NEXUS BETWEEN TAX YEAR, INVENTORY ACQUISITIONS METHOD, AND INVENTORY EXPERIENCE IS KEY TO INVENTORY PRICE INDEX CHANGES.

Rev. Rul. 89-29

ISSUE

In the situations described below, will the Commissioner consent to a taxpayer's request to change its month for selecting price indexes in computing the LIFO value of its dollar-value pool under the inventory price index (IPI) computation method provided by section 1.472-8(e)(3) of the Income Tax Regulations?

FACTS

In each of the situations below, the taxpayer, a retailer, uses the accrual method of accounting, and employs a calendar tax year. Beginning with its tax year ending December 31, 1985, the taxpayer elected the dollar-value LIFO inventory method by filing Form 970. Application to Use LIFO Inventory Method. On the Form 970, the taxpayer: (1) elected the latest acquisitions method to determine the cost of the goods in the closing inventory over those in the opening inventory under section 1.472-8(e)(2)(ii)(a) of the regulations; (2) elected the IPI computation method provided by section 1.472-8(e)(3); (3) elected to use a single pool for its entire inventory; and (4) made a "one-time binding election" under section 1.472- 8(e)(3)(iii)(C) of the regulations regarding which month's Producer Prices and Price Indexes (PPI) to use in determining the current-year cost of the pool. In SITUATIONS 1, 2, and 3, below, the taxpayer chose the PPI for December; in SITUATION 4, below, it chose the PPI for January.

In each of the four situations, the taxpayer's experience is that it purchases its inventory fairly uniformly throughout the year. The first purchases of inventory items normally occur in January and the last purchases normally occur in December. The taxpayer does not use the retail method of pricing inventories under section 1.471-8 and is not eligible to use the retail price indexes prepared by the United States Bureau of Labor Statistics for use by department stores.

SITUATION 1. The taxpayer filed a Form 3115, Application for Change in Accounting Method, requesting to change from the December PPI to the November PPI for computing the LIFO value of the pool, beginning with its tax year ending December 31, 1987.

SITUATION 2. The taxpayer filed a Form 3115 requesting (1) to change from the latest acquisitions method to the earliest acquisitions method, and (2) to change from the December PPI to the January PPI, effective for the tax year ending December 31, 1987.

SITUATION 3. Pursuant to the provisions of section 1.442-1(c) of the regulations, the taxpayer changed its annual accounting period from the calendar tax year to a fiscal tax year ending June 30. The short period required to effect the change of annual accounting period ends on June 30, 1987. The taxpayer filed a Form 3115 requesting to change from the December PPI to the June PPI, beginning with the short tax year ending June 30, 1987.

SITUATION 4. The taxpayer filed a Form 3115 requesting to change from the January PPI to the December PPI beginning with the tax year ending December 31, 1987.

LAW AND ANALYSIS

Section 1.472-8(e)(3)(iii)(C) of the regulations states, in part, that taxpayers that do not use the retail inventory method must either select indexes as of the month or months most appropriate to the taxpayer's method of determining the current-year cost of the inventory pool under section 1.472-8(e)(2)(ii) or make a one-time binding election of an appropriate representative month during the tax year. The election must be clearly set forth on Form 970.

Section 1.472-8(e)(2)(ii)(b) of the regulations provides that the total current-year cost of items making up a dollar-value LIFO pool may be determined by reference to the actual cost of the goods purchased or produced during the tax year in the order of acquisition (earliest acquisitions method). Section 1.472-8(e)(2)(ii)(a) provides that the total current-year cost may be determined by reference to the actual cost of the goods most recently purchased or produced (latest acquisitions method).

Section 446(e) of the Code and section 1.446-1(e)(2)(i) of the regulations provide that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. See Rev. Proc. 84-74, 1984-2 C.B. 736, for the procedures to be followed in requesting the Commissioner's consent to change a method of accounting.

Selection of an "appropriate representative month" under section 1.472-8(e)(3)(iii)(C) of the regulations is an alternative to using the indexes as of the month or months most appropriate to the taxpayer's method of determining the current-year cost of the inventory pool, and normally the appropriate representative month will be one of the months most appropriate to the taxpayer's method. Thus, an appropriate representative month must be a month that has a nexus, or relationship, to the taxpayer's method of determining current-year cost and its historical experience of inventory purchases during the year. The timing of the index (the month selected) must relate to the timing of the determination of current- year cost; otherwise, distortion could occur. For example, if a taxpayer uses the latest acquisitions method for determining current- year cost, an appropriate representative month is almost invariably a month toward the end of the year (assuming uniform purchases during the year). If a taxpayer uses the earliest acquisitions method for determining current-year cost, an appropriate representative month is almost invariably a month toward the beginning of the year (assuming uniform purchases during the year).

In SITUATION 1, the taxpayer's "one-time binding" election of the December PPI as "an appropriate representative month" was proper because there is a nexus between the month of December, the taxpayer's election to use the latest acquisitions method, and the taxpayer's historical experience of inventory purchases during the year. In other words, the election of the December PPI was an "appropriate representative month," within the meaning of section 1.472-8(e)(3)(iii)(C) of the regulations, because the taxpayer had elected the latest acquisitions method, and it normally made its latest purchases in December.

Since the taxpayer had elected an appropriate representative month and that month continues to be an appropriate representative month, consent will not be granted to use the November PPI, regardless of whether November is also an appropriate representative month. The words "one-time binding election" in section 1.472- 8(e)(3)(iii)(C) of the regulations mean that the taxpayer's election of an appropriate representative month may not be changed unless the elected month is not an appropriate representative method.

In SITUATION 2, if the Commissioner consents to the taxpayer's request to change from the latest acquisitions method to the earliest acquisitions method, December will no longer be an appropriate representative month because there will be no nexus between that month, the earliest acquisitions method, and the taxpayer's historical experience of inventory purchases during the year. If the taxpayer continued to use PPI indexes for December, distortion could result because the timing of the index (December) would not relate to the timing of the determination of current-year cost (beginning of the year). Therefore, the Commissioner will consent to the taxpayer's request to change to the January PPI.

In SITUATION 3, December is no longer an appropriate representative month because the taxpayer changed its annual accounting period from the calendar tax year to a fiscal tax year ending June 30. There is no nexus between the use of the December PPI, the latest acquisitions method and the taxpayer's historical experience of inventory purchases during the year. The taxpayer's latest purchases for the year now occur in June rather than December. Therefore, the Commissioner will consent to the taxpayer's request to change to the June PPI.

In SITUATION 4, the taxpayer is requesting a change from a month that is not an appropriate representative month to a month that is an appropriate representative month. Therefore, the Commissioner will consent to the taxpayer's request to change to the December PPI.

In SITUATIONS 2, 3, and 4, not only will the Commissioner consent to the request to change the taxpayer's month, but a change would be required even if the taxpayer did not request a change, since the taxpayer in each situation would be using a month that is not an appropriate representative month.

HOLDING

The Commissioner will not consent to a taxpayer's request to change its month for selecting price indexes in computing the LIFO value of its dollar-value pool under the IPI regulations unless the previously elected month is no longer an appropriate representative month under section 1.472-8(e)(3)(iii)(C) of the regulations. A month is an appropriate representative month if there is a nexus between the selected month, the taxpayer's method for determining current-year cost, and the taxpayer's historical experience of inventory purchases during the year.

DRAFTING INFORMATION

The principal author of this revenue ruling is Richard Davis of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Davis on (202) 343-2383 (not a toll-free call).