IRS SPECIFIES PROCEDURE FOR OBTAINING CONSENT TO MAKE HISTORIC ABSORPTION RATIO ELECTION.

                              CONTENTS

.01 This revenue procedure provides the exclusive procedure for a taxpayer on a simplified production or simplified resale method of accounting for fewer than three taxable years to obtain consent to make a historic absorption ratio election under the transition rules of section 1.263A-2(b)(4)(v) or 1.263A-3(d)(4)(v) of the Income Tax Regulations. This procedure is applicable only for a taxpayer's first, second, or third taxable year beginning on or after January 1, 1994. A taxpayer complying with all the applicable provisions of this revenue procedure will be deemed to have obtained the consent of the Commissioner of Internal Revenue to make a historic absorption ratio election under section 446(e).

SECTION 2. BACKGROUND

.01 Section 263A of the Internal Revenue Code generally requires producers of real or tangible personal property and resellers of real or personal property described in section 1221(1) to capitalize the direct costs of such property and certain indirect costs allocable to such property, including "additional section 263A costs."

.02 "Additional section 263A costs" are the indirect costs, other than interest, that must be capitalized under section 263A, but that were not capitalized under the taxpayer's method of accounting immediately prior to the effective date of section 263A.

.03 Sections 1.263A-2(b) and 1.263A-3(d) provide a simplified production and a simplified resale method, respectively, for determining the additional section 263A costs that must be capitalized to ending inventory (or to the current-year increment in the case of a taxpayer using the last-in, first-out (LIFO) inventory method) or other property on hand at the end of the year. Under these simplified methods, a taxpayer determines the additional section 263A costs that must be capitalized by multiplying section 471 costs (as defined in section 1.263A-1(d)(2)) remaining on hand at year end (or reflected in the current-year increment in the case of a taxpayer using the LIFO inventory method) by an absorption ratio. In general, the absorption ratio is total additional section 263A costs incurred during the taxable year, divided by total section 471 costs incurred during the taxable year.

.04 Sections 1.263A-2(b)(4) and 1.263A-3(d)(4) permit a taxpayer changing to or using a simplified method to elect a "historic" absorption ratio. Under the historic absorption ratio election, a taxpayer determines an absorption ratio generally by dividing total additional section 263A costs incurred during the immediately preceding three-year period by total section 471 costs incurred during the immediately preceding three-year period (the "test period"). However, a taxpayer generally may make a historic absorption ratio election only if it has used a simplified method for each of the three immediately preceding taxable years.

.05 Sections 1.263A-2(b)(4)(v) and 1.263A-3(d)(4)(v) provide transition rules for a taxpayer to elect a historic absorption ratio in its first, second, or third taxable year beginning after December 31, 1993, under such terms and conditions as may be prescribed by the Commissioner. A taxpayer is eligible to make an election under these transition rules even though it has not used a simplified method for the three immediately preceding taxable years. A taxpayer making this election must compute or recompute its additional section 263A costs for the test period as if the rules prescribed in sections 1.263A-1, 1.263A-2, and 1.263A-3 had applied throughout such test period.

.06 Sections 1.263A-2(b)(4)(iii)(A) and 1.263A-3(d)(4)(iii)(A) provide that the election to use the historic absorption ratio is a method of accounting.

.07 Section 446(e) and section 1.446-1(e)(2)(i) state that, except as otherwise expressly provided, a taxpayer must obtain the consent of the Commissioner to change a method of accounting for federal income tax purposes.

.08 Section 1.446-1(e)(3)(i) requires that in order to obtain this consent, a Form 3115, Application for Change in Accounting Method, generally must be filed within 180 days after the beginning of the taxable year in which the proposed change is to be made.

.09 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 its method of accounting in accordance with section 446(e).

.10 Rev. Proc. 92-20, 1992-1 C.B. 685, provides the general procedures under section 1.446-1(e) for obtaining the consent of the Commissioner to change a method of accounting for federal income tax purposes. Section 2.04 of Rev. Proc. 92-20 provides that, unless other published guidance provides terms and conditions that must be used in making a specific type of accounting method change, a change in method of accounting will be made pursuant to the terms and conditions provided in Rev. Proc. 92-20.

.11 Rev. Proc. 94-49, 1994-30 I.R.B. 31, provides an automatic consent procedure for a taxpayer changing its method of accounting under sections 1.263A-1, 1.263A-2, and 1.263A-3 for its first taxable year beginning on or after January 1, 1994. However, section 3.02(2) of Rev. Proc. 94-49 expressly excludes from the scope of its automatic consent procedures any election of the historic absorption ratio under a simplified method.

SECTION 3. SCOPE

.01 Except as provided in sections 3.02 through 3.05 below, this revenue procedure applies to a taxpayer on a simplified production or simplified resale method of accounting for fewer than three taxable years that makes a historic absorption ratio election under the transition rules of section 1.263A-2(b)(4)(v) or 1.263A-3(d)(4)(v) for its first, second, or third taxable year beginning on or after January 1, 1994.

.02 This revenue procedure does not apply to a taxpayer that has not properly adopted or changed to a simplified production or simplified resale method of accounting without making a historic absorption ratio election. However, a taxpayer changing to a simplified production or simplified resale method of accounting under Rev. Proc. 94-49 for its first taxable year beginning on or after January 1, 1994, or under Rev. Proc. 92-20 for its second or third taxable year beginning on or after January 1, 1994, may concurrently or subsequently use this revenue procedure to make a historic absorption ratio election.

.03 This revenue procedure does not apply to a taxpayer that has used a simplified production or simplified resale method for three or more taxable years immediately preceding the year of change. Those taxpayers must make a historic absorption ratio election under section 1.263A-2(b)(4)(iii)(A) or 1.263A-3(d)(4)(iii)(A).

.04 This revenue procedure does not apply to a taxpayer unless the taxpayer has been in existence for the entire test period.

.05 A taxpayer that is the subject of a pending criminal investigation or proceeding concerning (1) any issue directly or indirectly related to the taxpayer's federal tax liability for any taxable year, or (2) the possibility of false or fraudulent statements made by the taxpayer regarding any issue related to its federal tax liability for any taxable year, must obtain the written consent of Criminal Investigation to make a historic absorption ratio election under this revenue procedure. The taxpayer must attach the written consent from Criminal Investigation to the statement required by section 4.02.

SECTION 4. APPLICATION

.01 CONSENT. In accordance with section 1.446-1(e)(3)(ii), the requirement to file an application on Form 3115 within the 180-day period is waived for a change in method of accounting filed under this revenue procedure. In addition, under section 1.446-1(e)(2)(i), the consent of the Commissioner is hereby granted to any taxpayer within the scope of this revenue procedure to make a historic absorption ratio election. This consent is granted for the taxpayer's first, second, or third taxable year beginning on or after January 1, 1994. This consent is conditioned, however, on the taxpayer filing the statement in the manner described in section 4.02 of this revenue procedure and otherwise complying with the provisions of this revenue procedure.

.02 FILING PROCEDURE. A taxpayer making a historic absorption ratio election pursuant to this revenue procedure must attach a statement to its timely filed (including extensions) original federal income tax return for the taxable year for which the election is made showing its absorption ratio for the test period as if the taxpayer had been on a simplified method for that entire period. For taxable years beginning in 1994, however, a taxpayer can attach the statement to an amended return filed on or before October 15, 1995. A taxpayer must maintain all appropriate records and details supporting its historic absorption ratio election until the expiration of the statute of limitations for the last year for which the taxpayer uses the historic absorption ratio. No user fee is required for a statement filed under this section 4.02.

.03 METHOD OF ACCOUNTING. The election to use the historic absorption ratio is a method of accounting. An election made under this revenue procedure is to be effected on a cut-off basis, and therefore no adjustment under section 481(a) is required or permitted. A taxpayer may revoke its election to use the historic absorption ratio with the consent of the Commissioner in a manner prescribed under section 446(e) and the regulations thereunder.

.04 COORDINATION WITH REV. PROC. 94-49. A taxpayer changing to a simplified method without a historic absorption ratio election under Rev Proc. 94-49 must take into account a section 481(a) adjustment equal to the change in value of its inventory at the beginning of the year of change. A taxpayer concurrently making a historic absorption ratio election under this revenue procedure must compute its ending inventory (or the current-year increment in the ease of a taxpayer using the LIFO inventory method) for the year of change using the historic absorption ratio election.

.05 NO NEW BASE YEAR. A taxpayer using the LIFO inventory method is not permitted to establish a new base year if it makes a historic absorption ratio election pursuant to this revenue procedure.

.06 APPLICABILITY OF REV. PROC. 92-20. The following definitions and provisions of Rev. Proc. 92-20 apply to a change in method of accounting made pursuant to this revenue procedure:

(1) sections 3.01 through 3.04, which provide definitions for the following terms: "taxpayer," "year of change," and "filed"; and

(2) section 8.02, which provides that a short taxable year is treated as a separate taxable year.

.07 NO PROTECTION FROM EXAMINATION CHANGES. A taxpayer that receives consent to make a historic absorption ratio election under this revenue procedure does not thereby obtain protection from examination changes for taxable years prior to the taxable year for which the election is made.

SECTION 5. EXCLUSIVE PROCEDURE

For changes in method of accounting to which this revenue procedure applies, this is the exclusive procedure available to a taxpayer for obtaining the Commissioner's consent to make a historic absorption ratio election. If a taxpayer to which this revenue procedure applies makes a historic absorption ratio election without complying with all the conditions of this revenue procedure, the taxpayer will be deemed to have initiated a change in method of accounting without obtaining the consent of the Commissioner as required under section 446(e).

SECTION 6. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention: Office of Assistant Chief Counsel (Income Tax and Accounting) CC:DOM:IT&A, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

SECTION 7. EFFECTIVE DATE

The provisions of this revenue procedure are effective for a taxpayer's first, second, or third taxable year beginning on or after January 1, 1994. The Service will return any Form 3115, pending on May 1, 1995, or received thereafter, that is filed with the National Office pursuant to the Code, regulations, or administrative guidance if the change in method of accounting is within the scope of this revenue procedure.

DRAFTING INFORMATION

The principal author of this revenue procedure is Paul K. Gibbs of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Gibbs at (202) 622-5020 (not a toll-free call).