C C O O R R P P O O R R A T A T E E B B U U S S I N I N E E S S S S T T A A X X A T A T I O I O N N M M O O N N T T H H L Y L Y Tax Accounting BY JAMES E. SALLES In this month’s column: deeper” than the approach taken under the regulation- by-ruling policy that has prevailed in the past. The pro- • Accounting issues figure prominently in the IRS posed regulations are expected to address such issues 2000 business plan; as repairs and the “plan of rehabilitation” doctrine, and • The T ax Court creates some confusion with a cryp- how to account for the cost of self-created intangible tic holding in Exxon Mobil Corp. v. Commissioner , assets, and may even incorporate a de minimis rule, 1 114 T .C. No. 20 (2000); which the IRS has steadfastly resisted until now. • The IRS concludes in a field service advice that mutual fund fees based on net asset value (NAV) are Other Accounting Issues not determinable with reasonable accuracy while Other accounting guidance scheduled for release the NAV remains susceptible to market fluctuation, includes the following: F .S.A. 200016002 (Jan. 13, 2000); and • There are several new developments in the ongoing controversy over whether taxpayers must accrue • Final regulations on various topics under the uniform merchandise receivables. capitalization (UNICAP) provisions • Final and proposed regulations under Code Section IRS BUSINESS PLAN 460 (concerning long-term contracts) • Additional guidance under Code Section 446 con- Accounting issues figure prominently in the IRS busi- cerning notional principal contracts ness plan for 2000, formally known as the Priority Guidance Plan, which was released in late March. • Finalization of the controversial proposed revenue procedure in Notice 98-31, 1998-1 C.B. 1165, set- INDOPCO Regulations ting forth how the IRS proposes to handle involun- T reasury and the IRS have responded to widespread tary changes in accounting methods requests for general guidance on capitalization issues EXXON MOBIL CORP. v. and the implications of the Supreme Court’s decision in INDOPCO v. United States , 503 U.S. 79 (1992). The COMMISSIONER business plan for 2000 promises specific guidance— In Exxon Mobil Corp. v. Commissioner , decided on probably in the form of revenue rulings—on whether and May 3, 2000, the T ax Court clarified the application of when to capitalize such items as cyclical maintenance the “all events” test, while obscuring the issue of what costs, sales commissions, mutual fund launch costs, constitutes a change in accounting method. The issue and bank loan origination costs. What all of these types was when Exxon could take a deduction for the costs of of expenditures have in common is that they produce “dismantlement, removal, and restoration” (DRR costs) some sort of future benefit, but are repetitive and are rou- incurred through different joint ventures in Alaska’s tinely incurred by taxpayers in particular businesses. Prudhoe Bay field. The plan also includes proposed regulations under Code Sections 162 and 263 that are described only as Background relating to “deduction and capitalization of expendi- A liability cannot be deducted or otherwise taken into tures.” Acting Assistant Secretary for T ax Policy account for tax purposes until “all events have occurred Jonathan T alisman explained that the intent is to take an which determine the fact of liability and the amount of approach to capitalization issues that is “broader and such liability can be determined with reasonable accuracy.” 2 It was long disputed whether this all events test could James E. Salles is a member of Caplin & Drysdale in Washington, D.C. be met when the taxpayer’s obligation was to perform in J U L Y 2 0 0 0 1 1
C O R P O R A T E B U S I N E S S T A X A T I O N M O N T H L Y kind rather than pay cash. The IRS argued that the all because “expectations and predictions simply do not events test was not met until the taxpayer actually began satisfy the all-events test of section 461. They do not incurring costs in performing its obligation. For example, rise to the level of fixed and definite legal obligations.” in Revenue Ruling 80-182, 1980-2 C.B. 167, an offshore The court held, however, that Alaska regulations did oil lease required the taxpayer to remove platforms and create an enforceable obligation to plug oil wells and well fixtures on termination. The ruling stated that even if clean up the immediate vicinity of well sites, and thus the taxpayer contracted with a third party to perform the that portion of Exxon’s DRR costs met the all events test. necessary services, it could not deduct anything until Changes in Method removal actually began. Several courts, however, dis- The remainder of the court’s opinion dealt with how to agreeing with this reasoning, allowed mining compa- treat the well cleanup costs that met the all events test. nies to amortize their estimated cost of restoring strip- The court held that Exxon could not change from mined land over the period during which the mine was operated. 3 The economic performance rules overruled deducting to capitalizing the costs because that would these cases, 4 but they remained good law for the years be in change accounting method. T axpayers ordinarily cannot change accounting methods without permis- involved in the Exxon case (1979-82). sion, or retroactively. 5 The court then dismissed Exxon’s The All Events Test fallback argument for an immediate deduction on the grounds that, although it might not be a change in Exxon’s original return followed the IRS’s position and accounting method, the resulting mismatch of income made no attempt to accrue Exxon’s DRR costs during and deductions would not clearly reflect income. the production period. On amended returns, however, In contrast to its exhaustive treatment of the all events Exxon treated its DRR liability as becoming “fixed” when test, the court’s discussion of the accounting issues was it signed the leases, and added them to basis in com- short, cryptic, and somewhat puzzling. Either changing puting percentage depletion and the investment tax to amortizing the DRR costs, or continuing to deduct credit. Alternatively, it argued for simply deducting the them but at an earlier time, would involve a change in DRR costs outright as soon as the leases were signed. “the proper time for . . . the taking of a deduction.” 6 Both, In either case, Exxon had to begin by showing that its therefore, could equally be changes in accounting meth- liability for DRR costs under the leases met the all ods. In either case, Exxon would have an argument that events test. Exxon and its co-venturers leased the land it was simply correcting an “error” rather than changing under an Alaska form contract referred to as a DL-1 lease. Under the DL-1 leases the venturers were methods, especially if it could show that it already treat- ed similar costs the same way. 7 This might have been allowed to remove any equipment or facilities left over from its operations. The companies were not, however, possible, since the IRS evidently conceded that the DRR generally obligated to remove facilities, although the costs imposed by the T APS leases could be capitalized. leases also provided that the lessees “shall remove any As a result of the court’s abbreviated opinion, it is hard to and all . . . properties when . . . directed” by the state, evaluate the strengths of the parties’ positions, and it is and that no site could be abandoned until “final cleanup hard to explain a holding that changing to amortizing the and revegetation, if required, [was] approved” by the DRR costs would be a change in accounting method state. In contrast, contemporary leases entered into but simply deducting them earlier might not. with the federal government in connection with the The court’s treatment of Exxon’s fallback argument is Alaska Pipeline project (T APS leases)—which the IRS almost equally mysterious. “Clear reflection of income” apparently conceded met the all events test—express- is almost never cited as independent grounds for disal- ly obliged the oil companies to “promptly remove all lowing use of an accounting method explicitly permitted improvements and equipment” and “restore the land” to by the Code or regulations. Indeed, the T ax Court has the satisfaction of federal officials. gone so far as to say that the IRS “may not reject, as not Despite testimony from experts and state officials that providing a clear reflection of income, a method of state policy favored restoration of lands and predictions accounting employed by the taxpayer which is specifi- that the state would use the authority granted it by the cally authorized in the Code or regulations and has leases to require a full cleanup of the property, the T ax been applied on a consistent basis.” Hallmark Cards v. Court held that the DL-1 leases did not create the nec- Commissioner , 90 T .C. 26, 31 (1988). T oo big a deal essary fixed liability as to “fieldwide” reclamation costs, should not be made of this semantic point. The T ax J U L Y 2 0 0 0 2 2 J U L Y 2 0 0 0
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