Proposed regulations on capitalization of expenditures related to tangible property: April 24, 2012.

On April 24, 2012, the Institute submitted the following comments to the Internal Revenue Service on temporary regulations relating to the treatment of materials and supplies, capitalization or deduction of expenditures for tangible property, and depreciation or recognition of gain or loss on the disposition of property affected by the so-called "tangibles" regulations. In addition, the Institute's comments on transitional guidance on changes in accounting methods provided in Revenue Procedures 2011-19 and 2011-20. TEI's comments were prepared under the aegis of the Institute's Federal Tax Committee, whose chair is Robert L. Howren of BlueLinx Corporation. Contributing to the development of TEI's comments were Richard A. Brandenburg of The Goodyear Tire & Rubber Company; Katherine C. Castillo of Guardian Industries Corporation; Sandhya K. Edupuganty of Texas Instruments Incorporated; Thomas L. Leffelman of the Bway Corporation; Charles N. (Sandy) Macfarlane of Chevron Corporation; John A. Mann of Walgreen Co.; and Madeline R. Schneider of Brunswick Corporation. Jeffery P. Rasmussen, TEI Senior Tax Counsel, serves as staff liaison to Federal Tax Committee and coordinated the preparation of the Institute's comments.

On December 23, 2011, the Internal Revenue Service and U.S. Department of Treasury issued temporary regulations under sections 162(a) and 263(a) of the Internal Revenue Code, relating to amounts paid to acquire, produce, or improve tangible property. The temporary regulations clarify and expand the standards in the current regulations concerning whether amounts must be capitalized or deducted currently and also revise the depreciation rules under the modified accelerated cost recovery system (MACRS) of section 168. The temporary regulations, which serve as the text of proposed regulations, were published in the December 27, 2011, issue of the Federal Register (76 Fed. Reg. 81060), and the April 2, 2012, issue of the Internal Revenue Bulletin (2012-14 I.R.B. 614). A hearing is scheduled for May 9, 2012.

Background

Tax Executives Institute is the preeminent association of in-house business tax executives in North America. Our nearly 7,000 members represent 3,000 of the leading corporations worldwide. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the issues raised by the temporary regulations.

General

The temporary regulations represent the culmination of an eight-year effort corn mencing with the announcement in Notice 2004-6 (1) that the IRS and Treasury Department intended to provide comprehensive guidance on whether amounts paid to restore or improve property are capital expenditures or deductible as ordinary and necessary business expenses. A comprehensive set of proposed regulations were issued in 2006 (2) and subsequently withdrawn and reproposed in 2008. (3) Many of the provisions from the 2008 proposed regulations have been retained in the temporary regulations and the rules generally follow the format of the 2006 and 2008 proposed regulations. Hence, the temporary regulations provide guidance on whether amounts paid should be treated as (i) materials and supplies under Temp. Reg. [section] 1.162-3T; (ii) costs to acquire (or produce) tangible property under Temp. Reg. [section] 1.263(a)-2T; or (iii) costs to improve tangible property under Temp. Reg. [section] 1.263(a)-3T. In addition to providing a comprehensive framework for the tax treatment of costs incurred to acquire, produce, improve, or repair tangible personal property, the temporary regulations significantly revise the accounting treatment for assets subject to the modified accelerated cost recovery system (MACRS) of section 168, especially those relating to determining gain or loss on the disposition of MACRS property. The Preamble to the temporary regulations raises several questions about the definitions and operation of the rules and invites comments on issues that are not addressed. Finally, since the new rules will require nearly all taxpayers to make changes in their accounting methods, transitional guidance to facilitate such changes has been issued in Revenue Procedures 2012-19 and 2012-20. (4)

In general, TEI believes that the temporary regulations represent a significant refinement of the previously proposed rules and should help resolve decades of thorny issues surrounding the treatment of tangible property, including the capitalization or deduction of the costs of property, incidental costs, repairs, and improvements. In many cases, the temporary regulations follow prior capitalization and deduction standards or adapt and clarify longstanding judicial interpretations of those rules. For example, Temp. Reg. [section] 1.263(a)-3T(h)(3) (iii) adopts the Plainfield-Union test (5) as the "appropriate comparison" for determining whether a repair required by an "event" (including normal wear and tear) constitutes an improvement or betterment. As another example, the judicially created plan of rehabilitation doctrine has been explicitly rejected as a capitalization rule. Moreover, Examples 11 and 12 of Temp. Reg. [section] 1.263(a)-3T(h)(4) seemingly reject the notion that repairs undertaken to comply with federal, state, or local requirements create a per se capitalization requirement; rather the nature of the work performed and whether it results in a material addition or material increase in capacity, productivity, etc., are deemed to be the determining factors in the analysis. In addition, several new rules have been added--such as the expansion of the definition of dispositions to include retirements of structural components of a building--that will improve current law.

Regrettably, in other areas the temporary regulations impose administrative burdens that impede the simplification that the rules would otherwise achieve. Moreover, in some cases the temporary regulations re verse longstanding rules or step back from the certainty that the bright lines in the 2008 proposed regulations would have promoted, thereby creating new ambiguities and compliance challenges for taxpayers or shifting the focus of disputes between taxpayers and the IRS. To improve the regulations, we offer the following comments.

Captilization Threshold De Minimis Accounts

Temp. Reg. [section] 1.263(a)-2T(g)(1) permits taxpayers to deduct amounts paid for the acquisition or production of property where the taxpayer (i) has an applicable financial statement (AFS), (ii) has at the beginning of the tax year written accounting procedures treating the amounts paid costing less than a certain dollar amount as an expense for non-tax purposes, and (iii) treats such amounts as an expense on its AFS in accordance with its written procedures. Under subparagraph (iv) of Temp. Reg. [section] 1.263(a)2T(g)(1) the total aggregate amounts deducted under this section and Temp. Reg. [section] 1.162-3T(f) (materials and supplies) for the taxable year must be less than or equal to the greater of (1) 0.1 percent of the taxpayer's gross receipts for the taxable year as determined for federal income tax purposes, or (2) 2 percent of the taxpayer's total depreciation and amortization expense for the taxable year as determined in its AFS. The provision eliminates the "no distortion of taxable income" requirement set forth in the 2008 de minimis property rule, but converts the rule in the temporary regulations to an absolute "ceiling" limiting annual deductions of de minimis property.

TEI has long supported the establishment of a de minimis rule for purchases of non-inventory tangible personal property because it strikes an appropriate balance between the requirements of the clear reflection of income standard of the Code and the costs and burdens of complying with and administering the tax laws. By creating a formal rule permitting deductions of de minimis property amounts, the regulations acknowledge longstanding IRS examination practices of acquiescing to taxpayers' deductions of amounts less than a de minimis dollar threshold. Those examination practices conserved IRS resources for more significant issues and we applaud the inclusion of a de minimis property rule in the temporary regulations. The ceiling rule, however, imposes a requirement to -or presupposes that taxpayers already -track and account for de minimis property purchases. Such a requirement is contrary to general practice, severely undermines the goal of administrative convenience, and imposes considerable burdens on taxpayers as well as the IRS. Thus, we have the following comments and recommendations about the ceiling rule.

1. Abandon the Ceiling Rule

   Even though the measurement and reporting of net income for financial and tax accounting purposes are guided by differing objectives, both are tempered by practical constraints. Indeed, the statutory requirement in section 446(a) that "taxable income ... be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books" is premised on the realization that in determining taxable income it is appropriate, convenient, and, most important, cost-effective to adhere as often and as closely as possible (within the different...