Coordinated Issue Paper released on bargain purchases.

• Author: Tovig, Barry A.

The IRS continues to press the issues raised by the Tax Court in Hamilton Industries, Inc., 97 TC 120 (1991), with respect to bargain purchases of inventory. Hamilton Industries made two bargain purchases: In the first acquisition, a residual purchase price allocation method resulted in a discount of 94% of the inventory's FIFO value. In the second acquisition, an allocation of purchase price equal to the inventory's LIFO value in the seller's hands resulted in a more than 60% disc Tax Court held that, in order to clearly reflect income, the taxpayer should be required to treat the bargain purchase items as separate items. Thus, the profit element attributable to the bargain purchased inventory items would be recognized immediately on disposition. The court also held that the IRS treatment of the items constituted a change in accounting method, and thus, that Sec. 481 (a) applied and permitted the Service to reconstruct the cost of the opening inventory (even though one o the bargain purchases occurred in a year closed by the statute of limitations).

In a Coordinated Issue Paper released on Sept. 12, 1995, the IRS has asserted that, for purposes of calculating inventory value under the dollar-value LIFO method, inventories purchased in bulk at discounted amounts are generally treated as separate items from goods purchased or produced subsequently. Such treatment would effectively eliminate the ability under LIFO to include the discounted inventory values in old layers. The Service noted that, based on the rationale of Hamilton Industries, gain from bargain cost inventory should be realized when the actual bargain cost units are sold. Furthermore, the taxpayer has the burden of proving that the specific inventory items purchased at a discount remain in ending inventory. Finally, a change in treatment of bargain purchases in order to conform with Hamilton Industries will constitute an accounting method change, necessitating a Sec. 481 (a) adjustment.

Interestingly, after the Tax Court decision, the IRS and Hamilton Industries agreed to a settlement stipulation under which the taxpayer received a substantial refund. Although the stipulation was ostensibly based on "difficulties in agreeing to computations,"...