Understanding the safe harbor for ratable service contracts.

• Author: Pentland, Peter

On July 30, 2015, the IRS issued Rev. Proc. 2015-39, which provides a safe harbor for accrual-basis taxpayers that would like to treat economic performance as occurring ratably over the term of certain types of service contracts (ratable service contracts). Many practitioners likely first familiarized themselves with the term "ratable service contract" upon reading this guidance. Some may still be questioning what the revenue procedure provides to taxpayers that was not previously available. The answer to that question is the focus of this discussion.

A ratable service contract must meet three requirements to qualify for the safe harbor: (1) The contract must provide for similar services to be provided on a regular basis (daily, weekly, or monthly); (2) each occurrence of the service must provide independent value, meaning that the benefits from each occurrence must not depend on the receipt of prior or subsequent services; and (3) the contract must not exceed 12 months. A contract containing both qualifying and nonqualifying services must contain separate pricing for a taxpayer to apply the safe harbor to those services that qualify.

The revenue procedure provides several examples of services that could qualify under the safe harbor, including janitorial services, landscape maintenance services, and information technology support and maintenance services. Additional services that could qualify include human resources, bookkeeping, payroll, marketing, advertising, and similar types of services.

Pursuant to Sec. 461 and the regulations thereunder, an accrual-basis taxpayer is generally allowed to treat a liability as incurred in the tax year in which all the events have occurred that establish the fact of the liability (fixing the liability), the amount of the liability can be determined with reasonable accuracy (these first two qualifying factors are collectively referred to as the all-events test), and economic performance has occurred with respect to the liability. Rev. Proc. 2015-39 deals exclusively with certain types of liabilities that arise from the provision of services to taxpayers (service liabilities).

Economic performance is generally deemed to occur with respect to a service liability as the service is provided to the taxpayer (Regs. Sec. 1.461-4(d)(2)(i)). However, two exceptions allow a taxpayer to treat a service liability as incurred in the tax year prior to the tax year in which the services are provided: the 3 1/2-month...