACT:

Cheryl Lynn Oseekey, (202) 622–4970

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On March 30, 1987 and August 7,

1987, temporary regulations under

section 263A were published in the

Federal Register (TD 8131, 52 FR 10052

and TD 8148, 52 FR 29375), and crossreferenced to notices of proposed

rulemaking published in the Federal

Register on the same date (52 FR 10118

and 52 FR 29391). The temporary

regulations contain rules for taxpayers

changing their method of accounting to

comply with the capitalization rules of

section 263A. A public hearing on these

temporary and proposed regulations

was held on December 7, 1987.

On August 9, 1993, final regulations

under section 263A were published in

the Federal Register (TD 8482, 58 FR

42198). These final regulations did not

address the accounting method

provisions in the 1987 temporary

regulations, which continued in effect.

On August 5, 1994, final and temporary

regulations were published in the

Federal Register (TD 8559, 59 FR

39958). These final regulations address

‘‘pick and pack costs’’ and other

expenses. The August 5, 1994 temporary

regulations renumbered the accounting

method provisions in the 1987

temporary regulations from § 1.263A–

1T(e) to § 1.263A–7T.

This document adopts, with

modifications, § 1.263A–7T as final

regulations.

Explanation of Provisions

In 1987, the IRS and the Treasury

Department issued temporary

regulations that provide guidance to

taxpayers changing their method of

accounting to comply with the

capitalization rules of section 263A. The

regulations provide automatic consent

for taxpayers required to change their

method of accounting for the first

taxable year section 263A was effective.

Subsequent to promulgation of the

1987 temporary regulations, the IRS and

the Treasury Department issued various

revenue procedures that set forth rules

and procedures applicable to certain

changes in method of accounting for

costs subject to section 263A for which

taxpayers can obtain automatic consent.

These revenue procedures provide

automatic consent to change the method

of accounting in years other than the

first taxable year section 263A was

effective. Where automatic consent is

not available by revenue procedure,

taxpayers can obtain the

Commissioner’s consent to change a

method of accounting for costs subject

to section 263A under Rev. Proc. 97–27

(1997–21 I.R.B. 10).

Rev. Proc. 97–27 and the automatic

change revenue procedures describe

how a change in method of accounting

may be effected, but they do not

describe how inventory and other

property on hand at the beginning of the

year of change should be revalued.

These final regulations provide

guidance regarding how taxpayers must

revalue property in connection with a

change in method of accounting for

costs subject to section 263A. The

revaluation rules for inventory are

substantially similar to the revaluation

rules contained in the 1987 temporary
42052 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

regulations. Section 1.263A–7(c)

provides guidance regarding how items

or costs included in beginning inventory

in the year of change must be revalued.

Section 1.263A–7(d) provides guidance

regarding how non-inventory property

on hand at the beginning of the year of

change must be revalued.

The regulations also provide certain

rules that apply to changes in method of

accounting for costs subject to section

263A, in addition to the rules and

procedures that apply under the

applicable revenue procedures. See,

§ 1.263A–7(b).

In addition, the regulations clarify

whether certain changes are changes in

method of accounting under section

263A and therefore are within the scope

of the regulations. For example, a

change from one permissible

capitalization method, such as the

simplified resale method in former

§ 1.263A–1T(d)(4), to another

permissible capitalization method, such

as the simplified resale method in

§ 1.263A–3(d), is a change in method of

accounting under section 263A and is

therefore within the scope of the

regulations. See § 1.263A–7(a)(5).

The final regulations delete certain

provisions of § 1.263A–7T that were

primarily applicable to accounting

method changes made in 1987. For

example, the final regulations do not

incorporate provisions such as

§ 1.263A–7T(e)(2), which provide

automatic consent to make the change

in method of accounting for the first

taxable year section 263A was effective,

and § 1.263A–7T(e)(7) (iii), (iv) and (v)

and § 1.263A–7T(e)(8), which provide

special rules for adjusting the

revaluation factor for costs attributable

to different methods of accounting for

depreciation (including cost recovery)

and differences in the percentage of

fixed indirect production costs that

were expensed by taxpayers using the

practical capacity concept.

Certain Administrative Guidance

The final regulations incorporate the

provisions of Notice 88–23 (1988–1 C.B.

490) (ordering rules for accounting

method changes), and sections IV(A)

(guidance regarding deferred

intercompany exchanges) and IV(B)

(permission to elect a new base year for

taxpayers using the last-in, first-out

(LIFO) inventory method) of Notice 88–

86 (1988–2 C.B. 401). These notices or

portions thereof are withdrawn for

taxable years to which this Treasury

decision applies.

Effect on Other Documents

The following publications are

obsolete as of August 5, 1997: Notice

88–23 (1988–1 C.B. 490). Notice 88–86

(1988–2 C.B. 401), sections IV(A) and

IV(B).

Public Comments

The IRS and the Treasury Department

received a number of comments in

response to the 1987 temporary and

proposed regulations. Most of the

comments received in response to the

temporary regulations issued in March

1987 were considered in connection

with the temporary regulations issued in

August 1987. In general, those

comments are not discussed again here.

Revaluing Beginning Inventory—the 3-

Year Average Method

A. Extending Availability of the Method

Under the temporary regulations,

taxpayers using the dollar-value LIFO

inventory method were permitted to use

a 3-year average method for revaluing

their beginning inventory in the year

they changed their method of

accounting to comply with section

263A. Several commentators suggested

that taxpayers other than those on the

dollar-value LIFO inventory method

should also be permitted to use this 3-

year average method for revaluing

beginning inventory in the year of

change. Specifically, commentators

suggested that the 3-year average

method be made available to taxpayers

using the specific goods LIFO inventory

method. Another suggestion was that

taxpayers using the first-in, first-out

(FIFO) inventory method should be

permitted to use the 3-year average

method even though those taxpayers

may have sufficient information to

revalue their inventory under the facts

and circumstances method.

The final regulations do not adopt

these suggestions. The House and

Senate Reports to the Tax Reform Act of

1986 indicate Congress intended that

taxpayers generally revalue their

inventory in the year of change using

the facts and circumstances method.

Because Congress realized that dollarvalue LIFO taxpayers may not have the

data needed to use the facts and

circumstances method, it suggested two

other revaluation methods that could be

used in conjunction with, or in lieu of,

the facts and circumstances method.

The 3-year average method was one of

those other methods. H.R. Rep. No. 426,

99th Cong., 1st Sess. 633–637 (1985),

1986–3 (Vol. 2) C.B. 633–637 and S.

Rep. No. 313, 99th Cong., 2nd Sess.

147–152 (1986), 1986–3 (Vol. 3) C.B.

147–152. The IRS and the Treasury

Department believe that limiting the 3-

year average method to dollar-value

LIFO taxpayers is more consistent with

legislative history which expresses

Congress’ concern that dollar-value

LIFO taxpayers may have particular

problems in revaluing inventory. H.R.

Rep. No. 426, 633, 1986–3 (Vol. 2) C.B.

633 and S. Rep. No. 313, 147, 1986–3

(Vol.3) C.B. 147.

B. Altering the Mechanics of the Method

One commentator suggested that

taxpayers be permitted to revalue items

or costs included in beginning inventory

in the year of change by using data from

the year of change instead of data from

the prior three years, and calculate a

section 481(a) adjustment accordingly.

This commentator further suggested that

three years after the year of change, the

taxpayer would recompute the section

481(a) adjustment using data from the

three new years to test its original

adjustment under section 481(a). If the

new adjustment were larger than the

original adjustment by a substantial

amount, the taxpayer would be required

to amend its federal income tax returns.

The final regulations do not adopt this

suggestion. Requiring taxpayers to

compute two adjustments under section

481(a) would unnecessarily complicate

application of the 3-year average

method.

Another commentator suggested that

some taxpayers be permitted to revalue

items or costs included in beginning

inventory in the year of change by using

data from the immediately preceding

year rather than the prior three years.

This proposal to use only the prior

year’s data would be limited to

taxpayers that can show they have not

had a significant change in costs over

the preceding three years. This

suggested modification to the 3-year

average method was not adopted. The

suggested modification would not

substantially simplify the process of

revaluing beginning inventory because

taxpayers would be required to

determine whether their costs

significantly changed during the

preceding three-year period.

C. Limiting Costs Subject to Revaluation

One commentator suggested that LIFO

layers should be revalued only if the

items of inventory comprising those

layers are still in existence in the year

of change. This suggestion was not

adopted. However, the final regulations

continue the rule in the temporary

regulations that taxpayers may adjust

the revaluation factor (under either the

3-year average method or the weighted

average method) to the extent they can

show that additional section 263A costs

included in the calculation of the

revaluation factor were not incurred in
Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42053

the prior years in which the LIFO layers

were accumulated.

D. New Base Year

Under the 3-year average method,

taxpayers generally are required to

establish a new base year. Several

commentators commented that

requiring link-chain LIFO taxpayers to

establish a new base year is costly and

pointless and suggested that these

taxpayers be excluded from the general

requirement that all dollar-value LIFO

taxpayers establish a new base year. The

IRS and the Treasury Department did

not adopt this suggestion. If a new base

year is not established, the current-year

index, determined under the taxpayer’s

new method of accounting, would be

multiplied by the prior-year cumulative

index, determined under the taxpayer’s

former method of accounting, and could

distort the taxpayer’s LIFO inventory

valuation. This distortion is eliminated

when the taxpayer establishes a new

base year and establishes a new index.

Accordingly, the final regulations

provide that all dollar-value LIFO

taxpayers (whether using double

extension or link-chain) should

generally establish a new base year

when they use the 3-year average

method to revalue their inventories

under section 263A.

Commentators also suggested that

taxpayers using the 3-year average

method and either the simplified

production method or the simplified

resale method be allowed, but not

required, to establish a new base year.

Section IV(B) of Notice 88–86 permits

these taxpayers to choose whether to

establish a new base year. This rule is

incorporated into the final regulations.

One commentator noted that the

example in the 1987 temporary

regulations illustrating the 3-year

average method did not use the current

year revaluation factor in computing the

updated base year cost of inventory. The

example has been revised to use the

current year revaluation factor.

Revaluing Beginning Inventory—Facts

and Circumstances Method

One commentator suggested that

specific rules or guidelines be adopted

to clarify what is a reasonable estimate

or procedure for revaluing beginning

inventory in connection with a change

in method of accounting. This

suggestion was not adopted. What is a

reasonable estimate or procedure must

be decided on a case-by-case basis in

light of all applicable facts and

circumstances. The final regulations

continue the provision in the temporary

regulations that permissible estimates

and procedures include using

information from a more recent period

to estimate the amount and nature of

inventory costs applicable to earlier

periods, and using information with

respect to comparable items of

inventory to estimate the costs

associated with other items of

inventory.

New Base Year When the 3-Year

Average Method Is Not Used

Several commentators suggested that

dollar-value LIFO taxpayers not using

the 3-year average method to revalue

beginning inventory be permitted to

update their base year if they so choose.

Section IV (B) of Notice 88–86 permits

these taxpayers to establish a new base

year. The final regulations adopt this

rule.

Scope of Accounting Method Change

Several commentators suggested that

the regulations should allow taxpayers

to change from the specific goods LIFO

inventory method to the dollar-value

LIFO inventory method in connection

with changing their method of

accounting for costs under section 263A

without obtaining the Commissioner’s

consent. Generally, taxpayers must

secure the Commissioner’s consent

before effecting a change in method of

accounting under section 446(e) unless

this requirement is specifically waived.

The IRS and the Treasury Department

do not believe an exception from this

general rule is warranted for changes

from the specific goods LIFO inventory

method to the dollar-value LIFO

inventory method except to the extent

permitted by § 1.472–8(f)(1).

Several commentators also suggested

that taxpayers that change their method

of accounting for costs subject to section

263A be permitted to make additional

changes in their methods of accounting

in future tax years under section 263A

without obtaining additional consents

from the Commissioner. The IRS and

the Treasury Department have issued

various revenue procedures that provide

automatic consent procedures for

taxpayers to change their method of

accounting for costs under section

263A.

One commentator suggested that the

regulations provide that when making

the change from the full absorption

rules of § 1.471–11 to the uniform

capitalization rules of section 263A,

taxpayers may cease taking into account

any costs not treated as inventoriable

under section 263A that may have been

erroneously inventoried under prior

law. The temporary regulations issued

in August 1987 and the final regulations

permit this result. In revaluing

beginning inventory to include

additional section 263A costs, taxpayers

may cease capitalizing costs that had

been capitalized but are not required to

be capitalized under section 263A.

Audit Protection

Several commentators noted that

taxpayers should be guaranteed audit

protection for costs or items that are part

of a change in method of accounting

under section 263A. The IRS’ longstanding administrative position is that

if a taxpayer files an application to

change its method of accounting in

accordance with the applicable

administrative guidance, for example,

Rev. Proc. 97–27, an examining agent

may not later propose that the taxpayer

change its method of accounting for the

same item for a taxable year prior to the

year of change.

Ordering Rules

One commentator suggested that

overall accounting method changes (for

example, the cash receipts and

disbursements method to an accrual

method) should be implemented prior

to any change in method of accounting

for costs under section 263A. The

temporary regulations generally provide

that a change in method of accounting

for costs under section 263A is deemed

to occur prior to any other change in

method of accounting effected during

the year of change. The final regulations

continue that general rule with four

modifications. Taxpayers that are

discontinuing the LIFO inventory

method may make that change prior to

a change in method of accounting under

section 263A. Additionally, taxpayers

that are changing from the specific

goods LIFO inventory method to the

dollar-value LIFO inventory method

may make that change prior to a change

in method of accounting under section

263A. Also, taxpayers that are changing

their overall method of accounting from

the cash method to an accrual method

must make the change to an accrual

method prior to a change in method of

accounting under section 263A. Finally,

taxpayers that are changing their

method of accounting for depreciation

when any portion of the depreciation is

subject to section 263A must make the

method change for depreciation prior to

a change in method of accounting under

section 263A.

Cost Allocation Method

Several commentators suggested that

the regulations be clarified to provide

that a taxpayer must use the same cost

allocation method to restate its

beginning inventory and to value its

ongoing inventory. The final regulations

clarify this point. Inventory on hand at
42054 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

the beginning of the year of change is

revalued as if the taxpayer’s new

method had applied to all prior periods.

The same cost allocation method must

be used both retroactively (for purposes

of restating beginning inventory) and

prospectively (for purposes of the

current year and all subsequent years,

unless the taxpayer seeks specific

consent from the Commissioner to

change this method of accounting).

Intercompany Items

One commentator suggested that

taxpayers be given automatic consent to

discontinue filing consolidated federal

income tax returns so that they could

avoid the need to revalue the amount of

intercompany items resulting from the

sale or exchange of inventory property

in intercompany transactions. The

regulations do not adopt this suggestion.

Generally, taxpayers must secure the

Commissioner’s consent before

discontinuing the filing of consolidated

tax returns. The IRS and the Treasury

Department do not think an exception

from this general rule is warranted in

this situation.

Effective Date

These regulations are effective for

taxable years beginning on or after

August 5, 1997.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

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 notice of

proposed rulemaking preceding the

regulations was issued prior to March

29, 1996, the Regulatory Flexibility Act

(5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the

Internal Revenue Code, these

regulations were submitted to the Small

Business Administration for comment

on their impact on small business.

Drafting Information

The principal author of these

regulations is Cheryl Lynn Oseekey,

Office of Assistant Chief Counsel

(Income Tax and Accounting). However,

other personnel from the IRS and the

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:

PART 1—INCOME TAXES

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–0 is amended

by revising the introductory text and

adding entries for § 1.263A–7 to read as

follows:

§ 1.263A–0 Outline of regulations under

section 263A.

This section lists the paragraphs in

§§ 1.263A–1 through 1.263A–3 and

§ 1.263A–7 through 1.263A–15.

* * * * *

§ 1.263A–7 Changing a method of

accounting under section 263A.

(a) Introduction.

(1) Purpose.

(2) Taxpayers that adopt a method of

accounting under section 263A.

(3) Taxpayers that change a method of

accounting under section 263A.

(4) Effective date.

(5) Definition of change in method of

accounting.

(b) Rules applicable to a change in

method of accounting.

(1) General rules.

(2) Special rules.

(i) Ordering rules when multiple

changes in method of accounting occur

in the year of change.

(A) In general.

(B) Exceptions to the general ordering

rule.

(1) Change from the LIFO inventory

method.

(2) Change from the specific goods

LIFO inventory method.

(3) Change in overall method of

accounting.

(4) Change in method of accounting

for depreciation.

(ii) Adjustment required by section

481(a).

(iii) Base year.

(A) Need for a new base year.

(1) Facts and circumstances

revaluation method used.

(2) 3-year average method used.

(i) Simplified method not used.

(ii) Simplified method used.

(B) Computing a new base year.

(c) Inventory

(1) Need for adjustments.

(2) Revaluing beginning inventory.

(i) In general.

(ii) Methods to revalue inventory.

(iii) Facts and circumstances

revaluation method.

(A) In general.

(B) Exception.

(C) Estimates and procedures allowed.

(D) Use by dollar-value LIFO

taxpayers.

(E) Examples.

(iv) Weighted average method.

(A) In general.

(B) Weighted average method for FIFO

taxpayers.

(1) In general.

(2) Example.

(C) Weighted average method for

specific goods LIFO taxpayers.

(1) In general.

(2) Example.

(D) Adjustments to inventory costs

from prior years.

(v) 3-year average method.

(A) In general.

(B) Consecutive year requirement.

(C) Example.

(D) Short taxable years.

(E) Adjustments to inventory costs

from prior years.

(1) General rule.

(2) Examples of costs eligible for

restatement adjustment procedure.

(F) Restatement adjustment

procedure.

(1) In general.

(2) Examples of restatement

adjustment procedure.

(3) Intercompany items.

(i) Revaluing intercompany

transactions.

(ii) Example.

(iii) Availability of revaluation

methods.

(4) Anti-abuse rule.

(i) In general.

(ii) Deemed avoidance of this section.

(A) Scope.

(B) General rule.

(iii) Election to use transferor’s LIFO

layers.

(iv) Tax avoidance intent not

required.

(v) Related corporation.

(d) Non-inventory property.

(1) Need for adjustments.

(2) Revaluing property.

§ 1.263A–1 [Amended]

Par. 3. Section 1.263A–1 is amended

by removing ‘‘1.263A–7T(e) generally’’

from the last sentence in paragraph

(a)(2)(i) and replacing it with ‘‘1.263A–

7’’.

Par. 4. Section 1.263A–7 is added to

read as follows:

§ 1.263A–7 Changing a method of

accounting under section 263A.

(a) Introduction—(1) Purpose. These

regulations provide guidance to

taxpayers changing their methods of

accounting for costs subject to section

263A. The principal purpose of these
Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42055

regulations is to provide guidance

regarding how taxpayers are to revalue

property on hand at the beginning of the

taxable year in which they change their

method of accounting for costs subject

to section 263A. Paragraph (c) of this

section provides guidance regarding

how items or costs included in

beginning inventory in the year of

change must be revalued. Paragraph (d)

of this section provides guidance

regarding how non-inventory property

should be revalued in the year of

change.

(2) Taxpayers that adopt a method of

accounting under section 263A.

Taxpayers may adopt a method of

accounting for costs subject to section

263A in the first taxable year in which

they engage in resale or production

activities. For purposes of this section,

the adoption of a method of accounting

has the same meaning as provided in

§ 1.446–1(e)(1). Taxpayers are not

subject to the provisions of these

regulations to the extent they adopt, as

opposed to change, a method of

accounting.

(3) Taxpayers that change a method

of accounting under section 263A.

Taxpayers changing their method of

accounting for costs subject to section

263A are subject to the revaluation and

other provisions of this section.

Taxpayers subject to these regulations

include, but are not limited to—

(i) Resellers of personal property

whose average annual gross receipts for

the immediately preceding 3-year

period (or lesser period if the taxpayer

was not in existence for the three

preceding taxable years) exceed

$10,000,000 where the taxpayer was not

subject to section 263A in the prior

taxable year;

(ii) Resellers of real or personal

property that are using a method that

fails to comply with section 263A and

desire to change to a method of

accounting that complies with section

263A;

(iii) Producers of real or tangible

personal property that are using a

method that fails to comply with section

263A and desire to change to a method

of accounting that complies with section

263A; and

(iv) Resellers and producers that

desire to change from one permissible

method of accounting for costs subject

to section 263A to another permissible

method.

(4) Effective date. The provisions of

this section are effective for taxable

years beginning on or after August 5,

1997. For taxable years beginning before

August 5, 1997, the rules of § 1.263A–

7T contained in the 26 CFR part 1

edition revised as of April 1, 1997, as

modified by other administrative

guidance, will apply.

(5) Definition of change in method of

accounting. For purposes of this section,

a change in method of accounting has

the same meaning as provided in

§ 1.446–1(e)(2)(ii). Changes in method of

accounting for costs subject to section

263A include changes to methods

required or permitted by section 263A

and the regulations thereunder. Changes

in method of accounting may be

described in the preceding sentence

irrespective of whether the taxpayer’s

previous method of accounting resulted

in the capitalization of more (or fewer)

costs than the costs required to be

capitalized under section 263A and the

regulations thereunder, and irrespective

of whether the taxpayer’s previous

method of accounting was a permissible

method under the law in effect when

the method was being used. However,

changes in method of accounting for

costs subject to section 263A do not

include changes relating to factors other

than those described therein. For

example, a change in method of

accounting for costs subject to section

263A does not include a change from

one inventory identification method to

another inventory identification

method, such as a change from the lastin, first-out (LIFO) method to the firstin, first-out (FIFO) method, or vice

versa, or a change from one inventory

valuation method to another inventory

valuation method under section 471,

such as a change from valuing inventory

at cost to valuing the inventory at cost

or market, whichever is lower, or vice

versa. In addition, a change in method

of accounting for costs subject to section

263A does not include a change within

the LIFO inventory method, such as a

change from the double extension

method to the link-chain method, or a

change in the method used for

determining the number of pools.

Further, a change from the modified

resale method set forth in Notice 89–67

(1989–1 C.B. 723), see § 601.601(d)(2) of

this chapter, to the simplified resale

method set forth in § 1.263A–3(d) is not

a change in method of accounting

within the meaning of § 1.446–1(e)(2)(ii)

and is therefore not subject to the

provisions of this section. However, a

change from the simplified resale

method set forth in former § 1.263A–

1T(d)(4) to the simplified resale method

set forth in § 1.263A–3(d) is a change in

method of accounting within the

meaning of § 1.446–1(e)(2)(ii) and is

subject to the provisions of this section.

(b) Rules applicable to a change in

method of accounting—

(1) General rules. All changes in

method of accounting for costs subject

to section 263A are subject to the rules

and procedures provided by the Code,

regulations, and administrative

procedures applicable to such changes.

The Internal Revenue Service has issued

specific revenue procedures that govern

certain accounting method changes for

costs subject to section 263A. Where a

specific revenue procedure is not

applicable, changes in method of

accounting for costs subject to section

263A are subject to the same rules and

procedures that govern other accounting

method changes. See Rev. Proc. 97–27

(1997–21 I.R.B. 10) and § 601.601(d)(2)

of this chapter.

(2) Special rules—(i) Ordering rules

when multiple changes in method of

accounting occur in the year of change.

(A) In general. A change in method of

accounting for costs subject to section

263A is generally deemed to occur

(including the computation of the

adjustment under section 481(a)) before

any other change in method of

accounting is deemed to occur for that

same taxable year.

(B) Exceptions to the general ordering

rule—(1) Change from the LIFO

inventory method. In the case of a

taxpayer that is discontinuing its use of

the LIFO inventory method in the same

taxable year it is changing its method of

accounting for costs subject to section

263A, the change from the LIFO method

may be made before the change in

method of accounting (and the

computation of the corresponding

adjustment under section 481 (a)) under

section 263A is made.

(2) Change from the specific goods

LIFO inventory method. In the case of a

taxpayer that is changing from the

specific goods LIFO inventory method

to the dollar-value LIFO inventory

method in the same taxable year it is

changing its method of accounting for

costs subject to section 263A, the

change from the specific goods LIFO

inventory method may be made before

the change in method of accounting

under section 263A is made.

(3) Change in overall method of

accounting. In the case of a taxpayer

that is changing its overall method of

accounting from the cash receipts and

disbursements method to an accrual

method in the same taxable year it is

changing its method of accounting for

costs subject to section 263A, the

taxpayer must change to an accrual

method for capitalizable costs (see

§ 1.263A–1(c)(2)(ii)) before the change

in method of accounting (and the

computation of the corresponding

adjustment under section 481(a)) under

section 263A is made.

(4) Change in method of accounting

for depreciation. In the case of a
42056 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

taxpayer that is changing its method of

accounting for depreciation in the same

taxable year it is changing its method of

accounting for costs subject to section

263A and any portion of the

depreciation is subject to section 263A,

the change in method of accounting for

depreciation must be made before the

change in method of accounting (and

the computation of the corresponding

adjustment under section 481(a)) under

section 263A is made.

(ii) Adjustment required by section

481(a). In the case of any taxpayer

required or permitted to change its

method of accounting for any taxable

year under section 263A and the

regulations thereunder, the change will

be treated as initiated by the taxpayer

for purposes of the adjustment required

by section 481(a). The adjustment

required by section 481(a) is to be taken

into account in computing taxable

income over a period not to exceed 4

taxable years.

(iii) Base year—(A) Need for a new

base year. Certain dollar-value LIFO

taxpayers (whether using double

extension or link-chain) must establish

a new base year when they revalue their

inventories under section 263A.

(1) Facts and circumstances

revaluation method used. A dollar-value

LIFO taxpayer that uses the facts and

circumstances revaluation method is

permitted, but not required, to establish

a new base year.

(2) 3-year average method used—(i)

Simplified method not used. A dollarvalue LIFO taxpayer using the 3-year

average method but not the simplified

production method or the simplified

resale method to revalue its inventory is

required to establish a new base year.

(ii) Simplified method used. A dollarvalue LIFO taxpayer using the 3-year

average method and either the

simplified production method or the

simplified resale method to revalue its

inventory is permitted, but not required,

to establish a new base year.

(B) Computing a new base year. For

purposes of determining future indexes,

the year of change becomes the new

base year (that is, the index at the

beginning of the year of change

generally must be 1.00) and all costs are

restated in new base year costs for

purposes of extending such costs in

future years. However, when a new base

year is established, costs associated with

old layers retain their separate identity

within the base year, with such layers

being restated in terms of the new base

year index. For example, for purposes of

determining whether a particular layer

has been invaded, each layer must

retain its separate identity. Thus, if a

decrement in an inventory pool occurs,

layers accumulated in more recent years

must be viewed as invaded first, in

order of priority.

(c) Inventory—(1) Need for

adjustments. When a taxpayer changes

its method of accounting for costs

subject to section 263A, the taxpayer

generally must, in computing its taxable

income for the year of change, take into

account the adjustments required by

section 481(a). The adjustments

required by section 481(a) relate to

revaluations of inventory property,

whether the taxpayer produces the

inventory or acquires it for resale. See

paragraph (d) of this section in regard to

the adjustments required by section

481(a) that relate to non-inventory

property.

(2) Revaluing beginning inventory—(i)

In general. If a taxpayer changes its

method of accounting for costs subject

to section 263A, the taxpayer must

revalue the items or costs included in its

beginning inventory in the year of

change as if the new method (that is, the

method to which the taxpayer is

changing) had been in effect during all

prior years. In revaluing inventory costs

under this procedure, all of the

capitalization provisions of section

263A and the regulations thereunder

apply to all inventory costs accumulated

in prior years. The necessity to revalue

beginning inventory as if these

capitalization rules had been in effect

for all prior years includes, for example,

the revaluation of costs or layers

incurred in taxable years preceding the

transition period to the full absorption

method of inventory costing as

described in § 1.471–11(e), regardless of

whether a taxpayer employed a cut-off

method under those regulations. The

difference between the inventory as

originally valued using the former

method (that is, the method from which

the taxpayer is changing) and the

inventory as revalued using the new

method is equal to the amount of the

adjustment required under section

481(a).

(ii) Methods to revalue inventory.

There are three methods available to

revalue inventory. The first method, the

facts and circumstances revaluation

method, may be used by all taxpayers.

Under this method, a taxpayer

determines the direct and indirect costs

that must be assigned to each item of

inventory based on all the facts and

circumstances. This method is

described in paragraph (c)(2)(iii) of this

section. The second method, the

weighted average method, is available

only in certain situations to taxpayers

using the FIFO inventory method or the

specific goods LIFO inventory method.

This method is described in paragraph

(c)(2)(iv) of this section. The third

method, the 3-year average method, is

available to all taxpayers using the

dollar-value LIFO inventory method of

accounting. This method is described in

paragraph (c)(2)(v) of this section. The

weighted average method and the 3-year

average method revalue inventory

through processes of estimation and

extrapolation, rather than based on the

facts and circumstances of a particular

year’s data. All three methods are

available regardless of whether the

taxpayer elects to use a simplified

method to capitalize costs under section

263A.

(iii) Facts and circumstances

revaluation method—(A) In general.

Under the facts and circumstances

revaluation method, a taxpayer

generally is required to revalue

inventories by applying the

capitalization rules of section 263A and

the regulations thereunder to the

production and resale activities of the

taxpayer, with the same degree of

specificity as required of inventory

manufacturers under the law

immediately prior to the effective date

of the Tax Reform Act of 1986 (Pub. L.

99–514, 100 Stat. 2085, 1986–3 C.B.

(Vol. 1)). Thus, for example, with

respect to any prior year that is relevant

in determining the total amount of the

revalued balance as of the beginning of

the year of change, the taxpayer must

analyze the production and resale data

for that particular year and apply the

rules and principles of section 263A and

the regulations thereunder to determine

the appropriate revalued inventory

costs. However, under the facts and

circumstances revaluation method, a

taxpayer may utilize reasonable

estimates and procedures in valuing

inventory costs if—

(1) The taxpayer lacks, and is not able

to reconstruct from its books and

records, actual financial and accounting

data which is required to apply the

capitalization rules of section 263A and

the regulations thereunder to the

relevant facts and circumstances

surrounding a particular item of

inventory or cost; and

(2) The total amounts of costs for

which reasonable estimates and

procedures are employed are not

significant in comparison to the total

restated value (including costs

previously capitalized under the

taxpayer’s former method) of the items

or costs for the period in question.

(B) Exception. A taxpayer that is not

able to comply with the requirement of

paragraph (c)(2)(iii)(A)(2) of this section

because of the existence of a significant

amount of costs that would require the

use of estimates and procedures must
Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42057

revalue its inventories under the

procedures provided in paragraph

(c)(2)(iv) or (v) of this section.

(C) Estimates and procedures allowed.

The estimates and procedures of this

paragraph (c)(2)(iii) include—

(1) The use of available information

from more recent years to estimate the

amount and nature of inventory costs

applicable to earlier years; and

(2) The use of available information

with respect to comparable items of

inventory produced or acquired during

the same year in order to estimate the

costs associated with other items of

inventory.

(D) Use by dollar-value LIFO

taxpayers. Generally, a dollar-value

LIFO taxpayer must recompute its LIFO

inventory for each taxable year that the

LIFO inventory method was used.

(E) Examples. The provisions of this

paragraph (c)(2)(iii) are illustrated by

the following three examples. The

principles set forth in these examples

are applicable both to production and

resale activities and the year of change

in all three examples is 1997. The

examples read as follows:

Example 1. Taxpayer X lacks information

for the years 1993 and earlier, regarding the

amount of costs incurred in transporting

finished goods from X’s factory to X’s

warehouse and in storing those goods at the

warehouse until their sale to customers. X

determines that, for 1994 and subsequent

years, these transportation and storage costs

constitute 4 percent of the total costs of

comparable goods under X’s method of

accounting for such years. Under this

paragraph (c)(2)(iii), X may assume that

transportation and storage costs for the years

1993 and earlier constitute 4 percent of the

total costs of such goods.

Example 2. Assume the same facts as in

Example 1, except that for the year 1993 and

earlier, X used a different method of

accounting for inventory costs whereunder

significantly fewer costs were capitalized

than amounts capitalized in later years. Thus,

the application of transportation and storage

based on a percentage of costs for 1994 and

later years would not constitute a reasonable

estimate for use in earlier years. X may use

the information from 1994 and later years, if

appropriate adjustments are made to reflect

the differences in inventory costs for the

applicable years, including, for example—

(i) Increasing the percentage of costs that

are intended to represent transportation and

storage costs to reflect the aggregate

differences in capitalized amounts under the

two methods of accounting; or

(ii) Taking the absolute dollar amount of

transportation and storage costs for

comparable goods in inventory and applying

that amount (adjusted for changes in general

price levels, where appropriate) to goods

associated with 1993 and prior periods.

Example 3. Taxpayer Z lacks information

for certain years with respect to factory

administrative costs, subject to capitalization

under section 263A and the regulations

thereunder, incurred in the production of

inventory in factory A. Z does have sufficient

information to determine factory

administrative costs with respect to

production of inventory in factory B, wherein

inventory items were produced during the

same years as factory A. Z may use the

information from factory B to determine the

appropriate amount of factory administrative

costs to capitalize as inventory costs for

comparable items produced in factory A

during the same years.

(iv) Weighted average method—(A) In

general. A taxpayer using the FIFO

method or the specific goods LIFO

method of accounting for inventories

may use the weighted average method

as provided in this paragraph (c)(2)(iv)

to estimate the change in the amount of

costs that must be allocated to

inventories for prior years. The

weighted average method under this

paragraph (c)(2)(iv) is only available to

a taxpayer that lacks sufficient data to

revalue its inventory costs under the

facts and circumstances revaluation

method provided for in paragraph

(c)(2)(iii) of this section. Moreover, a

taxpayer that qualifies for the use of the

weighted average method under this

paragraph (c)(2)(iv) must utilize such

method only with respect to items or

costs for which it lacks sufficient

information to revalue under the facts

and circumstances revaluation method.

Particular items or costs must be

revalued under the facts and

circumstances revaluation method if

sufficient information exists to make

such a revaluation. If a taxpayer lacks

sufficient information to otherwise

apply the weighted average method

under this paragraph (c)(2)(iv) (for

example, the taxpayer is unable to

revalue the costs of any of its items in

inventory due to a lack of information),

then the taxpayer must use reasonable

estimates and procedures, as described

in the facts and circumstances

revaluation method, to whatever extent

is necessary to allow the taxpayer to

apply the weighted average method.

(B) Weighted average method for FIFO

taxpayers—(1) In general. This

paragraph (c)(2)(iv)(B) sets forth the

mechanics of the weighted average

method as applicable to FIFO taxpayers.

Under the weighted average method, an

item in ending inventory for which

sufficient data is not available for

revaluation under section 263A and the

regulations thereunder must be revalued

by using the weighted average

percentage increase or decrease with

respect to such item for the earliest

subsequent taxable year for which

sufficient data is available. With respect

to an item for which no subsequent data

exists, such item must be revalued by

using the weighted average percentage

increase or decrease with respect to all

reasonably comparable items in the

taxpayer’s inventory for the same year

or the earliest subsequent taxable year

for which sufficient data is available.

(2) Example. The provisions of this

paragraph (c)(2)(iv)(B) are illustrated by

the following example. The principles

set forth in this example are applicable

both to production and resale activities

and the year of change in the example

is 1997. The example reads as follows:

Example. Taxpayer A manufactures bolts

and uses the FIFO method to identify

inventories. Under A’s former method, A did

not capitalize all of the costs required to be

capitalized under section 263A. A maintains

inventories of bolts, two types of which it no

longer produces. Bolt A was last produced in

1994. The revaluation of the costs of Bolt A

under this section for bolts produced in 1994

results in a 20 percent increase of the costs

of Bolt A. A portion of the inventory of Bolt

A, however, is attributable to 1993. A does

not have sufficient data for revaluation of the

1993 cost for Bolt A. With respect to Bolt A,

A may apply the 20 percent increase

determined for 1994 to the 1993 production

as an acceptable estimate. Bolt B was last

produced in 1992 and no data exists that

would allow revaluation of the inventory cost

of Bolt B. The inventories of all other bolts

for which information is available are

attributable to 1994 and 1995. Revaluation of

the costs of these other bolts using available

data results in an average increase in

inventory costs of 15 percent for 1994

production. With respect to Bolt B, the

overall 15 percent increase for A’s inventory

for 1994 may be used in revaluing the cost

of Bolt B.

(C) Weighted average method for

specific goods LIFO taxpayers—(1) In

general. This paragraph (c)(2)(iv)(C) sets

forth the mechanics of the weighted

average method as applicable to LIFO

taxpayers using the specific goods

method of valuing inventories. Under

the weighted average method, the

inventory layers with respect to an item

for which data is available are revalued

under this section and the increase or

decrease in amount for each layer is

expressed as a percentage of change

from the cost in the layer as originally

valued. A weighted average of the

percentage of change for all layers for

each type of good is computed and

applied to all earlier layers for each type

of good that lack sufficient data to allow

for revaluation. In the case of earlier

layers for which sufficient data exists,

such layers are to be revalued using

actual data. In cases where sufficient

data is not available to make a weighted

average estimate with respect to a

particular item of inventory, a weighted

average increase or decrease is to be

determined using all other inventory

items revalued by the taxpayer in the
42058 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

same specific goods grouping. This

percentage increase or decrease is then

used to revalue the cost of the item for

which data is lacking. If the taxpayer

lacks sufficient data to revalue any of

the inventory items contained in a

specific goods grouping, then the

weighted average increase or decrease of

substantially similar items (as

determined by principles similar to the

rules applicable to dollar-value LIFO

taxpayers in § 1.472–8(b)(3)) must be

applied in the revaluation of the items

in such grouping. If insufficient data

exists with respect to all the items in a

specific goods grouping and to all items

that are substantially similar (or such

items do not exist), then the weighted

average for all revalued items in the

taxpayer’s inventory must be applied in

revaluing items for which data is

lacking. (2) Example. The provisions of this

paragraph (c)(2)(iv)(C) are illustrated by

the following example. The principles

set forth in this example are applicable

both to production and resale activities

and the year of change in the example

is 1997. The example reads as follows:

Example. (i) Taxpayer M is a manufacturer

that produces two different parts. Under M’s

former method, M did not capitalize all of the

costs required to be capitalized under section

263A. Work-in-process inventory is recorded

in terms of equivalent units of finished

goods. M’s records show the following at the

end of 1996 under the specific goods LIFO

inventory method:

LIFO Product and layer Number Cost Carrying

values

Product #1:

1993 ...................................................................................................................................... 150 $5.00 $750

1994 ...................................................................................................................................... 100 6.00 600

1995 ...................................................................................................................................... 100 6.50 650

1996 ...................................................................................................................................... 50 7.00 350

$2,350

Product #2:

1993 ...................................................................................................................................... 200 $4.00 $800

1994 ...................................................................................................................................... 200 4.50 900

1995 ...................................................................................................................................... 100 5.00 500

1996 ...................................................................................................................................... 100 6.00 600

2,800

Total carrying value of Products #1 and #2 under M’s former method ......................... ........................ ........................ 5,150

(ii) M has sufficient data to revalue the unit

costs of Product #1 using its new method for

1994, 1995 and 1996. These costs are: $7.00

in 1994, $7.75 in 1995, and $9.00 in 1996.

This data for Product #1 results in a weighted

average percentage change of 20.31 percent

((100×($7.00¥$6.00))+(100×($7.75¥$6.50))+

(50×($9.00¥$7.00)) divided by (100×$6.00) +

(100×$6.50) + (50×$7.00)]. M has sufficient

data to revalue the unit costs of Product #2

only in 1995 and 1996. These costs are: $6.00

in 1995 and $7.00 in 1996. This data for

Product #2 results in a weighted average

percentage change of 18.18 percent

[(100×($6.00¥$5.00))+(100×($7.00¥$6.00))

divided by (100×$5.00)+(100×$6.00)].

(iii) M can estimate its revalued costs for

Product #1 for 1993 by applying the weighted

average increase computed for Product #1

(20.31 percent) to the unit costs originally

carried on M’s records for 1993 under M’s

former method. The estimated revalued unit

cost of Product #1 would be $6.02

($5.00×1.2031). M estimates its revalued

costs for Product #2 for 1993 and 1994 in a

similar fashion. M applies the weighted

average increase determined for Product #2

(18.18 percent) to the unit costs of $4.00 and

$4.50 for 1993 and 1994 respectively. The

revalued unit costs of Product #2 are $4.73

for 1993 ($4.00×1.1818) and $5.32 for 1994

($4.50×1.1818).

(iv) M’s inventory would be revalued as

follows:

LIFO product and layer Number Cost Carrying

values

Product #1:

1993 ...................................................................................................................................... 150 $6.02 $903

1994 ...................................................................................................................................... 100 7.00 700

1995 ...................................................................................................................................... 100 7.75 775

1996 ...................................................................................................................................... 50 9.00 450

$2,828

Product #2:

1993 ...................................................................................................................................... 200 4.73 946

1994 ...................................................................................................................................... 200 5.32 1,064

1995 ...................................................................................................................................... 100 6.00 600

1996 ...................................................................................................................................... 100 7.00 700

3,310

Total value of Products #1 and #2 as revalued under M’s new method ...................... ........................ ........................ 6,138

Total amount of adjustment required under section 481(a) [$6,138¥$5,150] ............. ........................ ........................ 988

(D) Adjustments to inventory costs

from prior years. For special rules

applicable when a revaluation using the

weighted average method includes costs

not incurred in prior years, see

paragraph (c)(2)(v)(E) of this section.

(v) 3-year average method—(A) In

general. A taxpayer using the dollarvalue LIFO method of accounting for

inventories may revalue all existing

LIFO layers of a trade or business based

on the 3-year average method as
Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42059

provided in this paragraph (c)(2)(v). The

3-year average method is based on the

average percentage change (the 3-year

revaluation factor) in the current costs

of inventory for each LIFO pool based

on the three most recent taxable years

for which the taxpayer has sufficient

information (typically, the three most

recent taxable years of such trade or

business). The 3-year revaluation factor

is applied to all layers for each pool in

beginning inventory in the year of

change. The 3-year average method is

available to any dollar-value taxpayer

that complies with the requirements of

this paragraph (c)(2)(v) regardless of

whether such taxpayer lacks sufficient

data to revalue its inventory costs under

the facts and circumstances revaluation

method prescribed in paragraph

(c)(2)(iii) of this section. The 3-year

average method must be applied with

respect to all inventory in a taxpayer’s

trade or business. A taxpayer is not

permitted to apply the method for the

revaluation of some, but not all,

inventory costs on the basis of pools,

business units, or other measures of

inventory amounts that do not

constitute a separate trade or business.

Generally, a taxpayer revaluing its

inventory using the 3-year average

method must establish a new base year.

See, paragraph (b)(2)(iii)(A)(2)(i) of this

section. However, a dollar-value LIFO

taxpayer using the 3-year average

method and either the simplified

production method or the simplified

resale method to revalue its inventory is

permitted, but not required, to establish

a new base year. See, paragraph

(b)(2)(iii)(A)(2)(ii) of this section. If a

taxpayer lacks sufficient information to

otherwise apply the 3-year average

method under this paragraph (c)(2)(v)

(for example, the taxpayer is unable to

revalue the costs of any of its LIFO

pools for three years due to a lack of

information), then the taxpayer must

use reasonable estimates and

procedures, as described in the facts and

circumstances revaluation method

under paragraph (c)(2)(iii) of this

section, to whatever extent is necessary

to allow the taxpayer to apply the 3-year

average method.

(B) Consecutive year requirement.

Under the 3-year average method, if

sufficient data is available to calculate

the revaluation factor for more than

three years, the taxpayer may use data

from such additional years in

determining the average percentage

increase or decrease only if the

additional years are consecutive to and

prior to the year of change. The

requirement under the preceding

sentence to use consecutive years is

applicable under this method regardless

of whether any inventory costs in

beginning inventory as of the year of

change are viewed as incurred in, or

attributable to, those consecutive years

under the LIFO inventory method.

Thus, the requirement to use data from

consecutive years may result in using

information from a year in which no

LIFO increment occurred. For example,

if a taxpayer is changing its method of

accounting in 1997 and has sufficient

data to revalue its inventory for the

years 1991 through 1996, the taxpayer

may calculate the revaluation factor

using all six years. If, however, the

taxpayer has sufficient data to revalue

its inventory for the years 1990 through

1992, and 1994 through 1996, only the

three years consecutive to the year of

change, that is, 1994 through 1996, may

be used in determining the revaluation

factor. Similarly, for example, a

taxpayer with LIFO increments in 1995,

1993, and 1992 may not calculate the

revaluation factor based on the data

from those years alone, but instead must

use the data from consecutive years for

which the taxpayer has information.

(C) Example. The provisions of this

paragraph (c)(2)(v) are illustrated by the

following example. The principles set

forth in this example are applicable both

to production and resale activities and

the year of change in the example is

1997. The example reads as follows:

Example. (i) Taxpayer G, a calendar year

taxpayer, is a reseller that is required to

change its method of accounting under

section 263A. G will not use either the

simplified production method or the

simplified resale method. G adopted the

dollar-value LIFO inventory method in 1991,

using a single pool and the double extension

method. G’s beginning LIFO inventory as of

January 1, 1997, computed using its former

method, for the year of change is as follows:

Base year

costs Index LIFO carryingvalue

Base layer $14,000 1.00 $14,000

1991 layer ..................................................................................................................................... 4,000 1.20 4,800

1992 layer ..................................................................................................................................... 5,000 1.30 6,500

1993 layer ..................................................................................................................................... 2,000 1.35 2,700

1994 layer ..................................................................................................................................... 0 1.40 0

1995 layer ..................................................................................................................................... 4,000 1.50 6,000

1996 layer ..................................................................................................................................... 5,000 1.60 8,000

Total ...................................................................................................................................... 34,000 ........................ 42,000

(ii) G is able to recompute total inventoriable costs incurred under its new method for the three preceding taxable years as

follows:

Current cost

as recorded

(former

method)

Current cost

as adjusted

(new method)

Percentage

change

1994 .............................................................................................................................................. $35,000 $45,150 .29

1995 .............................................................................................................................................. 43,500 54,375 .25

1996 .............................................................................................................................................. 54,400 70,720 .30

Total ...................................................................................................................................... 132,900 170,245 .28

(iii) Applying the average revaluation factor of .28 to each layer, G’s inventory is restated as follows:

Restated base

year costs Index Restated LIFOcarrying value

Base layer .................................................................................................................................... $17,920 1.00 $17,920
42060 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

Restated base

year costs Index Restated LIFOcarrying value

1991 layer ..................................................................................................................................... 5,120 1.20 6,144

1992 layer ..................................................................................................................................... 6,400 1.30 8,320

1993 layer ..................................................................................................................................... 2,560 1.35 3,456

1994 layer ..................................................................................................................................... 0 1.40 0

1995 layer ..................................................................................................................................... 5,120 1.50 7,680

1996 layer ..................................................................................................................................... 6,400 1.60 10,240

Total ...................................................................................................................................... 43,520 ........................ 53,760

(iv) The adjustment required by section 481(a) is $11,760. This amount may be computed by multiplying the average percentage

of .28 by the LIFO carrying value of G’s inventory valued using its former method ($42,000). Alternatively, the adjustment required

by section 481(a) may be computed by the difference between—

(A) The revalued costs of the taxpayer’s inventory under its new method ($53,760), and

(B) The costs of the taxpayer’s inventory using its former method ($42,000).

(v) In addition, the inventory as of the first day of the year of change (January 1, 1997) becomes the new base year cost for

purposes of determining the LIFO index in future years. See, paragraphs (b)(2)(iii)(A)(2)(i) and (b)(2)(iii)(B) of this section. This requires

that layers in years prior to the base year be restated in terms of the new base year index. The current year cost of G’s inventory,

as adjusted, is $70,720. Such cost must be apportioned to each layer in proportion to the restated base year cost of that layer to

total restated base year costs ($43,520), as follows:

Restated base

year costs

Restated

index

Restated LIFO

carrying value

Old base layer .............................................................................................................................. $29,120 .615 $17,920

1991 layer ..................................................................................................................................... 8,320 .738 6,144

1992 layer ..................................................................................................................................... 10,400 .80 8,320

1993 layer ..................................................................................................................................... 4,160 .831 3,456

1994 layer ..................................................................................................................................... 0 ........................ 0

1995 layer ..................................................................................................................................... 8,320 .923 7,680

1996 layer ..................................................................................................................................... 10,400 .985 10,240

Total ............................................................................................................................... 70,720 ........................ 53,760

(D) Short taxable years. A short

taxable year is treated as a full 12

months.

(E) Adjustments to inventory costs

from prior years—(1) General rule—(i)

The use of the revaluation factor, based

on current costs, to estimate the

revaluation of prior inventory layers

under the 3-year average method, as

described in paragraph (c)(2)(v) of this

section, may result in an allocation of

costs that include amounts attributable

to costs not incurred during the year in

which the layer arose. To the extent a

taxpayer can demonstrate that costs that

contributed to the determination of the

revaluation factor could not have

affected a prior year, the revaluation

factor as applied to that year may be

adjusted under the restatement

adjustment procedure, as described in

paragraph (c)(2)(v)(F) of this section.

The determination that a cost could not

have affected a prior year must be made

by a taxpayer only upon showing that

the type of cost incurred during the

years used to calculate the revaluation

factor (revaluation years) was not

present during such prior year. An item

of cost will not be eligible for the

restatement adjustment procedure

simply because the cost varies in

amount from year to year or the same

type of cost is described or referred to

by a different name from year to year.

Thus, the restatement adjustment

procedure allowed under paragraph

(c)(2)(v)(F) of this section is not

available in a prior year with respect to

a particular cost if the same type of cost

was incurred both in the revaluation

years and in such prior year, although

the amount of such cost and the name

or description thereof may vary.

(ii) The provisions of this paragraph

(c)(2)(v)(E) are also applicable to

taxpayers using the weighted average

method in revaluing inventories under

paragraph (c)(2)(iv) of this section.

Thus, to the extent a taxpayer can

demonstrate that costs that contributed

to the determination of the restatement

of a particular year or item could not

have affected a prior year or item, the

taxpayer may adjust the revaluation of

that prior year or item accordingly

under the weighted average method. All

the requirements and definitions,

however, applicable to the restatement

adjustment procedure under this

paragraph (c)(2)(v)(E) fully apply to a

taxpayer using the weighted average

method to revalue inventories.

(2) Examples of costs eligible for

restatement adjustment procedure. The

provisions of this paragraph (c)(2)(v)(E)

are illustrated by the following four

examples. The principles set forth in

these examples are applicable both to

production and resale activities and the

year of change in the four examples is

1997. The examples read as follows:

Example 1. Taxpayer A is a reseller that

introduced a defined benefit pension plan in

1994, and made the plan available to

personnel whose labor costs were (directly or

indirectly) properly allocable to resale

activities. A determines the revaluation factor

based on data available for the years 1994

through 1996, for which the pension plan

was in existence. Based on these facts, the

costs of the pension plan in the revaluation

years are eligible for the restatement

adjustment procedure for years prior to 1994.

Example 2. Assume the same facts as in

Example 1, except that a defined

contribution plan was available, during prior

years, to personnel whose labor costs were

properly allocable to resale activities. The

defined contribution plan was terminated

before the introduction of the defined benefit

plan in 1994. Based on these facts, the costs

of the defined benefit pension plan in the

revaluation years are not eligible for the

restatement adjustment procedure with

respect to years for which the defined

contribution plan existed.

Example 3. Taxpayer C is a manufacturer

that established a security department in

1995 to patrol and safeguard its production

and warehouse areas used in C’s trade or

business. Prior to 1995, C had not been

required to utilize security personnel in its

trade or business; C established the security

department in 1995 in response to increasing

vandalism and theft at its plant locations.

Based on these facts, the costs of the security
Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations 42061

department are eligible for the restatement

adjustment procedure for years prior to 1995.

Example 4. Taxpayer D is a reseller that

established a payroll department in 1995 to

process the company’s weekly payroll. In the

years 1991 through 1994, D engaged the

services of an outside vendor to process the

company’s payroll. Prior to 1991, D’s payroll

processing was done by D’s accounting

department, which was responsible for

payroll processing as well as for other

accounting functions. Based on these facts,

the costs of the payroll department are not

eligible for the restatement adjustment

procedure. D was incurring the same type of

costs in earlier years as D was incurring in

the payroll department in 1995 and

subsequent years, although these costs were

designated by a different name or

description.

(F) Restatement adjustment

procedure—(1) In general—(i) This

paragraph (c)(2)(v)(F) provides a

restatement adjustment procedure

whereunder a taxpayer may adjust the

restatement of inventory costs in prior

taxable years in order to produce a

different restated value than the value

that would otherwise occur through

application of the revaluation factor to

such prior taxable years.

(ii) Under the restatement adjustment

procedure as applied to a particular

prior year, a taxpayer must determine

the particular items of cost that are

eligible for the restatement adjustment

with respect to such prior year. The

taxpayer must then recompute, using

reasonable estimates and procedures,

the total inventoriable costs that would

have been incurred for each revaluation

year under the taxpayer’s former

method and the taxpayer’s new method

by making appropriate adjustments in

the data for such revaluation year to

reflect the particular costs eligible for

adjustment.

(iii) The taxpayer must then compute

the total percentage change with respect

to each revaluation year, using the

revised estimates of total inventoriable

costs for such year as described in

paragraph (c)(2)(v)(F)(1)(ii) of this

section. The percentage change must be

determined by calculating the ratio of

the revised total of the inventoriable

costs for such revaluation year under

the taxpayer’s new method to the

revised total of the inventoriable costs

for such revaluation year under the

taxpayer’s former method.

(iv) An average of the resulting

percentage change for all revaluation

years is then calculated, and the

resulting average is applied to the prior

year in issue.

(2) Examples of restatement

adjustment procedure. The provisions

of this paragraph (c)(2)(v)(F) are

illustrated by the following two

examples. The principles set forth in

these examples are applicable both to

production and resale activities and the

year of change in the two examples is

1997. The examples read as follows:

Example 1. Taxpayer A is a reseller that is

eligible to make a restatement adjustment by

reason of the costs of a defined benefit

pension plan that was introduced in 1994,

during the revaluation period. The

revaluation factor, before adjustment of data

to reflect the pension costs, is as provided in

the example in paragraph (c)(2)(v)(C) of this

section. Thus, for example, with respect to

the year 1994, the total inventoriable costs

under A’s former method is $35,000, the total

inventoriable costs under A’s new method is

$45,150, and the percentage change is .29.

Under the method of accounting used by A

during 1994 (the former method), none of the

pension costs were included as inventoriable

costs. Thus, under the restatement

adjustment procedure, the total inventoriable

cost under A’s former method would remain

at $35,000 if the pension plan had not been

in existence. Similarly, A determines that the

total inventoriable costs for 1994 under A’s

new method, if the pension plan had not

been in existence, would have been $42,000.

The restatement adjustment for 1994

determined under this paragraph (c)(2)(v)(F)

would then be equal to .20 ([$42,000–

$35,000]/$35,000). A would make similar

calculations with respect to 1995 and 1996.

The average of such amounts for each of the

three years in the revaluation period would

then be determined as in the example in

paragraph (c)(2)(v)(C) of this section. Such

average would be used to revalue cost layers

for years for which the pension plan was not

in existence. Such revalued layers would

then be viewed as restated in compliance

with the requirements of this paragraph.

With respect to cost layers incurred during

years for which the pension plan was in

existence, no adjustment of the revaluation

factor would occur.

Example 2. Assume the same facts as in

Example 1, except that a portion of the

pension costs were included as inventoriable

costs under the method used by A during

1994 (the former method). Under the

restatement adjustment procedure, A

determines that the total inventoriable costs

for 1994 under the former method, if the

pension plan had not been in existence,

would have been $34,000. Similarly, A

determines that the total inventoriable costs

for 1994 under A’s new method, if the

pension plan had not been in existence,

would have been $42,000. The restatement

adjustment for 1994 determined under this

paragraph (c)(2)(v)(F) would then be equal to

.24 ([$42,000–$34,000]/$34,000). A would

make similar calculations with respect to

1995 and 1996. The average of such amounts

for each of the three years in the revaluation

period would then be determined as in the

example in paragraph (c)(2)(v)(C) of this

section. Such average would be used to

revalue cost layers for years for which the

pension plan was not in existence.

(3) Intercompany items—(i) Revaluing

intercompany transactions. Pursuant to

any change in method of accounting for

costs subject to section 263A, taxpayers

are required to revalue the amount of

any intercompany item resulting from

the sale or exchange of inventory

property in an intercompany transaction

to an amount equal to the intercompany

item that would have resulted, had the

cost of goods sold for that inventory

property been determined under the

taxpayer’s new method. The

requirement of the preceding sentence

applies with respect to both inventory

produced by a taxpayer and inventory

acquired by the taxpayer for resale. In

addition, the requirements of this

paragraph (c)(3) apply only to any

intercompany item of the taxpayer as of

the beginning of the year of change in

method of accounting. See § 1.1502–

13(b)(2)(ii). A taxpayer must revalue the

amount of any intercompany item only

if the inventory property sold in the

intercompany transaction is held as

inventory by a buying member as of the

date the taxpayer changes its method of

accounting under section 263A.

Corresponding changes to the

adjustment required under section

481(a) must be made with respect to any

adjustment of the intercompany item

required under this paragraph (c)(3).

Moreover, the requirements of this

paragraph (c)(3) apply regardless of

whether the taxpayer has any items in

beginning inventory as of the year of

change in method of accounting. See

§ 1.1502–13 for the definition of

intercompany transaction.

(ii) Example. The provisions of this

paragraph (c)(3) are illustrated by the

following example. The principles set

forth in this example are applicable both

to production and resale activities and

the year of change in the example is

1997. The example reads as follows:

Example. (i) Assume that S, a member of

a consolidated group filing its federal income

tax return on a calendar year, manufactures

and sells inventory property to B, a member

of the same consolidated group, in 1996. The

sale between S and B is an intercompany

transaction as defined under § 1.1502–

13(b)(1). The gain from the intercompany

transaction is an intercompany item to S

under § 1.1502–13(b)(2). As of the beginning

of the year of change in method of accounting

(January 1, 1997), the inventory property is

still held by B based on the particular

inventory method of accounting used by B

for federal income tax purposes (for example,

the LIFO or FIFO inventory method). The

property was sold by S to B in 1996 for $150;

the cost of goods sold with respect to the

property under the method in effect at the

time the inventory was produced was $100,

resulting in an intercompany item of $50 to

S under § 1.1502–13. As of January 1, 1997,

S still has an intercompany item of $50.

(ii) S is required to revalue the amount of

its intercompany item to an amount equal to

what the intercompany item would have
42062 Federal Register / Vol. 62, No. 150 / Tuesday, August 5, 1997 / Rules and Regulations

been had the cost of goods sold for that

inventory property been determined under

S’s new method. Assume that the cost of the

inventory under this method would have

been $110, had the method applied to S’s

manufacture of the property in 1996. Thus,

S is required to revalue the amount of its

intercompany item to $40 (that is, $150 less

$110), necessitating a negative adjustment to

the intercompany item of $10. Moreover, S is

required to increase its adjustment under

section 481(a) by $10 in order to prevent the

omission of such amount by virtue of the

decrease in the intercompany item.

(iii) Availability of revaluation

methods. In revaluing the amount of any

intercompany item resulting from the

sale or exchange of inventory property

in an intercompany transaction to an

amount equal to the intercompany item

that would have resulted had the cost of

goods sold for that inventory property

been determined under the taxpayer’s

new method, a taxpayer may use the

other methods and procedures

otherwise properly available to that

particular taxpayer in revaluing

inventory under section 263A and the

regulations thereunder, including, if

appropriate, the various simplified

methods provided in section 263A and

the regulations thereunder and the

various procedures described in this

paragraph (c). (4) Anti-abuse rule—(i) In general.

Section 263A(i)(1) provides that the

Secretary shall prescribe such

regulations as may be necessary or

appropriate to carry out the purposes of

section 263A, including regulations to

prevent the use of related parties, passthru entities, or intermediaries to avoid

the application of section 263A and the

regulations thereunder. One way in

which the application of section 263A

and the regulations thereunder would

be otherwise avoided is through the use

of entities described in the preceding

sentence in such a manner as to

effectively avoid the necessity to restate

beginning inventory balances under the

change in method of accounting

required or permitted under section

263A and the regulations thereunder. (ii) Deemed avoidance of this

section—(A) Scope. For purposes of this

paragraph (c), the avoidance of the

application of section 263A and the

regulations thereunder will be deemed

to occur if a taxpayer using the LIFO

method of accounting for inventories,

transfers inventory property to a related

corporation in a transaction described in

section 351, and such transfer occurs:

(1) On or before the beginning of the

transferor’s taxable year beginning in

1987; and

(2) After September 18, 1986.

(B) General rule. Any transaction

described in paragraph (c)(4)(ii)(A) of

this section will be treated in the

following manner:

(1) Notwithstanding any provision to

the contrary (for example, section 381),

the transferee corporation is required to

revalue the inventories acquired from

the transferor under the provisions of

this paragraph (c) relating to the change

in method of accounting and the

adjustment required by section 481(a),

as if the inventories had never been

transferred and were still in the hands

of the transferor; and

(2) Absent an election as described in

paragraph (c)(4)(iii) of this section, the

transferee must account for the

inventories acquired from the transferor

by treating such inventories as if they

were contained in the transferee’s LIFO

layer(s). (iii) Election to use transferor’s LIFO

layers. If a transferee described in

paragraph (c)(4)(ii) of this section so

elects, the transferee may account for

the inventories acquired from the

transferor by allocating such inventories

to LIFO layers corresponding to the

layers to which such properties were

properly allocated by the transferor,

prior to their transfer. The transferee

must account for such inventories for all

subsequent periods with reference to

such layers to which the LIFO costs

were allocated. Any such election is to

be made on a statement attached to the

timely filed federal income tax return of

the transferee for the first taxable year

for which section 263A and the

regulations thereunder applies to the

transferee.

(iv) Tax avoidance intent not

required. The provisions of paragraph

(c)(4)(ii) of this section will apply to any

transaction described therein, without

regard to whether such transaction was

consummated with an intention to

avoid federal income taxes.

(v) Related corporation. For purposes

of this paragraph (c)(4), a taxpayer is

related to a corporation if— (A) the relationship between such

persons is described in section

267(b)(1), or

(B) such persons are engaged in trades

or businesses under common control

(within the meaning of paragraphs (a)

and (b) of section 52).

(d) Non-inventory property—(1) Need

for adjustments. A taxpayer that

changes its method of accounting for

costs subject to section 263A with

respect to non-inventory property must

revalue the non-inventory property on

hand at the beginning of the year of

change as set forth in paragraph (d)(2)

of this section, and compute an

adjustment under section 481(a). The

adjustment under section 481(a) will

equal the difference between the

adjusted basis of the property as

revalued using the taxpayer’s new

method and the adjusted basis of the

property as originally valued using the

taxpayer’s former method.

(2) Revaluing property. A taxpayer

must revalue its non-inventory property

as of the beginning of the year of change

in method of accounting. The facts and

circumstances revaluation method of

paragraph (c)(2)(iii) of this section must

be used to revalue this property. In

revaluing non-inventory property,

however, the only additional section

263A costs that must be taken into

account are those additional section

263A costs incurred after the later of

December 31, 1986, or the date the

taxpayer first becomes subject to section

263A, in taxable years ending after that

date. See § 1.263A–1(d)(3) for the

definition of additional section 263A

costs.

§ 1.263A–7T [Removed]

Par. 5. Section 1.263A–7T is removed.

§ 1.263A–15 [Amended]

Par. 6. Section 1.263A–15 is amended

by removing ‘‘1.263A–7T (e) generally’’

from the last sentence in paragraph

(a)(1) and replacing it with ‘‘1.263A–7’’.

Dated: July 28, 1997.

Michael P. Dolan,

Acting Commissioner of Internal Revenue.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 97–20530 Filed 8–4–97; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF THE INTERIOR

Minerals Management Service

30 CFR Parts 210 and 218

RIN 1010–AC38

Designation of Payor Recordkeeping

AGENCY: Minerals Management Service,

Interior.

ACTION: Interim final rulemaking.

SUMMARY: The Minerals Management

Service (MMS) Royalty Management

Program (RMP) is amending its

regulations to authorize the collection of

information from lessees and payors

concerning designations by lessees of

other persons to make royalty and other

payments on their behalf.

DATES: This rule is effective August 5,

1997. Comments regarding this interim

final rulemaking and the information

collection must be received on or before

October 6, 1997.

ADDRESSES: Comments should be sent

to: David S. Guzy, Chief, Rules and

Publications Staff, Royalty Management