REVENUE PROCEDURE ALLOWS AUTOMATIC ACCOUNTING CHANGE FOR WARRANTY CONTRACTS.

Rev. Proc. 92-97

SECTION 1. PURPOSE

Pursuant to Announcement 92-93, 1992-27 I.R.B. 43, this revenue procedure provides procedures by which manufacturers, wholesalers, and retailers of motor vehicles or other durable consumer goods may change their method of accounting for the costs of multi-year insurance policies purchased in conjunction with the sale of multi- year service warranty contracts to customers. Under this revenue procedure, the above qualifying taxpayers may obtain the expeditious approval of the Commissioner to change their method of accounting for the costs paid or incurred to insure their obligations to customers under their service warranty contracts.

SEC. 2 BACKGROUND

01 Section 162(a) of the Internal Revenue Code allows as a deduction all the ordinary and necessary expenses paid or incurred in carrying on any trade or business.

02 Section 263 of the Code allows no deduction for amounts paid for new buildings or for permanent improvements or betterments that increase the value of any property or estate (i.e., capital expenditures). Section 1.263(a)-2 of the Income Tax Regulations provides examples of capital expenditures, including the cost of acquisition, construction or erection of buildings, machinery and equipment, furniture and fixtures, and similar property "having a useful life substantially beyond the taxable year."

03 With respect to taxpayers using the cash receipts and disbursements method of accounting, section 1.461-1(a)(1) of the regulations provides that an expenditure which results in the creation of an asset having a useful life that extends substantially beyond the close of the taxable year may not be deductible, or may be deductible only in part, for the year in which made.

04 With respect to taxpayers using an accrual method of accounting, section 1.461-1(a)(2) of the regulations provides that a liability is incurred, and generally is taken into account for federal income tax purposes under an accrual method, in the taxable year in which all events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. Under section 1.461-4(g)(5), economic performance occurs as payment is made to the person to which the liability is owed if the liability of an accrual method taxpayer arises out of the provision of insurance to the taxpayer. Section 1.461-1(a)(2) of the regulations further provides that a liability that has been incurred is taken into account through capitalization under section 263 or section 263A of the Code if the liability relates to the creation of an asset having a useful life extending substantially beyond the close of the taxable year, and may later affect the computation of taxable income through depreciation or otherwise over a period including subsequent taxable years.

05 Section 167(a) of the Code allows as a depreciation deduction a reasonable allowance for the exhaustion, wear, and tear of property used in the trade or business. Section 1.167(a)-3 of the regulations generally allows amortization of the cost of an intangible asset (which term includes certain capital expenditures) if it is known from experience or other factors to be of use in the business for only a limited period, the length of which can be estimated with reasonable accuracy.

06 Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting, including such procedures as may be necessary to prevent the omission or duplication of items includible in gross income or deductions.

07 If a taxpayer purchases a multi-year service warranty insurance policy in connection with its sale of multi-year service warranty contracts to customers by paying a lump-sum premium in advance, the taxpayer must capitalize the amount paid or incurred and may only obtain deductions for the amount by prorating or amortizing it over the life of the insurance policy (whether the cash or accrual method of accounting is used to account for service warranty transactions).

08 This revenue procedure provides the procedures, terms, and conditions by which a qualifying taxpayer may change from its current method of accounting for its costs under service warranty insurance programs to a method consistent with that described in section 2.07.

SEC. 3. SCOPE

01 Except as provided in section 3.03 below, this revenue procedure applies to any manufacturer, wholesaler, or retailer of motor vehicles or other durable consumer goods changing, in its first taxable year ending on or after June 12, 1992, its method of accounting for insurance costs paid or incurred to insure its risks under multi-year service warranty contracts to the method described in section 2.07 of this revenue procedure. Multi-year service warranty contracts to which this revenue procedure applies include only those separately priced contracts sold by a manufacturer, wholesaler, or retailer also selling the motor vehicles or other durable consumer goods (to the ultimate customer or to an intermediary) underlying the contracts.

02 The classification of goods as "durable consumer goods" for purposes of this revenue procedure depends on the common usage of the goods, rather than the purchaser's actual intended use of the goods.

03 This revenue procedure does not apply to any taxpayer that:

(1) covers its risks under its service warranty contracts through arrangements not constituting insurance;

(2) has received written notification from an examining agent (e.g., by examination plan, information document request, notification of proposed adjustments, or income tax examination changes) prior to June 12, 1992, specifically citing as an issue under consideration the taxpayer's method of accounting for the insurance costs of policies that cover its risks under its service warranty contracts;

(3) is, at the time for filing the Form 3115, Application for Change in Accounting Method, before an appeals office or a federal court if the method of accounting for its insurance costs relating to its service warranty contracts is an issue under consideration; or

(4) is, at the time for filing the Form 3115, the subject of a criminal investigation or proceeding concerning (a) directly or indirectly the taxpayer's federal tax liability for any year, or (b) the possibility of false or fraudulent statements made by the taxpayer with respect to any issue relating to its federal tax liability for any year.

04 Any taxpayer not within the scope of this revenue procedure that desires to change its method of accounting for service warranty insurance costs to the method described in section 2.07 must file Form 3115 with the Commissioner in accordance with the requirements of section 1.446-1(e)(3)(i) of the regulations and Rev. Proc. 92-20, 1992-12 I.R.B. 10. The Service considers methods of accounting for service warranty insurance costs contrary to the method described in section 2.07 of this revenue procedure to be Category A methods of accounting.

SEC. 4. MAKING THE METHOD CHANGE

01 RULE FOR A TAXPAYER THAT FAILS TO MAKE THE EXPEDITIOUS METHOD CHANGE PERMITTED BY THIS REVENUE PROCEDURE. If a qualifying taxpayer fails to change its method of accounting for its service warranty insurance costs in accordance with the expeditious method change procedures provided in this revenue procedure, the taxpayer is subject to the accounting method change provisions of Rev. Proc. 92- 20. Thus, subject to the availability of the Rev. Proc. 92-20 window periods to the taxpayer, an examining agent may propose an adjustment to the taxpayer's method of accounting for the service warranty insurance costs in any open taxable year.

02 MANNER OF MAKING AN EXPEDITIOUS METHOD CHANGE. In making the expeditious change in method of accounting for the service warranty insurance costs covered by this revenue procedure, the new method of accounting described in section 2.07 of this revenue procedure will apply to insurance costs relating to all service warranty contracts sold by the taxpayer beginning with the first day of the first taxable year ending on or after June 12, 1992. In using this cut-off method, the taxpayer retains its former method of accounting for insurance costs relating to all service warranty contracts sold to customers prior to the first day of the first taxable year ending on or after June 12, 1992. Because the change in accounting method under this revenue procedure is made using a cut-off method, no omissions or duplications are created, and no adjustment under section 481(a) of the Code is necessary or permitted. Thus, taxpayers are precluded from taking a net section 481(a) adjustment into account in any taxable year.

03 PROCEDURES IN MAKING AN EXPEDITIOUS METHOD CHANGE.

(1) A taxpayer applying for a change in method of accounting for service warranty insurance costs under this revenue procedure must attach a completed Form 3115 to the taxpayer's timely filed (including extensions) original federal income tax return for its first taxable year ending on or after June 12, 1992. No user fee is required for an application made under this revenue procedure.

(2) If, however, on or before December 31, 1992, a taxpayer files or has filed its original federal income tax return for its first taxable year ending on or after June 12, 1992, the taxpayer may attach a completed Form 3115 to an amended return for that year, provided the amended return is filed no later than March 1, 1993.

(3) In addition to including all the information required on the Form 3115, the taxpayer must attach to the Form 3115 a signed written statement providing that it agrees to the terms and conditions of Rev. Proc. 92-97.

(4) In order to assist in the processing of this change in method of accounting, reference to this revenue procedure must be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "CHANGE IN METHOD OF ACCOUNTING FOR SERVICE WARRANTY INSURANCE COSTS UNDER REV. PROC. 92-97."

(5) The Form 3115 and the statement described in sections 4.03(1) through (3) above must be signed by or on behalf of the taxpayer requesting the change by an individual with the authority to bind the taxpayer in such matters. For example, an officer must sign on behalf of a corporation, a general partner on behalf of a partnership, a trustee on behalf of a trust, or an individual on behalf of a sole proprietorship. See the signature requirements in the General Instructions attached to a current Form 3115, and in section 10.07 of Rev. Proc. 92-20.

(6) If the taxpayer is a member of a consolidated group, a Form 3115 submitted on behalf of the taxpayer must be signed by a duly authorized officer of the common parent. See section 1.1502-77 of the regulations and section 10.08 of Rev. Proc. 92-20.

04 PROTECTION FOR PRIOR YEARS. If a taxpayer within the scope of this revenue procedure timely files a completed Form 3115 (i.e., by the date prescribed in section 4.03(1) or (2)) to change its method of accounting for its service warranty insurance costs to the method described in section 2.07, and accounts for its service warranty insurance costs as described in section 2.07, an examining agent may not propose that the taxpayer change its method of accounting for an earlier taxable year.

SEC. 5. EXPEDITIOUS CONSENT

In accordance with section 1.446-1(e)(3)(ii) of the regulations, the requirement to file an application on Form 3115 within the 180- day period normally required for that form is waived for method changes made under this revenue procedure. Under section 1.446- 1(e)(2)(i), the consent of the Commissioner is hereby granted to change to the method of accounting for service warranty insurance costs prescribed in this revenue procedure to any taxpayer within the scope of this revenue procedure and complying with sections 4.02 and 4.03. See section 6 regarding compliance with the provisions of this revenue procedure.

SEC. 6. COMPLIANCE WITH CONDITIONS

If a taxpayer to which this revenue procedure applies changes its method of accounting to the method prescribed in this revenue procedure without complying with all the conditions of this revenue procedure, the taxpayer will be deemed to have initiated the change in method of accounting without obtaining the permission of the Commissioner as required under section 446(e) of the Code.

SEC. 7. EFFECT OF PENDING REQUESTS FOR CONSENT

01 Requests for changes in the method of accounting for service warranty insurance costs that qualify under this revenue procedure and are received by the National Office on or after June 12, 1992, will be returned to the taxpayer. Taxpayers to which this revenue procedure applies may not use the procedures of Rev. Proc. 92-20, but rather must use the provisions of this revenue procedure to change their method of accounting for service warranty insurance costs.

02 Taxpayers that are within the scope of this revenue procedure and have timely filed a Form 3115 with the National Office prior to June 12, 1992, may use the automatic provisions of this revenue procedure and will be so notified to this effect by the National Office. Any user fee submitted with the earlier application on Form 3115 will be returned to a taxpayer that chooses to use this revenue procedure.

SEC. 8. APPLICABILITY OF REV. PROC. 92-20

The definitions in Rev. Proc. 92-20 apply to a change in method of accounting made under this revenue procedure, except to the extent provided otherwise in this revenue procedure.

SEC. 9. INQUIRIES

Inquiries regarding this revenue procedure should refer to Rev. Proc. 92-97 and be addressed to the Commissioner of Internal Revenue, Attention: Office of Assistant Chief Counsel (Income Tax and Accounting) CC:IT&A, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044.

SEC. 10. EFFECT ON OTHER DOCUMENTS

Taxpayers that use the method of accounting for service warranty insurance costs provided in this revenue procedure may qualify to elect the service warranty income method provided in Rev. Proc. 92- 98, 1992-48 I.R.B.

SEC. 11. EFFECTIVE DATE

This revenue procedure is effective, with respect to changes in the method of accounting for the insurance costs that cover a taxpayer's risks under service warranty contracts, only for the taxpayer's first taxable year ending on or after June 12, 1992.

DRAFTING INFORMATION

The principal author of this revenue procedure is Eliot L. Kaplan of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Kaplan of that office at (202) 622-4960 (not a toll-free call).