[Federal Register Volume 70, Number 148 (Wednesday, August 3, 2005)]
[Rules and Regulations]
[Pages 44467-44470]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-15363]



[[Page 44467]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9217]
RIN 1545-BE61


Guidance Regarding the Simplified Service Cost Method and the 
Simplified Production Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations 
relating to the capitalization of costs under the simplified service 
cost method of the Income Tax Regulations and the simplified production 
method. The regulations affect taxpayers that use the simplified 
service cost method or the simplified production method for self-
constructed assets that are produced on a routine and repetitive basis 
in the ordinary course of their businesses. The text of the temporary 
regulations also serves as the text of the proposed regulations set 
forth in the notice of proposed rulemaking on this subject in the 
Proposed Rules section in this issue of the Federal Register. The 
portions of this rule that are final regulations provide necessary 
cross-references to the temporary regulations.

DATES: Effective Date: These regulations are effective August 2, 2005.
    Applicability Date: These regulations apply to taxable years ending 
on or after August 2, 2005. See Sec. Sec.  1.263A-1T(l) and 1.263A-
2T(f).

FOR FURTHER INFORMATION CONTACT: Scott Rabinowitz, (202) 622-4970 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Under section 263A of the Internal Revenue Code (Code), producers 
of real or tangible personal property and resellers of real or personal 
property must capitalize the direct costs and a proper share of the 
indirect costs of such property. Indirect costs include indirect labor 
costs, overhead, and service costs. Service costs are indirect costs 
that can be identified specifically with an administrative or support 
department. Service costs consist of capitalizable service costs, 
deductible service costs, and mixed service costs. Capitalizable 
service costs are service costs that directly benefit, or are incurred 
by reason of, a production or resale activity. Deductible service costs 
are service costs that do not directly benefit, or are not incurred by 
reason of, a production or resale activity. Mixed service costs are 
service costs that are partially allocable to production or resale 
activities and partially allocable to non-production or non-resale 
activities.
    Although section 263A requires capitalization of indirect costs, 
the statute generally does not set forth methods for allocating 
indirect costs, including mixed service costs. Instead, in accordance 
with the legislative history of the section, the regulations under 
section 263A generally provide that indirect costs are to be allocated 
to property using detailed or specific (facts-and-circumstances) cost 
allocation methods, including a specific identification method, the 
standard cost method, and methods using burden rates. The regulations 
further provide that allocations of mixed service costs are to be made 
on the basis of a factor or relationship that reasonably relates such 
costs with the benefit provided. To alleviate the administrative 
burdens of using these detailed or specific methods, the Treasury 
Department and the Internal Revenue Service developed simplified 
methods. In particular, the simplified production method provided by 
Sec.  1.263A-2(b) determines aggregate amounts of additional section 
263A costs allocable to produced ``eligible property.'' Additional 
section 263A costs are those costs, other than interest, that were not 
capitalized under a taxpayer's method of accounting immediately prior 
to the effective date of section 263A, but that are required to be 
capitalized under section 263A. In addition, the final regulations 
provide a simplified method, the simplified service cost method 
provided by Sec.  1.263A-1(h), for determining capitalizable mixed 
service costs incurred during the taxable year with respect to 
``eligible property.''
    On March 30, 1987, temporary regulations under section 263A were 
published in the Federal Register (TD 8131, 1987-1 C.B. 98, [52 FR 
10052]). The temporary regulations limited the availability of the 
simplified production method and the simplified service cost method to 
two types of ``eligible property'': Stock in trade or other property 
properly includible in the inventory of the taxpayer and non-inventory 
property held by a taxpayer primarily for sale to customers in the 
ordinary course of the taxpayer's trade or business. The preamble to 
the temporary regulations indicates that this limitation was prescribed 
because the simplified production method is not appropriate to account 
for the casual or occasional production of property (i.e., property 
that is not mass-produced on a repetitive and routine basis and that 
does not have a high ``turnover'' rate.) Similarly, the simplified 
service cost method is not appropriate to account for the casual or 
occasional production of property.
    On August 22, 1988, the IRS published Notice 88-86 (1988-2 C.B. 
401). Notice 88-86 states that forthcoming regulations will expand the 
categories of property eligible for the simplified production method 
and simplified service cost method to other types of property that 
share characteristics that are appropriate for application of the 
methods. In particular, the notice indicates that the regulations will 
provide that the simplified production method and the simplified 
service cost method are available to (1) self-constructed assets 
substantially identical in nature to, and produced in the same manner 
as, inventory property or other property held primarily for sale to 
customers in the ordinary course of the taxpayer's trade or business, 
and (2) self-constructed assets produced by the taxpayer on a routine 
and repetitive basis in the ordinary course of the taxpayer's 
production activities.
    On August 9, 1993, final regulations under section 263A were 
published in the Federal Register (TD 8482, 1993-2 C.B. 77, [58 FR 
42198]). The final regulations follow Notice 88-86 and expand the 
categories of eligible property for the simplified production method 
and the simplified service cost method.
    Notice 2003-36 (2003-1 C.B. 992), as modified by Notice 2003-59 
(2003-59 C.B. 429), indicates that the Treasury Department and the IRS 
are aware that uncertainty exists as to what types of property 
constitute ``eligible property'' under Sec. Sec.  1.263A-1(h)(2)(i)(D) 
and 1.263A-2(b)(2)(i)(D) for purposes of the simplified service cost 
method and the simplified production method. These sections provide 
that self-constructed assets produced by a taxpayer on a routine and 
repetitive basis in the ordinary course of the taxpayer's trade or 
business are ``eligible property.''
    To provide guidance as to what types of property constitute 
``eligible property'' under the final regulations, Rev. Rul. 2005-53, 
2005-35 I.R.B. ---- (dated August 29, 2005), holds that a taxpayer's 
production of property will be considered ``routine and repetitive'' 
for purposes of Sec. Sec.  1.263A-1(h)(2)(i)(D) and 1.263A-
2(b)(2)(i)(D) only if the property is mass-produced (i.e., numerous 
identical goods are manufactured using standardized

[[Page 44468]]

designs and assembly line techniques) or the produced property has a 
high degree of turnover (i.e., the costs of production are recovered 
over a relatively short amount of time).

Explanation of Provisions

    Upon further consideration of the simplified service cost method 
and the simplified production method under Sec. Sec.  1.263A-
1(h)(2)(i)(D) and 1.263A-2(b)(2)(i)(D), the Treasury Department and the 
IRS believe that, to minimize the distortion of income that may arise 
from the use of those methods, a taxpayer's production of property is 
considered ``routine and repetitive'' for purposes of those sections 
only if the property is mass-produced and has a high degree of 
turnover. Accordingly, the temporary regulations provide that self-
constructed property is considered produced on a routine and repetitive 
basis for purposes of the simplified service cost method and the 
simplified production method only if numerous substantially identical 
units of tangible personal property are produced within a taxable year 
using standardized designs and assembly line techniques and the 
applicable recovery period of the assets under Sec.  168(c) is not 
longer than 3 years.
    A change in a taxpayer's treatment of mixed service costs or 
additional section 263A costs to comply with these temporary 
regulations is a change in method of accounting to which the provisions 
of sections 446 and 481 and the regulations thereunder apply. For the 
taxpayer's first taxable year ending on or after August 2, 2005, the 
taxpayer is granted the consent of the Commissioner to change its 
method of accounting to comply with these temporary regulations, 
provided the taxpayer follows the applicable administrative procedures 
for obtaining the Commissioner's automatic consent to a change in 
accounting method (for further guidance, for example, see Rev. Proc. 
2002-9 (2002-1 C.B. 327), as modified and clarified by Announcement 
2002-17 (2002-1 C.B. 561), modified and amplified by Rev. Proc. 2002-19 
(2002-1 C.B. 696), and amplified, clarified, and modified by Rev. Proc. 
2002-54 (2002-2 C.B. 432)). For purposes of Form 3115, ``Application 
for Change in Accounting Method'', the designated number for the 
automatic accounting method change authorized by this regulation is 
``95.'' If Form 3115 is revised or renumbered, any reference in this 
section to that form is treated as a reference to the revised or 
renumbered form. For the taxpayer's second and subsequent taxable years 
ending on or after August 2, 2005, requests to secure the consent of 
the Commissioner must be made under the administrative procedures for 
obtaining the Commissioner's advance consent to a change in accounting 
method (for further guidance, for example, see Rev. Proc. 97-27 (1997-1 
C.B. 680), as modified and amplified by Rev. Proc. 2002-19 (2002-1 C.B. 
696), as amplified and clarified by Rev. Proc. 2002-54 (2002-2 C.B. 
432)). However, notwithstanding section 5.04(1) of Rev. Proc. 2002-9 
and section 5.02(3)(a) of Rev. Proc. 97-27, the section 481(a) 
adjustment period is two taxable years for a net positive adjustment 
for an accounting method change that is made to conform to these 
temporary regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. Please refer to 
the cross-reference notice of proposed rulemaking published elsewhere 
in this issue of the Federal Register for applicability of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6). Pursuant to section 
7805(f) of the Code, these temporary regulations will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Scott Rabinowitz of 
the Office of Associate Chief Counsel (Income Tax and Accounting). 
However, other personnel from the IRS and the Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.263A-1 is amended by revising paragraph (h)(2)(i)(D) 
and adding paragraphs (k) and (l) to read as follows:


Sec.  1.263A-1  Uniform capitalization of costs.

* * * * *
    (h) * * *
    (2) * * *
    (i) * * *
    (D) [Reserved]. For further guidance, see Sec.  1.263A-
1T(h)(2)(i)(D).
* * * * *
    (k) and (l) [Reserved]. For further guidance, see Sec.  1.263A-
1T(k) and (l).

0
Par 3. Section 1.263A-1T is added to read as follows:


Sec.  1.263A-1T  Uniform capitalization of costs (temporary).

    (a) through (h)(2)(i)(C) [Reserved]. For further guidance, see 
Sec.  1.263A-1(a) through (h)(2)(i)(C).
    (D) Self-constructed tangible personal property produced on a 
routine and repetitive basis--(1) In general. Self-constructed tangible 
personal property produced by the taxpayer on a routine and repetitive 
basis in the ordinary course of the taxpayer's trade or business. Self-
constructed tangible personal property is produced by the taxpayer on a 
routine and repetitive basis in the ordinary course of the taxpayer's 
trade or business when units of tangible personal property (as defined 
in Sec.  1.263A-10(c)) are mass-produced, i.e., numerous substantially 
identical assets are manufactured within a taxable year using 
standardized designs and assembly line techniques, and the applicable 
recovery period of the property determined under section 168(c) is not 
longer than 3 years. For purposes of this paragraph, the applicable 
recovery period of the assets will be determined at the end of the 
taxable year in which the assets are placed in service for purposes of 
Sec.  1.46-3(d). Subsequent changes to the applicable recovery period 
after the assets are placed in service will not affect the 
determination of whether the assets are produced on a routine and 
repetitive basis for purposes of this paragraph.
    (2) Examples. The following examples illustrate this paragraph 
(h)(2)(i)(D):

    Example 1. Y is a manufacturer of automobiles. During the 
taxable year Y produces numerous substantially identical dies and 
molds using standardized designs and assembly line techniques. The 
dies and molds have a 3-year applicable recovery period for purposes 
of section 168(c). Y uses the dies and molds to produce or process 
particular automobile components and does not hold them for sale. 
The dies and molds are produced on a routine and repetitive basis in 
the ordinary course of Y's business for purposes of this paragraph 
because the dies and molds are both mass-produced and have a 
recovery period of not longer than 3 years.

[[Page 44469]]

    Example 2. Z is an electric utility that regularly manufactures 
and installs identical poles that are used in transmitting and 
distributing electricity. The poles have a 20-year applicable 
recovery period for purposes of section 168(c). The poles are not 
produced on a routine and repetitive basis in the ordinary course of 
Z's business for purposes of this paragraph because the poles have 
an applicable recovery period that is longer than 3 years.

    (h)(2)(ii) through (j) [Reserved]. For further guidance, see Sec.  
1.263A-1(h)(2)(ii) through (j).
    (k) Change in method of accounting--(1) In general. A change in a 
taxpayer's treatment of mixed service costs to comply with these 
temporary regulations is a change in method of accounting to which the 
provisions of sections 446 and 481 and the regulations thereunder 
apply. See Sec.  1.263A-7. For a taxpayer's first taxable year ending 
on or after August 2, 2005, the taxpayer is granted the consent of the 
Commissioner to change its method of accounting to comply with these 
temporary regulations, provided the taxpayer follows the administrative 
procedures, as modified by paragraphs (k)(2) through (4) of this 
section, issued under Sec.  1.446-1(e)(3)(ii) for obtaining the 
Commissioner's automatic consent to a change in accounting method (for 
further guidance, for example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), 
as modified and clarified by Announcement 2002-17 (2002-1 C.B. 561), 
modified and amplified by Rev. Proc. 2002-19 (2002-1 C.B. 696), and 
amplified, clarified, and modified by Rev. Proc. 2002-54 (2002-2 C.B. 
432), and Sec.  601.601(d)(2)(ii)(b) of this chapter). For purposes of 
Form 3115, ``Application for Change in Accounting Method,'' the 
designated number for the automatic accounting method change authorized 
by this paragraph (k) is ``95.'' If Form 3115 is revised or renumbered, 
any reference in this section to that form is treated as a reference to 
the revised or renumbered form. For the taxpayer's second and 
subsequent taxable years ending on or after August 2, 2005, requests to 
secure the consent of the Commissioner must be made under the 
administrative procedures, as modified by paragraphs (k)(2) through (4) 
of this section, for obtaining the Commissioner's advance consent to a 
change in accounting method (for further guidance, for example, see 
Rev. Proc. 97-27 (1997-1 C.B. 680), as modified and amplified by Rev. 
Proc. 2002-19 (2002-1 C.B. 696), as amplified and clarified by Rev. 
Proc. 2002-54 (2002-2 C.B. 432), and Sec.  601.601(d)(2)(ii)(b) of this 
chapter).
    (2) Scope limitations. Any limitations on obtaining the automatic 
consent of the Commissioner do not apply to a taxpayer seeking to 
change its method of accounting to comply with this section for its 
first taxable year ending on or after August 2, 2005.
    (3) Audit protection. A taxpayer that changes its method of 
accounting in accordance with this paragraph (k) to comply with these 
temporary regulations does not receive audit protection if its method 
of accounting for mixed service costs is an issue under consideration 
at the time the application is filed with the national office.
    (4) Section 481(a) adjustment. A change in method of accounting to 
conform to these temporary regulations requires a section 481(a) 
adjustment. The section 481(a) adjustment period is two taxable years 
for a net positive adjustment for an accounting method change that is 
made to conform to these temporary regulations.
    (l) Effective date. This section applies for taxable years ending 
on or after August 2, 2005.

0
Par. 4. Section 1.263A-2 is amended by revising paragraph (b)(2)(i)(D) 
and adding paragraphs (e) and (f) to read as follows:


Sec.  1.263A-2  Rules relating to property produced by the taxpayer.

* * * * *
    (b) * * *
    (2) * * *
    (i) * * *
    (D) [Reserved]. For further guidance, see Sec.  1.263A-
2T(b)(2)(i)(D).
* * * * *
    (e) and (f) [Reserved]. For further guidance, see Sec.  1.263A-
2T(e) and (f).

0
Par. 5. Section 1.263A-2T is added to read as follows:


Sec.  263A-2T  Rules relating to property produced by the taxpayer 
(temporary).

    (a) through (b)(2)(i)(C) [Reserved]. For further guidance, see 
Sec.  1.263A-2(a) through (b)(2)(i)(C).
    (D) Self-constructed tangible personal property produced on a 
routine and repetitive basis--(1) In general. Self-constructed tangible 
personal property produced by the taxpayer on a routine and repetitive 
basis in the ordinary course of the taxpayer's trade or business. Self-
constructed tangible personal property is produced by the taxpayer on a 
routine and repetitive basis in the ordinary course of the taxpayer's 
trade or business when units of tangible personal property (as defined 
in Sec.  1.263A-10(c)) are mass-produced, i.e., numerous substantially 
identical assets are manufactured within a taxable year using 
standardized designs and assembly line techniques, and the applicable 
recovery period of the property determined under section 168(c) is not 
longer than 3 years. For purposes of this paragraph, the applicable 
recovery period of the assets will be determined at the end of the 
taxable year in which the assets are placed in service for purposes of 
Sec.  1.46-3(d). Subsequent changes to the applicable recovery period 
after the assets are placed in service will not affect the 
determination of whether the assets are produced on a routine and 
repetitive basis for purposes of this paragraph.

    (2) Examples. The following examples illustrate this paragraph (D):

    Example 1. Y is a manufacturer of automobiles. During the 
taxable year Y produces numerous substantially identical dies and 
molds using standardized designs and assembly line techniques. The 
dies and molds have a 3-year applicable recovery period for purposes 
of section 168(c). Y uses the dies and molds to produce or process 
particular automobile components and does not hold them for sale. 
The dies and molds are produced on a routine and repetitive basis in 
the ordinary course of Y's business for purposes of this paragraph 
because the dies and molds are both mass-produced and have an 
applicable recovery period of not longer than 3 years.
    Example 2. Z is an electric utility that regularly manufactures 
and installs identical poles that are used in transmitting and 
distributing electricity. The poles have a 20-year applicable 
recovery period for purposes of section 168(a). The poles are not 
produced on a routine and repetitive basis in the ordinary course of 
Z's business for purposes of this paragraph because the poles have 
an applicable recovery period that is longer than 3 years.

    (b)(2)(ii) through (d) [Reserved]. For further guidance, see Sec.  
1.263A-2(b)(2)(ii) though (d).
    (e) Change in method of accounting--(1) In general. A change in a 
taxpayer's treatment of additional section 263A costs to comply with 
these temporary regulations is a change in method of accounting to 
which the provisions of sections 446 and 481 and the regulations 
thereunder apply. See Sec.  1.263A-7. For a taxpayer's first taxable 
year ending on or after August 2, 2005, the taxpayer is granted the 
consent of the Commissioner to change its method of accounting to 
comply with these temporary regulations, provided the taxpayer follows 
the administrative procedures, as modified by paragraphs (e)(2) through 
(4) of this section, issued under Sec.  1.446-1(e)(3)(ii) for obtaining 
the Commissioner's automatic consent to a change in accounting method 
(for further guidance, for example, see Rev. Proc. 2002-9 (2002-1 C.B. 
327), as

[[Page 44470]]

modified and clarified by Announcement 2002-17 (2002-1 C.B. 561), 
modified and amplified by Rev. Proc. 2002-19 (2002-1 C.B. 696), and 
amplified, clarified, and modified by Rev. Proc. 2002-54 (2002-2 C.B. 
432), and Sec.  601.601(d)(2)(ii)( b) of this chapter). For purposes of 
Form 3115, ``Application for Change in Accounting Method,'' the 
designated number for the automatic accounting method change authorized 
by this paragraph (e) is ``95.'' If Form 3115 is revised or renumbered, 
any reference in this section to that form is treated as a reference to 
the revised or renumbered form. For the taxpayer's second and 
subsequent taxable years ending on or after August 2, 2005, requests to 
secure the consent of the Commissioner must be made under the 
administrative procedures, as modified by paragraphs (e)(2) through (4) 
of this section, for obtaining the Commissioner's advance consent to a 
change in accounting method (for further guidance, for example, see 
Rev. Proc. 97-27 (1997-1 C.B. 680), as modified and amplified by Rev. 
Proc. 2002-19 (2002-1 C.B. 696), as amplified and clarified by Rev. 
Proc. 2002-54 (2002-2 C.B. 432), and Sec.  601.601(d)92)(ii)(b) of this 
chapter).
    (2) Scope limitations. Any limitations on obtaining the automatic 
consent of the Commissioner do not apply to a taxpayer seeking to 
change its method of accounting to comply with this section for its 
first taxable year ending on or after August 2, 2005.
    (3) Audit protection. A taxpayer that changes its method of 
accounting in accordance with this paragraph (e) to comply with these 
temporary regulations does not receive audit protection if its method 
of accounting for additional section 263A costs is an issue under 
consideration at the time the application is filed with the national 
office.
    (4) Section 481(a) adjustment. A change in method of accounting to 
conform to these temporary regulations requires a section 481(a) 
adjustment. The section 481(a) adjustment period is two taxable years 
for a net positive adjustment for an accounting method change that is 
made to conform to these temporary regulations.
    (f) Effective date. This section applies for taxable years ending 
on or after August 2, 2005.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: July 14, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-15363 Filed 8-2-05; 8:45 am]
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