[Federal Register Volume 76, Number 195 (Friday, October 7, 2011)]
[Proposed Rules]
[Pages 62327-62329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-25946]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-125949-10]
RIN 1545-BJ64
Retail Inventory Method
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to the
retail inventory method of accounting. The regulations restate and
clarify the computation of ending inventory values under the retail
inventory method and provide a special rule for certain taxpayers that
receive margin protection payments and similar vendor allowances. The
regulations affect taxpayers that are retailers and elect to use a
retail inventory method.
DATES: Written or electronically generated comments and requests for a
public hearing must be received by January 5, 2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-125949-10), room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
125949-10), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-125949-10).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Natasha M. Mulleneaux, (202) 622-3967; concerning submission of
comments and requests for a public hearing, Richard Hurst at
[email protected].
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to 26 CFR part 1
relating to the retail inventory method under Sec. 1.471-8 of the
Income Tax Regulations.
Section 471 provides that a taxpayer's method of accounting for
inventories must clearly reflect income. Section 1.471-2(c) provides
that the bases of inventory valuation most commonly used and meeting
the requirements of section 471 are (1) cost and (2) cost or market,
whichever is lower (LCM). Section 1.471-8 allows retailers to
approximate cost or LCM by using the retail inventory method. A last-
in, first out (LIFO) taxpayer that elects to use the retail inventory
method must approximate cost.
Under the retail inventory method, the retail selling price of
ending inventory is converted to approximate cost or approximate LCM
using a cost-to-retail ratio, or cost complement. The numerator of the
cost complement is the value of beginning inventory plus the cost of
purchases during the taxable year, and the denominator is the retail
selling prices of beginning inventories plus the initial retail selling
prices of purchases. The cost complement is then multiplied by the
retail selling price of ending inventory (multiplicand) to determine
the ending inventory value.
Section 1.471-3 provides that, for inventory valuation purposes,
the cost of purchases during the year generally includes invoice price
less trade or other discounts. A discount may be based on a retailer's
sales volume (sales-based allowance) or on the quantity of merchandise
a retailer purchases (volume-based allowance), or may relate to a
retailer's reduction in retail selling price (markdown allowance or
margin protection payment). A vendor may provide a retailer with a
markdown allowance or margin protection payment when the retailer
temporarily or permanently reduces the retail selling price of its
inventory to sell it. A markdown allowance or margin protection payment
differs from other types of discounts because it is intended to
maintain the retailer's profit margin and therefore is directly related
to the inventory selling price.
Under proposed Sec. 1.471-3(e) (75 FR 78944), the amount of an
allowance, discount, or price rebate a taxpayer earns by selling
specific merchandise (a sales-based vendor allowance) is a reduction in
the cost of the merchandise sold and does not reduce the inventory cost
or value of goods on hand at the end of the taxable year.
Explanation of Provisions
1. Overview
The proposed regulations restructure and restate the regulations
under Sec. 1.471-8 in plain language. The proposed regulations also
add rules addressing the treatment of sales-based vendor allowances and
of vendor markdown allowances and margin protection payments in the
retail inventory method computation.
2. Sales-Based Vendor Allowances
The proposed regulations clarify the interaction of proposed Sec.
1.471-3(e) with the retail inventory method by excluding from the
numerator of the cost complement formula the amount of a sales-based
vendor allowance.
3. Computation of Cost Complement Under the Retail LCM Method
The retail inventory method determines an ending inventory value by
maintaining proportionality between costs and selling prices. Under the
retail LCM method, a reduction in retail selling price reduces the
value of ending inventory in the same ratio as the cost complement.
If a taxpayer earns an allowance, discount, or price rebate, the
inventory cost in the numerator of the cost complement declines,
resulting in a reduction of ending inventory value computed under the
retail inventory method. If the allowance, discount, or price rebate is
related to a permanent markdown of the retail selling price (as in the
case of a markdown allowance or margin protection payment), ending
inventory value is further reduced as a result of the decrease in
ending retail selling prices (the multiplicand in the formula). This
additional reduction of ending inventory value caused by reducing both
the numerator of the cost complement and the multiplicand (1) Generally
results in a lower ending inventory value for a retail LCM method
taxpayer than for a similarly situated first-in, first-out (FIFO)
taxpayer that values inventory at LCM, and (2) does not clearly reflect
income.
To address this distortion, the proposed regulations provide that a
retail LCM method taxpayer may not reduce the numerator of the cost
complement for an allowance, discount, or price rebate that is related
to or intended to compensate for a permanent markdown of retail selling
prices. Thus, in the case of markdown allowances and margin protection
payments, the value of ending inventory as computed under the retail
LCM method is reduced solely as a result of the reduction in retail
selling price, avoiding an unwarranted
[[Page 62328]]
additional reduction in inventory value for a single markdown allowance
and more reasonably approximating LCM.
As an alternative to this proposed modification, the retail
inventory method could achieve the same result by permitting taxpayers
to reduce the numerator of the cost complement for all non-sales based
allowances, discounts, or price rebates, including markdown allowances,
but requiring a reduction of the denominator of the cost complement for
all permanent markdowns related to markdown allowances. Comments are
specifically requested on whether the final regulations should provide
this or other alternative retail LCM methods.
4. Temporary Price Adjustments
The proposed regulations clarify that under the retail inventory
method taxpayers do not adjust the cost complement or ending retail
selling prices for temporary markdowns and markups.
Effective/Applicability Date
These regulations are proposed to apply for taxable years beginning
after the date the regulations are published as final regulations in
the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and because
these regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on their
impact on small business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments that are submitted
timely to the IRS. Comments may be submitted electronically or via a
signed original with eight (8) copies. Comments are requested on the
clarity of the proposed rules and how they can be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing will be scheduled if requested in writing by any
person that timely submits comments. If a public hearing is scheduled,
notice of the date, time, and place for the hearing will be published
in the Federal Register.
Drafting Information
The principal author of these regulations is Natasha M. Mulleneaux
of the Office of the Associate Chief Counsel (Income Tax & Accounting).
Other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.471-8 is revised to read as follows:
Sec. 1.471-8 Inventories of retail merchants.
(a) In general. A taxpayer that is a retail merchant may use the
retail inventory method of accounting described in this section. The
retail inventory method uses a formula to convert the retail selling
price of ending inventory to an approximation of cost (retail cost
method) or an approximation of lower of cost or market (retail LCM
method). A taxpayer may use the retail inventory method instead of
valuing inventory at cost under Sec. 1.471-3 or lower of cost or
market under Sec. 1.471-4.
(b) Computation--(1) In general. A taxpayer computes the value of
ending inventory under the retail inventory method by multiplying a
cost complement by the retail selling prices of the goods on hand at
the end of the taxable year.
(2) Cost complement--(i) In general. The cost complement is a ratio
computed as follows--
(A) The numerator is the value of beginning inventory plus the cost
of goods purchased during the taxable year; and
(B) The denominator is the retail selling prices of beginning
inventory plus the retail selling prices of goods purchased during the
year (that is, the bona fide retail selling prices of the items at the
time acquired), adjusted for all permanent markups and markdowns,
including markup and markdown cancellations and corrections. The
denominator is not adjusted for temporary markups or markdowns.
(ii) Sales-based vendor allowances. A taxpayer may not reduce the
numerator of the cost complement by the amount of an allowance,
discount, or price rebate a taxpayer earns by selling specific
merchandise.
(iii) Special rules for cost complement for retail LCM method--(A)
Margin protection payments and similar allowances. A taxpayer using the
retail inventory method to approximate LCM may not reduce the numerator
of the cost complement by the amount of an allowance, discount, or
price rebate that is related to or intended to compensate for a
permanent reduction in the taxpayer's retail selling price of inventory
(for example, a margin protection payment or markdown allowance).
(B) Exclusion of markdowns in denominator. A taxpayer using the
retail inventory method to approximate LCM excludes markdowns (and
markdown cancellations or corrections) from the denominator of the cost
complement. Any markups must be reduced by the markdowns made to cancel
or correct them.
(3) Ending inventory retail selling prices. A taxpayer must include
all permanent markups and markdowns but may not include temporary
markups or markdowns in determining the retail selling prices of goods
on hand at the end of the taxable year. A taxpayer may not include a
markdown that is not an actual reduction of retail selling price.
(c) Special rules for LIFO taxpayers. A taxpayer using the last-in,
first-out (LIFO) inventory method with the retail inventory method uses
the retail inventory method to approximate cost. See Sec. 1.472-1(k)
for additional adjustments for a taxpayer using the LIFO inventory
method with the retail cost method.
(d) Scope of retail inventory method. A taxpayer may use the retail
inventory method to value ending inventory for a department, a class of
goods, or a stock-keeping unit. A taxpayer maintaining more than one
department or dealing in classes of goods with different percentages of
gross profit must compute cost complements separately for each
department or class of goods.
(e) Examples. The following examples illustrate the rules of this
section:
Example 1. (i) R, a retail merchant who uses the retail method
to approximate LCM, has no beginning inventory in 2010. R purchases
40 tables during 2010 for $60 each for a total of $2,400. R offers
the tables for
[[Page 62329]]
sale at $100 each for an aggregate retail selling price of $4,000. R
does not sell any tables at a price of $100, so R permanently marks
down the retail selling price of its tables to $90 each. As a result
of the $10 markdown, R's supplier provides R a $6 per table margin
protection payment. R sells 25 tables during 2010 and has 15 tables
in ending inventory at the end of 2010.
(ii) Under paragraph (b)(2)(i)(A) of this section, the numerator
of the cost complement is the aggregate cost of the tables. Under
paragraph (b)(2)(iii)(A) of this section, R may not reduce the
numerator of the cost complement by the amount of the margin
protection payment. Under paragraph (b)(2)(i)(B) of this section,
the denominator of the cost complement is the aggregate of the bona
fide retail selling prices of all the tables at the time acquired.
Under paragraph (b)(2)(iii)(B) of this section, R excludes the
markdown from the denominator of the cost complement. Therefore, R's
cost complement is $2,400/$4,000, or 60 percent.
(iii) Under paragraph (b)(3) of this section, R includes the
permanent markdown in determining year-end retail selling prices.
Therefore, the aggregate retail selling price of R's ending table
inventory is $1,350 (15 * $90). Approximating LCM under the retail
method, the value of R's ending table inventory is $810 (60 percent
* $1,350).
Example 2. (i) The facts are the same as in Example 1, except
that R permanently reduces the retail selling price of all 40 tables
to $50 per unit and the 15 tables on hand at the end of the year are
marked for sale at that price. In contrast to the $10 markdown, the
additional $40 markdown is unrelated to a margin protection payment
or other allowance.
(ii) Under paragraph (b)(2)(iii)(B) of this section, R excludes
the markdowns from the denominator of the cost complement.
Therefore, R's cost complement is $2,400/$4,000, or 60 percent.
(iii) Under paragraph (b)(3) of this section, R includes the
markdowns in determining year-end retail selling prices. Therefore,
the aggregate retail selling price of R's ending inventory is $750
(15 * $50). Approximating LCM under the retail method, the value of
R's ending inventory is $450 (60 percent * $750).
Example 3. (i) The facts are the same as in Example 1, except
that R uses the LIFO inventory method. R must value inventories at
cost and, under paragraph (c) of this section, uses the retail
method to approximate cost.
(ii) Under paragraph (b)(2)(i)(A) of this section, R reduces the
numerator of the cost complement by the amount of the margin
protection payment. Under paragraph (b)(2)(i)(B) of this section, R
includes the markdown in the denominator of the cost complement.
Therefore, R's cost complement is $2,160/$3,600, or 60 percent.
(iii) Under paragraph (b)(3) of this section, R includes the
markdown in determining year-end retail selling prices. Therefore,
the aggregate retail selling price of R's ending inventory is $1,350
(15 * $90). Approximating cost under the retail method, the value of
R's ending inventory is $810 (60 percent * $1,350).
(f) Effective/applicability date. This section applies to taxable
years beginning after the date these regulations are published as final
regulations in the Federal Register.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-25946 Filed 10-6-11; 8:45 am]
BILLING CODE 4830-01-P