Acquisition price establishes base-year cost of bargain inventory.

• Author: Herndon, Diane

In the latest in a long line of cases and rulings addressing bargain-purchase inventories, the Federal Circuit ruled that a manufacturer should have used acquisition cost to establish the base-year cost of bargain-priced inventory (La Crosse Footwear Inc., 9/14/99). Reversing the Court of Federal Claims, the Federal Circuit concluded that the manufacturer's use of fair market value (FMV) resulted in avoidance of gain.

Background--Hamilton Industries

La Crosse Footwear must be viewed in the context of an earlier significant case addressing the bargain-purchase inventory issue--Hamilton Industries, Inc., 97 TC 120 (1991). In Hamilton Industries, the taxpayer acquired assets in two transactions, each of which involved a residual price allocation to the acquired inventory. The residual allocation resulted in an inventory value substantially less (approximately 96% and 60% for the two transactions) than the value assigned by the target corporation under FIFO. In keeping its inventory records, the taxpayer made no distinction between the acquired inventory and inventory subsequently purchased or produced. The acquiring corporation timely elected the dollar-value LIFO method of accounting and a single natural business pool. The result was that the discounted inventory value was treated as the base-year cost for items that could be inventoried. The IRS proposed a deficiency, claiming that Hamilton improperly treated as one item both the acquired inventory and the subsequently purchased or produced inventory. Because an adjustment in the acquisition year was barred by the statute of limitations (SOL), the Service argued that its adjustment was a change in Hamilton's method of accounting subject to Sec. 481.

The Tax Court agreed with the IRS and held that, while Hamilton correctly placed the acquired inventory in the same pool as subsequently purchased or produced inventory, it Constituted a separate item. The court concluded that the artificially low value assigned to the acquired base-year inventory would generate inventory value increases attributable not to inflation, but merely to the discount element. Further, the court noted that the disparity between the bargain-purchase inventory and any inventory subsequently acquired or produced evinced materially different cost characteristics, resulting in inventory with a different character. Accordingly, the court held that the bargain-purchase inventory must be accorded separate-item treatment.

Since...