ABA Capital Recovery and Leasing Committee
Current Developments Report and
Update on Capital Recovery Guidance Projects
Saturday, September 27, 2007
7:00 a.m. -8:00 a.m.
Panelists:
Sharon Kay, Office of Tax Legislative Counsel, Treasury Department, Washington, DC
Dennis Tingey, Office of Tax Legislative Counsel, Treasury DepartmentWashington, DC
Glenn Johnson, Ernst & Young LLP, Washington, DC
Moderator: Katherine Breaks, KPMG LLP, Washington, DC
I. Selected Guidance Projects on the Treasury/IRS Priority Guidance Plan for 2007/2008 (August 13, 2007)
(Numbered as in the Plan, with annotations by the Committee)
GENERAL TAX ISSUES
- Final regulations under section 45G relating to the railroad track maintenance credit.
The IRS issued temporary regulations (T.D. 9286) on September 8, 2006, that provide rules for taxpayers eligible to claim the section 45G railroad track maintenance credit (RTMC) for qualified railroad track maintenance costs (QRTMCs).
The temporary regulations provide that an eligible taxpayer is a Class II or III railroad, any person that transports property using the rail facilities of a Class II or III railroad, or any person that provides railroad-related property or services to those classes of railroads. The regulations further define and provide examples of rail facilities, railroad-related property, and railroad-related services.
Subject to credit limitations, the temporary regulations provide guidance on calculating the RTMC, which is 50 percent of the QRTMCs, paid or incurred by an eligible taxpayer. The QRTMCs, as defined under the regulations, are limited to actual out-of-pocket costs and do not include direct or indirect reimbursements to the taxpayer. The temporary regulations also provide guidance on an assignment of railroad track miles, adjustments to the basis for the RTMC, and the treatment of a controlled group of corporations under section 45G.
Tax Relief and Health Care Act of 2006 (TRHCA), which passed in December of 2006,overruled the temporary regulations regarding the treatment of direct or indirect reimbursements to the taxpayer. It modifies the definition of qualified railroad track expenditures, so that theterm means gross expenditures (whether or not otherwise chargeable to capital account) formaintaining railroad track (including roadbed, bridges, and related track structures) owned orleased as of January 1, 2005, by a Class II or Class III railroad (determined without regard to anyconsideration for such expenditures given by the Class II or Class III railroad which made theassignment of such track).
Thus, for example, under the provision, QRTMCs are not reduced by the discount amount in the case of discounted freight shipping rates, the increment in a markup of the price for track materials, or by debt forgiveness or by cash payments made by the Class II or Class III railroad to the assignee as consideration for the expenditures. Consideration received directly or indirectly from persons other that the Class II or Class III railroad, however, does reduce the amount of qualified railroad track maintenance expenditures. No inference is intended under the provision as to whether or not any such consideration is or is not includable in the assignee's income for Federal tax purposes.
The final regulations will presumably be amended to reflect this change.
11. Guidance concerning the credit for the production of low sulfur diesel fuel under section 45H regarding the certification requirement for complying with EPA regulations.
Section 45H (the low sulfur diesel fuel production credit) provides a production tax credit for the production of low sulfur diesel fuel by a small business refiner.
A credit is not allowed unless, not later than the date which is 30 months after the first day of the first taxable year in which the low sulfur diesel fuel production credit is determined with respect to a facility, the small business refiner obtains certification from the Secretary of the Treasury, after consultation with the Administrator of the EPA, that the taxpayer’s qualified capital costs with respect to such facility will result in compliance with the applicable EPA regulations.
Some taxpayers began producing low sulfur diesel fuel in 2005 so the period remaining for obtaining a certification is growing smaller.
13. Regulations under sections 46 and 167 relating to normalization.
14. Guidance under section 48 on the energy credit for qualified fuel cell and microturbine property.
17. Revenue ruling addressing the consequences of certain transactions on the treatment of arrangements as leases for federal income tax purposes.
26. Guidance under section 174 concerning inventory property.
27. Temporary regulations under section 179B regarding the deduction for capital cost incurred by a refinery in complying with EPA regulations
Section 179B allows, generally, an elective deduction by a small business refiner of 75 percent of the “qualified capital costs” paid or incurred by the taxpayer to build low-sulfur diesel fuel facilities in compliance with EPA requirements.
The regulations are expected to address what types of costs constitute “qualified capital costs” for purposes of the rule.
Issues that have arisen include how to deal with “dual-use property” – that is, property that is used to produce low sulfur diesel fuel as well as other types of fuel.
28. Guidance under section 179C on the election to expense certain refineries.
Section 179C provides a temporary election to expense 50% of the cost of qualified refinery property placed in service during the tax year. Taxpayers that elect to expense certain refinery property under section 179C must file an election in accordance with rules issued by the Secretary.
For the 2006 return filing season, taxpayers madethe election under section 179C, even though the guidance was not released in time for the 2006 filing season. In Notice 2006-47, the IRS issued guidance on making the election under section 179B, and the guidance in Notice 2006-47 may be a model for what will be required.
29. Guidance under section 179D, amplifying Notice 2006-52, on the deduction for energy efficient commercial building property
Under section 179D, a deduction is available for the cost of energy efficient commercial building property expenditures. The deduction is capped at $1.80 per square foot.
The statute also provides that the basis of the property must be reduced by the amount of the deduction claimed.
In the case of energy efficient commercial building property installed on or in property owned by a Federal, State, or local government or a political subdivision thereof, the Secretary is required promulgate a regulation to allow the allocation of the deduction to the person primarily responsible for designing the property in lieu of the owner of such property. Such person is treated as the taxpayer for purposes of the provision.
Open issues include whether the designer is required to reduce its basis in unrelated assets and whether the amount of the deduction is based on the designer’s cost or the purchaser’s cost.
TAX ACCOUNTING
2. Regulations under sections 162 and 263 regarding the deduction and capitalization of expenditures for tangible assets.
On August 19, 2006, Treasury issued proposed regulations (REG-168745-03) that provide guidance on the treatment of payments to acquire, produce, or improve tangible property by clarifying and expanding section 263(a) standards and providing bright-line tests.
The proposed regulations specify amounts that must be capitalized, such as amounts paid for property intended to be used as a component in the repair or improvement of a unit of property and amounts paid to produce or acquire real or personal property for sale or resale.
The proposed regulations provide a 12-month rule similar to the rule adopted in case law for determining whether property has a useful life substantially beyond the tax year. Generally, an amount paid for the acquisition or production of a unit of property with an economic useful life of 12 months or less would not be a capital expenditure. The regulations also provide a coordination rule and examples to clarify the interaction between the 12-month rule and the section 461 timing rules.
The proposed regulations also provide a new repair allowance method.
The proposed regulations have been criticized by a wide variety of industry groups, and significant changes to the proposed regulations have been recommended by the taxpayer community. Given the complexity of the issues raised in the proposed regulations, portions of the regulations are expected to be re-proposed in the coming year.
5. Regulations under sections 195, 248 and 709 (as amended by the American Jobs Creation Act of 2004, section 902) regarding the elections to amortize start-up and organizational expenditures.
Amounts paid or incurred after October 22, 2004, generally must be amortized over a 180-month period, rather than a period of at least 60 months.
6. Proposed regulations under section 263(a) regarding the treatment of capitalized transaction costs.
Notice 2004-18 announced the intention to propose regulations to address the treatment of amounts that facilitate certain tax-free and taxable transactions and other restructurings and that are required to be capitalized under section 263(a) and Reg. Sec. 1.263(a)-5.
7. Guidance regarding the supporting documentation required under section 1.263(a)-5(f) to allocate success-based fees between activities that facilitate a transaction and activities that do not facilitate a transaction.
26. Guidance regarding the application of the Gulf Opportunity Zone bonus depreciation recapture rule in section 1400N(d)(5) to like-kind exchanges.
INTERNATIONAL ISSUES
A.1. Regulations and other guidance under subpart F related to the American Jobs Creation Act of 2004 and the Tax Increase Prevention and Reconciliation Act of 2005. See Notice 2006-48 regarding active aircraft or vessel leasing rents under section 954(c)(2)(A), which was published on May 22, 2006, and Notice 2007-9 regarding section 954(c)(6), which was published on January 29, 2007.
H.1. Regulations or other guidance related to shipping and aircraft transportation. Temporary regulations under section 1.883-3 were published on June 25, 2007.
- Notable Recent Cases, Guidance, Pronouncements, and Rulings
- Section 48A – Qualifying Advanced Coal Project Credit – Notice 2007-52
Section 48A(d) grants the Secretary authority to certify qualifying clean coal projects as eligible for the qualifying advance coal project credit. The Secretary of Treasury, in consultation with the Secretary of Energy, may allocate up to $800 million of credits to credit-eligible projects using an integrated gasification combined cycle (IGCC) technology, and up to $500 million in credits to credit-eligible projects that use other advanced coal-based generation technologies. The eligible credit amount is equal to 20% of qualified investments in a qualifying IGCC project and 15% of qualified investments in other advanced coal-based technologies. The credits for IGCC projects must be allocated in relatively equal amounts to: (i) projects using bituminous coal as a primary feedstock, (ii) projects using subbituminous coal as a primary feedstock, and (iii) projects using lignite as a primary feedstock. In determining which qualified projects to certify, the Secretary of Treasury will give priority to IGCC projects that include greenhouse gas capture capability, increased by-product utilization and other benefits.
In Notice 2006-24, the IRS authorized up to three credit allocation rounds, with the first beginning February 21, 2006. Taxpayers must obtain: (i) a certification from the Department of Energy, and a (ii) section 48A certification from the IRS.
In Notice 2007-52, the IRS updates guidance for credit allocation applications and changes the credit allocation criteria. The new credit allocation criteria is intended to favor projects that capture and sequester carbon dioxide emissions. Specifically, projects capturing and sequestering 50 percent or more of the plant’s carbon dioxide emissions will be given priority. Within this group, higher rankings will be given to those projects capturing and sequestering higher percentages of plant carbon dioxide emissions.
For this second round, the application for DOE certification must be mailed by October 31, 2007, in order to be assured that DOE certification will be provided in time for the section 48B certification deadline. The deadlinefor filing the application for section 48B certification is March 3, 2008.
2.Section 48B – Qualifying Gasification Project Credit – Notice 2007-53
Section 48B(d) grants the Secretary authority to certify gasification projects as eligible for the qualifying gasification project credit. Qualified gasification projects convert coal, petroleum residue, biomass, or other materials recovered for their energy or feedstock value into a synthesis gas composed primarily of carbon monoxide and hydrogen for direct use or subsequent chemical or physical conversion. The total amount of gasification credits allocable by the Secretary is limited to $350 million. A maximum of $130 million in credits can be allocated to any single gasification project. The credit amount is equal to 20% of qualified investments.
In Notice 2006-25, the IRS authorizes up to three credit allocation rounds, with the first beginning February 21, 2006. Taxpayers must obtain: (i) a certification from the Department of Energy, and a (ii) section 48B certification from the IRS.
In Notice 2007-53, the IRS updates guidance for credit allocation applicationschanges the allocation criteria. The new allocation method will substantially favor projects that capture and sequester carbon dioxide emissions.Specifically, projects capturing and sequestering 50 percent or more of the plant’s carbon dioxide emissions will have first priority.Within this group, higher rankings will be given to those projects capturing and sequestering higher percentages of plant carbon dioxide emissions.
For the second round, the application for DOE certification must be mailed by October 31, 2007, in order to be assured that DOE certification will be provided in time for the section 48B certification deadline. The deadlinefor filing the application for section 48B certification is March 3, 2008.
- Rev Proc. 2007-48
On June 28, the IRS issued Revenue Procedure 2007-48, which provides taxpayers with a safe harbor allowing them to treat rotable spare parts as depreciable assets.
In March 2003, the IRS issued Rev. Rul. 2003-37 which -- in addressing the tax treatment of rotable spare parts -- provided that taxpayers could treat rotable spare parts as depreciable assets consistent with the court decisions in the Hewlett Packard and Honeywell cases.
In Hewlett Packard v. United States, 71 F.3d 398 (Fed. Cir. 1995) rev’g Apollo Computer, Inc. v. United States, 32 Fed. Cl. 334 (1994), the taxpayer manufactured and sold computers and related products. In conjunction with the sale of its products, the taxpayer provided maintenance and repair services under product warranty and maintenance agreements, which obligated the taxpayer to provide parts and labor in exchange for a predetermined fee. To service the computers it sold under the maintenance agreements, the taxpayer maintained a pool of rotable spare parts from which repair technicians would use a tool or part to diagnose problems with a customer’s equipment. A customer’s part identified as the cause of the malfunction was replaced with an identical, functioning part from the taxpayer’s pool of spare parts, and the malfunctioning part was returned to the taxpayer’s pool for repair, so that it could continue to be used in the taxpayer’s maintenance business.
The Federal Circuit held that the taxpayer’s pool of spare parts was a depreciable asset used in the taxpayer’s business of providing maintenance services—contrary to the IRS’s and lower court’s view that such parts were property held for sale to customers and thus must be treated as inventory.
Based on similar facts, the Tax Court and Eight Circuit in Honeywell v. Commissioner, T.C.Memo 1992-453, aff’d. 27 F.3d 571 (8th Cir. 1994), also held that the taxpayer was not required to treat its pool of spare parts as inventory, because such pool was properly characterized as an asset used in the trade or business within the meaning of section 167.
In Rev. Rul. 2003-37, the IRS stated that it intended to issue a revenue procedure under which qualifying taxpayers could apply to obtain automatic consent to change to a method of accounting consistent with Hewlett Packard and Honeywell.
The revenue procedure addressessituations in which certain taxpayers, such as computermanufacturers, service their equipment with rotable spare parts as part of a maintenance orother customer service agreement, but operate their maintenance operations separately fromtheir manufacturing operations and rotable spare parts are physically segregated from thetaxpayers' regular manufacturing inventories.
A taxpayer using the safe harbor method of accounting for rotable spare parts under the revenue procedure must: (i) capitalize the cost of the rotable spare parts under section 263(a) and depreciate these parts under Section 168, (ii) establish one or more pools for the rotable spare parts in accordance with the revenue procedure's rules, and (iii) determine the depreciable basis of the rotable spare parts for depreciation purposes in accordance with Section 167.
It also contains specific rules regarding the establishment of permissible pools of rotable spare parts. If a taxpayer uses the revenue procedure's safe harbor it must use a method of accounting identifying the disposed rotable spare parts that is outlined in the revenue procedure.
The revenue procedure applies to taxpayers that:
- Repair customer-owned or customer-leased equipment under warranty or maintenance agreements provided to the customer for either no charge or a predetermined fee that does not change during the term of the agreement;
- Are obligated under the warranty or maintenance agreements to repair the customer's equipment, including all parts and labor related to the repair, for either no charge or a nominal service fee that is unrelated to the actual cost of parts and labor provided;
- Maintain a pool or pools of spare parts used primarily in the taxpayer's maintenance operation of repairing customer-owned or customer-leased equipment under warranty or maintenance agreements, exchange spare parts for defective parts in the equipment, and generally repair and reuse defective parts in its pool of spare parts; and
- Have a depreciable interest in the rotable spare parts and have placed in service the rotable spare parts after 1986.
A taxpayer is eligible to use the safe harbor method of accounting in any taxable year in which the taxpayer has sales of rotable spare parts from the taxpayer's maintenance operation that do not exceed 10 percent of the taxpayer's total gross revenues from its maintenance operation for the taxable year.
The revenue procedure also provides procedures that taxpayers may use to obtain an automatic consent to change to the safe harbor method of accounting. Any taxpayer making a change in method of accounting under the revenue procedure must make the change using a Section 481 adjustment.