Safe Harbor Provided for 'Ratable Service Contracts'

26 CFR 601.204 Changes in accounting periods and methods of accounting (Also: Part I, §§ 461; 1.461-4; 481)

SECTION 1. PURPOSE

This revenue procedure provides a safe harbor under which a taxpayer using an accrual method of accounting may treat economic performance as occurring on a ratable basis for certain service contracts described in section 4.02 of this revenue procedure. This revenue procedure also provides procedures for obtaining the automatic consent of the Commissioner to change to the method of accounting described in this revenue procedure.

SECTION 2. BACKGROUND

.01 Section 461(a) of the Internal Revenue Code provides that the amount of any deduction or credit must be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.

.02 Section 1.461-1(a)(2)(i) of the Income Tax Regulations provides that, under an accrual method of accounting, a liability is incurred, and generally taken into account for federal income tax purposes, in the taxable year in which (1) all the events have occurred that establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy (requirements (1) and (2) are collectively referred to as the "all events test"), and (3) economic performance has occurred with respect to the liability. See also § 1.446-1(c)(1)(ii)(A).

.03 All the events have occurred that establish the fact of the liability when (1) the event fixing the liability occurs, whether that is the required performance or other event, or (2) the payment is due, whichever happens earliest. Rev. Rul. 2007-3, 2007-1 C.B. 350; Rev. Rul. 80-230, 1980-2 C.B. 169; Rev. Rul. 79-410, 1979-2 C.B. 213, amplified by Rev. Rul. 2003-90, 2003-2 C.B. 353.

.04 Section 461(h)(1) and § 1.461-4(a)(1) provide that, for purposes of determining whether an accrual basis taxpayer can treat the amount of any liability as incurred, the all events test is not treated as met any earlier than the taxable year in which economic performance occurs with respect to the liability.

.05 Section 461(h)(2)(A)(i) provides that if the liability of a taxpayer arises out of the provision of services to the taxpayer by another person, economic performance occurs as the person provides those services. See also § 1.461-4(d)(2)(i).

.06 Neither § 461(h)(2)(A)(i) nor § 1.461-4(d)(2)(i) explain when a person has provided services for purposes of satisfying the economic performance requirement in the context of a Ratable Service Contract as described in section 4.02 of this revenue procedure.

.07 There are two exceptions to the general rule of economic performance in § 461(h)(2)(A) that allow a taxpayer to accelerate the accrual of a liability into a year prior to the year that the economic performance requirement is satisfied. These exceptions are the 3 1/2 month rule and the recurring item exception.

.08 Under the 3 1/2 month rule in § 1.461-4(d)(6)(ii), a taxpayer may treat economic performance as occurring as the taxpayer makes payment to the person providing the services if the taxpayer can reasonably expect the person to provide the services within 3 1/2 months after the taxpayer makes the payment.

.09 Under the recurring item exception in § 461(h)(3)(A) and § 1.461-5(b), a liability is treated as incurred for a taxable year if: (i) at the end of the taxable year, all the events have occurred that establish the fact of the liability and the amount can be determined with reasonable accuracy; (ii) economic performance occurs on or before the earlier of (A) the date that the taxpayer files a timely return (including extensions) for the taxable year, or (B) the 15th day of the ninth calendar month after the close of the taxable year; (iii) the liability is recurring in nature; and (iv) either (A) the amount of the liability is not material or (B) the accrual of the liability in the taxable year results in a better matching of the liability with the income to which it relates than would result from accruing the liability for the taxable year in which economic performance occurs. See, Rev. Rul. 2012-1, 2012-1 I.R.B. 255.

.10 Section 1.461-4(d)(6)(iv) provides that if different services are required to be provided to the taxpayer under a single contract, economic performance occurs over the time each service is provided.

.11 In Caltex Oil Venture v. Commissioner, 138 T.C. 18, 36 (2012), the Tax Court construed the 3 1/2 month rule as contemplating that all of the services called for under an undifferentiated, nonseverable contract must be provided within 3 1/2 months of payment.

.12 Under § 446(b), the Commissioner has broad authority to determine whether a method of accounting clearly reflects income. Section 1.446-1(c)(2)(ii) provides that the Commissioner may authorize a taxpayer to adopt or change to a permissible method of accounting although the method is not specifically described in the regulations as permissible if, in the opinion of the Commissioner, that method clearly reflects income.

.13 Section 446(e) and § 1.446-1(e)(2)(i) state 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. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions necessary to obtain the Commissioner's consent to effect the change in method of accounting and to prevent amounts from being duplicated or omitted.

.14 Section 481(a) requires adjustments necessary to prevent amounts from being duplicated or omitted by reason of a change in method of accounting.

.15 Rev. Proc. 2015-13, 2015-5 I.R.B. 419, provides the automatic change procedures by which a taxpayer may obtain consent to change to a method of accounting described in the List of Automatic Changes of Rev. Proc. 2015-14, 2015-5 I.R.B. 450.

SECTION 3. SCOPE

This revenue procedure applies to an accrual method taxpayer that wants to change its method of accounting for liabilities arising out of the provision of services to the taxpayer under a Ratable Service Contract, as defined in section 4.02 of this revenue procedure, to the safe harbor method provided in section 4.01 of this revenue procedure.

SECTION 4. SAFE HARBOR METHOD

.01 In General. Under the safe harbor method of accounting for Ratable Service Contracts, as defined in section 4.02, a taxpayer may treat economic performance as occurring on a ratable basis over the term of the service contract.

.02 Ratable Service Contract. For purposes of this revenue procedure, a contract is a Ratable Service Contract if: (1) the contract provides for similar services to be provided on a regular basis, such as daily, weekly, or monthly; (2) each occurrence of the service provides independent value, such that the benefits of receiving each occurrence of the service is not dependent on the receipt of any previous or subsequent occurrence of the service, and; (3) the term of the contract does not exceed 12 months (contract renewal provisions will not be considered in determining whether a contract exceeds 12 months). If a single contract includes services that satisfy the requirements of this section and services (or other items) that do not satisfy the requirements of this section, the services (or other items) that do not satisfy the requirements of this section must be separately priced in the contract for the contract to qualify as a Ratable Service Contract.

.03 Examples. The following examples illustrate the application of the safe harbor method of accounting for Ratable Service Contracts. In each example the taxpayer uses an accrual method of accounting for federal income tax purposes, including the use of the 3 1/2 month rule and the recurring item exception, and files its returns on a calendar year basis.

.01 In general. A change in the treatment of Ratable Service Contracts to conform to the safe harbor method provided by this revenue procedure is a change in method of accounting to which the provisions of §§ 446 and 481 and the regulations thereunder apply. A taxpayer that wants to change to the method of accounting described in this revenue procedure must, if eligible, use the automatic change procedures in Rev. Proc. 2015-13 and Rev. Proc. 2015-14, or successors, as modified by section 5.02 of this revenue procedure.

.02 Rev. Proc. 2015-14 is modified to add new section 19.12 to the List of Automatic Changes to read as follows:

.12 Economic Performance Safe Harbor for Ratable Service Contracts.

(1) Description of change. This change applies to an accrual method taxpayer that wants to change its treatment of Ratable Service Contracts to conform to the safe harbor method provided by Rev. Proc. 2015-39, 2015-33 I.R.B. ___.

(2) Eligibility rule temporarily inapplicable. The eligibility rule in section 5.01(1)(f) of Rev. Proc. 2015-13, does not apply to a taxpayer that wants to make a change for a taxpayer's first, second, or third taxable years ending on or after July 30, 2015.

(3) Designated automatic accounting method change number. The designated automatic accounting method change number for changes in methods of accounting under this section 19.12 is "220."

(4) Contact information. For further information regarding a change under this section, contact David Christensen or Peter Ford at 202-317-7011 (not a toll-free call).

SECTION 6. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2015-14 is modified to add new section 19.12 to the List of Automatic Changes.

SECTION 7. REQUEST FOR COMMENTS

Section 461(h)(2)(A) and § 1.461-4(d)(2)(i) do not define the phrase "as services are provided" for purposes of determining when economic performance occurs for liabilities arising from services to be provided to the taxpayer by another person. The Treasury Department and the Internal Revenue Service invite comments regarding when economic performance occurs for liabilities arising from services to be provided to the taxpayer by another person under contracts for: (1) deliverable-type services that are not completed on a periodic basis, (2) multiple services that are not separately priced, and (3) Ratable Service Contracts that are longer than one year.

Comments may be submitted in writing on or before November 15, 2015. Comments should be submitted to Internal Revenue Service, CC:PA:LPD:PR (Rev. Proc. 2015-39), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044, or electronically to Notice.comments@irscounsel.treas.gov. Please include Rev. Proc. 2015-39 in the subject line of any electronic communication.

Alternatively, comments may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Rev. Proc. 2015-39), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC.

All comments will be available for public inspection and copying.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective for taxable years ending on or after July 30, 2015.

SECTION 9. DRAFTING INFORMATION

The principal author of this revenue procedure is David M. Christensen of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this revenue procedure contact David M. Christensen on (202) 317-7011 (not a toll free call).