Rev. Proc. 77-19

SECTION 1. PURPOSE.

The purpose of this Revenue Procedure is to set forth certain procedures is to set forth certain procedures to be followed in applying the full absorption method of inventory costing rules of section 1.471-11 of the Income Tax Regulations in determining the earnings and profits of a controlled foreign corporation, as defined in section 957(a) of the Internal Revenue Code of 1954, that is a manufacturer not engaged in a trade or business within the United States.

SECTION 2. BACKGROUND.

.01 Section 1.471-11 of the regulations provides rules for the maintaining of inventories by manufacturers. Section 1.471-11(a) provides, in part, that in order to conform as nearly as may be possible to the best accounting practices and to clearly reflect income, both direct and indirect production costs must be taken into account in the computation of inventoriable costs in accordance with the "full absorption method of inventory costing."

.02 Section 1.471-11(e)(1)(i) of the regulations provides, in part, that a taxpayer not using the full absorption method of inventory costing must change to that method.

.03 Section 1.471-11(e)(1)(ii) of the regulations provides a special election during a 2-year-transitional period in which a taxpayer may elect on Form 3115 (Application for Change in Accounting Method) to change to a full absorption method of inventory costing. This special election is intended to encourage taxpayers to voluntarily change to the full absorption method of inventory costing. A taxpayer that properly makes such an election may elect to take any adjustment required by section 481 of the Code with respect to any inventory being revalued under the full absorption method into account ratably over a period designated by the taxpayer at the time of the election, not to exceed the lesser of 10 taxable years commencing with the year of transition or the number of years the taxpayer has been on the inventory method from which the taxpayer is changing. Section 1.471-11(e)(3)(i). Such election was required to be made during the first 180 days of any taxable year beginning on or after September 19, 1973, and before September 19, 1975. However, under Rev. Proc. 75-34, 1975-2 C.B. 560, as clarified by Rev. Proc. 75-40, 1975-2 C.B. 571, as modified by Rev. Proc. 75-53, 1975-2 C.B. 594, the time for making the election to change to the full absorption method of inventory costing and to use the transitional procedures set forth in section 1.471-11(e)(1)(ii) was extended for an additional 60 days to January 27, 1976, or the end of such 180 days, whichever is later.

.04 Section 1.964-1(a) of the regulations provides, in part, that, for purposes of sections 951 through 964 of the Code, the earnings and profits of a foreign corporation shall be determined according to rules substantially similar to those applicable to domestic corporations.

.05 Sections 1.964-1(a)(1),(2), and (3) of the regulations prescribe the procedures to be followed in computing a foreign corporation's earnings and profits. Section 1.964-1(a)(1) requires that a profit and loss statement be prepared from the books of account regularly maintained by the corporation for the purpose of accounting to its shareholders; Section 1.964-1(a)(2) requires the making of adjustments necessary to conform such statement to the accounting principles described in section 1.964-1(b), and section 1.964-1(a)(3) requires the making of further adjustments necessary to conform such statement to the tax accounting standards described in section 1.964-1(c).

.06 Section 1.964-1(b) of the regulations provides, in part, that the accounting principles to be applied in making the adjustments required by section 1.964-1(a)(2) shall be those accounting principles generally accepted in the United States for purposes of reflecting in the financial statements of a domestic corporation the operations of its foreign affiliates.

.07 Section 1.964-1(c)(1)(ii) of the regulations provides that inventories shall be taken into account in accordance with the provisions of sections 471 and 472 of the Code and the regulations thereunder.

.08 Section 1.964-1(c)(1)(iv) of the regulations provides, in part, that effect shall be given to any election made in accordance with an applicable provision of the Code and the regulations thereunder and these regulations (regulations under section 964 of the Code).

.09 Section 1.964-1(c)(6) of the regulations provides, in part, that notwithstanding any other provision of section 1.964-1(c), action by or on behalf of a foreign corporation (other than a foreign corporation subject to tax under section 882 of the Code) to make an election or to adopt a method of accounting shall not be required until 180 days after the close of the first taxable year for which one of the significant events enumerated therein occurs.

.10 Rev. Proc. 75-40 sets forth certain procedures to be used by the Internal Revenue Service with respect to taxpayers who are changing to or have changed to the full absorption method of inventory costing under section 1.471-11(e) of the regulations and who, under their proposed method of full absorption costing, have or will exclude from inventoriable costs any or all of the indirect production costs listed in or subject to section 1.471-11(c)(2)(iii). Specifically that Revenue Procedure requires certain representations to be made for the purpose of determining whether or not the proposed treatment of indirect production costs under section 1.471-11(c)(2)(iii) of the regulations is inconsistent with generally accepted accounting principles.

SECTION 3. APPLICATION.

.01 Although section 1.471-11(e)(1)(i) of the regulations is mandatory and requires that taxpayers not using the full absorption method of inventory costing change to that method, such regulations do not specify the time when a controlled foreign corporation not engaged in a trade or business in the United States must change.

.02 However, section 1.964-1(c)(6) of the regulations deals specifically with the time to make an election or to adopt a method of accounting by foreign corporations (other than those subject to tax under section 882 of the Code). That regulation authorizes the deferral of the making of such an election or the adoption of the method until 180 days after the close of the first taxable year in which a significant event occurs.

.03 Therefore, the mandatory provisions of section 1.471-11(e)(1)(i) of the regulations are applicable to a controlled foreign corporation engaged in manufacturing.

.04 An election by or on behalf of a controlled foreign corporation not engaged in a trade or business within the United States to voluntarily elect to change to the full absorption method of inventory costing pursuant to section 1.471-11(c)(1)(ii) may be made by properly filing Form 3115 within the prescribed transitional period. However, in the case of a controlled foreign corporation not engaged in a trade or business within the United States that has not had a significant event within the meaning of section 1.964-1(c)(6), the time for making the "special voluntary election" to change to the full absorption method of inventory costing (and to thereby take any required adjustment into account ratably over a period not exceeding ten years properly designated by the controlled foreign corporation or its shareholder) is not limited to the period prescribed in section 1.471-11(e)(1)(ii), as extended by Rev. Proc. 75-40 and Rev. Proc. 75-53. In such a case, the election may be made, pursuant to section 1.964-1(c)(6), within 180 days after the close of the first taxable year in which a significant event occurs or at a later date with the permission of the Commissioner of Internal Revenue.

.05 In the case of a controlled foreign corporation not engaged in a trade or business within the United States that has had a significant event within the meaning of section 1.964-1(c)(6) of the regulations, the time for making such election is limited to the period prescribed in section 1.471-11(e)(1)(ii), as extended by Rev. Proc. 75-40 and Rev. Proc. 75-53. Although the prescribed period for making such election has expired, the Internal Revenue Service will accept Form 3115 making such election filed by or on behalf of a foreign corporation until 120 days after June 13, 1977, the date this Revenue Procedure is published in the Internal Revenue Bulletin.

SECTION 4. EFFECT ON OTHER DOCUMENTS.

Rev. Proc. 75-40 and Rev. Proc. 75-53 are modified to provide that a controlled foreign corporation not engaged in a trade or business within the United States that has had a significant event within the meaning of section 1.964-1(c)(6) has until 120 days after the date this Revenue Procedure is published in the Internal Revenue Bulletin to make the election provided in section 1.147-11(e)(1)(ii) of the regulations.

SECTION 5. INQUIRIES.

Inquiries in regard to this Revenue Procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, Attention: T:C:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.