Change in accounting method for trade discounts.

• Author: Luchs, Lorin D.

The IRS National Office recently corrected its "heads we win, tails you lose" approach to Form 3115, Application for Change in Accounting Method, filed for trade discounts. Trade discounts are adjustments to the purchase price granted by a vendor based on the volume or quantity of items purchased or other factors established by the vendor. Trade discounts do not include reductions in the purchase price attributable to payment within a prescribed period of time, compensation for services provided or a reimbursement of expenditures.

There has been no recent disagreement as to the proper method of accounting for trade discounts. Regs. Sec. 1.471-3(b) clearly provides that cost means "in the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed." Accordingly, trade discounts are taken into account in arriving at inventory cost as a reduction to the invoice price of merchandise in the year purchased if the taxpayer has a fixed right to the discount in that year; see Rev. Ruls. 76-96, 84-41 and 85-30. In this manner, the profit attributable to a trade discount is properly included in taxable income in the year the inventory is sold, in accordance with the taxpayer's FIFO or LIFO inventory method.

Rather, the disagreement has been over the terms and conditions imposed by the Service for receiving permission to change from an improper method to a proper method of accounting for trade discounts. More specifically, the disagreement has been over the spread period allowed by the IRS in the case of a positive or negative Sec. 481 (a) adjustment resulting from the change, which in turn depends on whether the improper method is viewed as a Category A or Category B method of accounting. A Category A method is defined as a method of accounting the taxpayer is specifically not permitted to use, or that differs from a method the taxpayer is specifically required to use, under the Code, the regulations or a Supreme Court decision. A Category B method is a method that is not a Category A method. (See Rev. Proc. 92-20, Sections 3.06 and 3.08.)

The Service, before its recent correction, appears to have been taking an inconsistent position on this question, with the consequence that a positive and negative Sec. 481 (a) adjustment...