Rev. Proc. 75-22

Section 1. Purpose.

The purpose of this Revenue Procedure is to set forth certain procedures to be used by the Internal Revenue Service in granting consent to taxpayers to change to the full absorption method of inventory costing as required by section 1.471-11(e)(1)(i) of the Income Tax Regulations whether or not such taxpayers have elected or will elect to use the last-in, first-out (LIFO) inventory method under section 472 of the Internal Revenue Code of 1954. The purpose of this Revenue Procedure is also to set forth procedures that the Service will use in the examination of returns involving related matters.

Sec. 2. Scope.

The scope of this Revenue Procedure is limited to the following situations:

.01 Situation (1)--Effective with the calendar year 1974, the taxpayer elected to use the LIFO inventory method under section 472 of the Code for all of its manufactured goods. In effecting the LIFO election the taxpayer, for Federal income tax purposes, used the same inventory costing method that it had used in the past for both tax and financial statement purposes, which did not reflect full absorption costing. Effective with the calendar year 1974, for financial statement purposes only, the taxpayer changed its inventory costing system to a full absorption costing method. For the calendar year 1975 taxpayer has elected to change to the full absorption method of inventory costing for Federal income tax purposes under the provisions of section 1.471-11(e)(1)(ii) of the regulations.

.02 Situation (2)--Effective with the calendar year 1974, the taxpayer elected the LIFO inventory method under section 472 of the Code for all of its manufactured goods. The taxpayer reviewed its inventory costing method for Federal income tax purposes and believed that its method complied with the full absorption method of inventory costing as described in section 1.471-11(a) of the regulations. Accordingly, the taxpayer used the same inventory costing method under the LIFO inventory method that it had previously used. Subsequently, the taxpayer's Federal income tax return for 1974 is examined and the Service determines that additional items of production cost should be included in the taxpayer's inventory under the full absorption method. The taxpayer agrees to the Service's determination.

.03 Situation (3)--The situation is the same as Situation 2, except that during the transition period referred to in section 1.471-11(e)(1)(ii) of the regulations, the taxpayer filed a "protective" Form 3115 (Application to Change Accounting Method) in which the taxpayer "elects" to change to the full absorption method of inventory costing in the event the Service determines that its present method of inventory costing method is not consistent with the provisions of section 1.471-11(a).

.04 Situation (4)--The situation is the same as in Situation 3, except that the taxpayer has not elected to use the LIFO method under section 472 of the Code and does not anticipate doing so. Instead, it has used and will continue to use the first-in, first-out (FIFO) inventory method under section 471 of the Code.

Sec. 3. Background.

.01 Section 472(a) of the Code authorizes the use of the LIFO inventory method if the taxpayer makes a proper application for such method under the regulations.

Section 472(b) provides in inventorying goods specified in the application described in subsection (a), the taxpayer shall:

(1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof; and second, those acquired in the taxable year;

(2) Inventory them at cost; and

(3) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.

Section 472(c) provides that subsection (a) shall apply only if the taxpayer establishes to the satisfaction of the Secretary or his delegate that the taxpayer has used no procedure other than that specified in paragraphs (1) and (3) of subsection (b) in inventorying such goods to ascertain the income, profit, or loss of the first taxable year for which the method described in subsection (b) is to be used, for the purpose of a report or statement covering such taxable year.

.02 Section 1.472-4 of the regulations provides that a taxpayer may not change to the LIFO method of taking inventories unless, at the time he files his application for adoption of such method, he agrees to such adjustments incident to the change to or from such method, or incident to the use of such method, in the inventories of prior taxable years or otherwise, as the district director upon the examination of the taxpayer's returns may deem necessary in order that the true income of the taxpayer will be clearly reflected for the years involved.

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

.04 Section 1.471-11(e)(1)(ii) of the regulations provides that if a taxpayer elects to change to the full absorption method of inventory costing during the transition period provided therein, he may elect on Form 3115 to change to such full absorption method of inventory costing, and in so doing, employ the transition procedures and adopt any of the transition methods prescribed in subparagraph (e)(3). Such election shall be made during the first 180 days of any taxable year beginning on or after September 19, 1973, and before September 19, 1975, (i.e., the "transition period") and the change in inventory costing method shall be made for the taxable year in which the election is made.

.05 Section 4.02 of Rev. Proc. 74-21, 1974-2 C.B. 475, provides that certain taxpayers electing the LIFO inventory method who decline to use the transition method described in section 1.471-11(e)(3)(ii)(A) of the regulations will be deemed to have violated the requirements of section 1.472-4 and thus may not be permitted to change to the LIFO inventory method.

.06 Section 3.01 of Rev. Proc. 74-51, 1974-2 C.B. 507, provides that Rev. Proc. 70-27, 1970-2 C.B. 509, dealing with procedures for changes in accounting matters, shall not apply to a taxpayer changing to the full absorption method of inventory costing under section 1.471-11(e)(1)(i) of the regulations and Section 3.02 of that Revenue Procedure provides that such a change will be subject to sections 446 and 481 of the Code.

Sec. 4. Application.

.01 In Situation 1 of Section 2 above, the Service will not attempt to terminate the taxpayer's LIFO election upon the grounds that the taxpayer's inventory costing method in its 1974 financial statements does not conform to the inventory costing method employed in its Federal income tax return for 1974. With certain exceptions not here relevant, the transition rules of section 1.471-11(e) of the regulations were intended to be applicable to taxpayers using the LIFO or FIFO inventory method. In this context the transition rules did not differentiate between taxpayers using the same or a different inventory costing method for tax and financial statement purposes. Accordingly, under these circumstances the taxpayer's LIFO election will not be terminated and its application to change to the full absorption method of inventory costing for 1975 will be consented to by the Service provided it is consistent with the provisions of section 1.471-11 and Rev. Proc. 74-21.

.02 In Situation 2 of Section 2 above, the Service will not attempt to terminate the taxpayer's LIFO election upon the ground that the taxpayer has "declined to use the transition method described in section 1.471-11(e)(3)(ii)(A) of the regulations" as set forth in Section 4.02 of Rev. Proc. 74-21. The application of Section 4.02 of Rev. Proc. 74-21 is specifically limited to taxpayers coming within Section 2 of that Revenue Procedure dealing with its scope. However, with respect to the additional items of production costs that the Service determines should be included in the taxpayer's inventory under the full absorption method, such adjustment will be made solely in accordance with the provisions of section 481 of the Code. Accordingly, no spread of the adjustment will be permitted under Rev. Proc. 70-27. See instead, Rev. Proc. 74-51, 1974-2 C.B. 507.

.03 In Situation 3 of Section 2 above, the Federal income tax consequences will be the same as in Section 4.02 above. The Service does not recognize and will neither approve nor deny anticipatory applications for changes in methods of accounting that are dependent upon the results of subsequent examinations of Federal income tax returns. Accordingly, in this situation the Service will decline to process the taxpayer's application to change its accounting method, and so notify the taxpayer.

.04 In Situation 4 of Section 2 above, the Federal income tax consequences are the same as in Section 4.03 in the sense that the Service will decline to process the taxpayer's application to change its accounting method, and so notify the taxpayer, since such application is dependent upon the results of subsequent examinations of its Federal income tax returns.

Sec. 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.

¹ Also released as TIR-1358, dated April 2, 1975.