Final regs. govern sales-based royalties and vendor allowances.

• Author: Schreiber, Sally P.

The IRS issued final regulations on sales-based royalties and vendor allowance rules under Sec. 263A and Sec. 471 (T.D. 9652). The rules, which adopt the proposed regulations (RF.G-149335-08) issued in 2011 with some changes in response to comments, apply to tax years ending on or after Jan. 13, 2014.

The sales-based royalty rules relate to the capitalization and allocation of royalties incurred upon the sale of property produced or property acquired for resale. Sales-based vendor allowances are the adjustments to the cost of merchandise inventory for an allowance, discount, or price rebate based on merchandise sales.

Sales-Based Royalties

The proposed regulations were issued in response to ongoing litigation over whether sales-based royalties were required to be capitalized under Sec. 263A. Rather than determining that sales-based royalty costs are inherently noncapitaliz-able, the proposed regulations provided that otherwise capitalizable sales-based royalty costs are properly allocable to property sold during the tax year. The proposed regulations allocated those costs to inventory that is already sold. Because cost of goods sold already includes the basis of the inventory, expense of the capitalized royalties essentially occurs as taxpayers make any payments.

In response to comments that the requirement to allocate sales-based royalties only to cost of goods sold would burden taxpayers using simplified allocation methods, the final regulations make this method optional, instead of mandatory. Therefore, the final regulations permit taxpayers to either allocate sales-based royalties entirely to property sold and include those costs in cost of goods sold or to allocate sales-based royalties between cost of goods sold and ending inventory using a facts-and-circumstances cost-allocation method described in Regs. Sec. l.263A-l(f) or a simplified method.

Vendor...