Capitalization of just-in-time manufacturing implementation costs.

• Author: Gordon, Frederick

The IRS has recently ruled in an unnumbered technical advice memorandum (TAM) (see BNA Daily Tax Report, 8/18/95) that a manufacturer must capitalize various costs incurred to adopt a just-in-time manufacturing process (JITM). The memorandum involved reconfiguration costs (to physically adapt the taxpayer's facilities to the JITM), acquisition costs of materials and supplies to be used in the JITM, employee training costs, and consulting costs related to implementing the JITM. The Service ruled that the taxpayer must capitalize these costs, since it would receive long-term future benefits from the change to its manufacturing process.

The JITM process generally combines several operations of production into a single work unit, or "cell." The goal is to eliminate nonutilized, work-in-process inventory by bringing manufactured units from a prior production stage to the next successive stage of production only when required. The cells perform the entire manufacturing process for an item previously done by various assembly lines.

The taxpayer adopted the JITM on a cell-by-cell basis to increase its productivity and competitiveness. To accomplish this, assembly lines were "reengineered" to combine previously segregated operations. (For example, factory layouts were changed to "U-line" configurations.)

In ruling against the deductibility of the taxpayer's overall reconfiguration costs, the IRS cited True, 894 F2d 1197 (10th Cir. 1990). In this case, the court looked at the effect that a move would have on the income-producing prospects of the assets moved in order to ascertain the deductibility of such move. Thus, in each case, the purpose, nature, extent and value of the work done must be examined. The IRS concluded that, based on the facts and circumstances, the taxpayer's reconfiguration costs were capital.

The Service found that the reconfiguration of the plants allowed the taxpayer to use its existing equipment in new and more efficient ways, and that the costs were part of an overall plan, capital in nature, to convert the taxpayer's facilities to the JITM. In addition to changing the physical characteristics of the plants, the plan required the acquisition of new equipment, and significantly improved the taxpayer's overall efficiency. The IRS cited INDOPCO, Inc., 503 US 79 (1992), for the proposition that increased operating efficiencies are a future benefit that may be taken into account in determining whether a cost is capital.

The...