[Federal Register Volume 79, Number 158 (Friday, August 15, 2014)]
[Rules and Regulations]
[Pages 48034-48037]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-19275]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9688]
RIN 1545-BJ64
Retail Inventory Method
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final 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 or vendor allowances that are
required to reduce only cost of goods sold. The regulations affect
taxpayers that are retailers and use a retail inventory method.
DATES: Effective Date: These regulations are effective on August 15,
2014.
Applicability Date: For date of applicability, see Sec. 1.471-
8(f).
FOR FURTHER INFORMATION CONTACT: Christopher Call, (202) 317-7007 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regulations that amend the Income Tax
Regulations (26 CFR part 1) relating to the retail inventory method of
accounting under Sec. 1.471-8 of the Income Tax Regulations. On
October 7, 2011, a notice of proposed rulemaking (REG-125949-10) was
published in the Federal Register (76 FR 62327). A public hearing was
not requested or held. No comments were received during the comment
period. Three comments were received after the end of the comment
period and were considered, as discussed later in this preamble. The
proposed regulations are adopted as amended by this Treasury decision.
Summary of Comments and Explanation of Revisions
Section 471 of the Internal Revenue Code 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 1.471-3
provides rules for determining inventories at cost. Section 1.471-4
provides rules for determining inventories at lower of cost or market.
Section 1.471-8 of the regulations contains rules specific to
retailers, allowing them to approximate cost or LCM of the goods in
their ending inventory by using the retail inventory method. Under the
retail inventory method, a taxpayer computes the value of ending
inventory by multiplying a cost complement by the retail selling prices
of the goods on hand at the end of the taxable year. 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 inventory plus the initial retail selling
prices of purchases. For taxpayers using the retail inventory method to
value inventories at cost (retail cost method), the denominator of the
cost complement is adjusted for all permanent markups and markdowns.
Taxpayers using the retail inventory method to value inventories at LCM
(retail LCM method) generally do not make adjustments to the
denominator for markdowns.
The proposed regulations provided that a taxpayer using the retail
LCM method 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, often called a margin protection
payment or a markdown allowance. The proposed regulations also provided
that a taxpayer using the retail inventory method (whether valuing
inventories at LCM or at cost) may not reduce the numerator of the cost
complement by the amount of a sales-based vendor allowance.
Commenters suggested that taxpayers using the retail LCM method to
value inventories should reduce the numerator of the cost complement
for all vendor allowances and discounts, including margin protection
payments and sales-based vendor allowances (but should not be required
to reduce the denominator by the related price reduction), because all
allowances and discounts reduce the cost of inventory and allow
retailers to achieve their margin goals. The commenters asserted that
if the numerator of the cost complement is not reduced for margin
protection payments and sales-based vendor allowances, taxpayers'
income will not be clearly reflected, the economics of the underlying
business transaction will be ignored, and small retailers would be
adversely affected. The commenters suggested that small
[[Page 48035]]
retailers have less bargaining power than large retailers and are less
able to negotiate purchase-based discounts from vendors.
The final regulations do not adopt these comments. A margin
protection payment, unlike other types of allowances, is inherently
related to a markdown that will be reflected in the retail selling
prices of the items remaining in ending inventory. When a taxpayer
using retail LCM reduces the numerator of the cost complement by the
amount of a margin protection payment without reducing the denominator
by the amount of the corresponding markdown, ending inventory value
does not clearly reflect income, and does not reflect the economics of
the underlying transaction. Taxpayers using the retail cost method to
value inventories, as opposed to retail LCM, are allowed to reduce the
numerator of the cost complement by the amount of a margin protection
payment because these taxpayers also reduce the denominator of the cost
complement by the amount of a related markdown, maintaining the
relationship between cost and retail price.
With regard to sales-based vendor allowances, the final regulations
adopt, with a modification, the proposed rule that the numerator of the
cost complement is not reduced for sales-based vendor allowances.
Proposed regulations under Sec. 1.471-3(e) provided that sales-based
vendor allowances (the amount of an allowance, discount, or price
rebate that a taxpayer earns by selling specific merchandise) reduce
cost of goods sold and do not reduce ending inventory value. Because
the retail inventory method produces an ending inventory value and
sales-based vendor allowances could not be allocated to ending
inventory, the proposed regulations under Sec. 1.471-8 provided that
sales-based vendor allowances do not reduce the numerator of the cost
complement. The final regulations under Sec. 1.471-3(e) (TD 9652, 79
FR 2094) apply specifically to only one type of sales-based vendor
allowance, a sales-based vendor chargeback, and reserve rules for other
types of sales-based vendor allowances. To conform to this
modification, these final regulations under Sec. 1.471-8 provide that
sales-based vendor allowances that are required to reduce only cost of
goods sold under Sec. 1.471-3(e) do not reduce the numerator of the
cost complement. This rule will apply only to sales-based vendor
chargebacks until further guidance is issued under Sec. 1.471-3(e).
Commenters also requested that the final regulations allow retail
LCM taxpayers to reduce the numerator of the cost complement by margin
protection payments and sales-based vendor allowances because requiring
taxpayers to track margin protection payments and sales-based vendor
allowances separately from other types of allowances would create
burdensome recordkeeping requirements. This comment is not adopted
because, as discussed earlier in this preamble, allowing a retail LCM
taxpayer to reduce the numerator of the cost complement by the amount
of a margin protection payment without reducing the denominator by the
amount of the corresponding markdown would not clearly reflect income
and would not reflect the economics of the underlying transaction.
Nonetheless, as discussed later in this preamble, to ease taxpayers'
compliance burden, the final regulations provide alternative methods
and procedures for computing the cost complement for retail LCM
taxpayers.
The preamble to the proposed regulations requested comments on an
alternative method for retail LCM taxpayers to account for margin
protection payments when computing the cost complement. The method
described in that preamble would have permitted retail LCM taxpayers to
reduce the numerator of the cost complement for all non-sales-based
allowances, discounts, or price rebates, including margin protection
payments or markdown allowances, and also would have required a
reduction of the denominator of the cost complement for permanent
markdowns to which the margin protection payments or markdown
allowances relate (related markdowns). Although commenters did not
address this proposal explicitly, they stated that in some cases, based
on the nature of their business dealings with vendors and the variety
of allowances offered, taxpayers have difficulty distinguishing between
the different types of vendor allowances their vendors provide. For
example, commenters contend that it might be difficult for a taxpayer
to distinguish the amount of a margin protection payment or markdown
allowance received from a vendor from the amounts of other types of
allowances received from that vendor, thus making it difficult to
determine the amount by which they were required to reduce the
numerator of the cost complement under the proposed regulations.
The final regulations address these comments and ease taxpayers'
compliance with the regulations by allowing retail LCM taxpayers to use
a method similar to the method described in the preamble to the
proposed regulations that does not require taxpayers to distinguish the
amounts of margin protection payments from the amounts of other vendor
allowances (except for vendor allowances required to be allocated to
cost of goods sold under Sec. 1.471-3(e)). Under the alternative
method provided in the final regulations, retail LCM taxpayers reduce
the numerator for margin protection payments and must quantify and
reduce the denominator for the related markdowns. This alternative
method results in a reduction of the numerator of the cost complement
by all vendor allowances other than those required to reduce cost of
goods sold under Sec. 1.471-3(e). This alternative method accordingly
reduces the compliance burden for taxpayers that cannot distinguish
margin protection payments from other allowances, but that can identify
the markdowns related to those margin protection payments.
Commenters also stated that some accounting systems cannot
sufficiently track the related markdowns. Accordingly, a second
alternative provided in the final regulations allows taxpayers that are
able to determine the amount of their margin protection payments to
reduce the numerator of the cost complement for the margin protection
payments and adjust the denominator by the amount that, in conjunction
with the reduction of the numerator, maintains what would have been the
cost complement percentage before taking into account the margin
protection payments and related markdowns. This second alternative
method assumes that a margin protection payment maintains the
taxpayer's profit margin after a related markdown in retail selling
price. Thus, if before taking into account the margin protection
payment and the related markdown the cost complement is 50 percent
($10/$20), and the taxpayer receives a margin protection payment of $2,
the taxpayer must reduce the denominator by $4 to maintain a cost
complement of 50 percent ($8/$16) under this second alternative method.
A retail LCM taxpayer must use one of these three methods (the
general method and the two alternative methods) for computing all of
its cost complements. A change from one to another of these methods is
a change in method of accounting.
The final regulations further facilitate identifying margin
protection payments and related markdowns by allowing retail LCM
taxpayers to use statistical sampling in accordance with Rev. Proc.
2011-42 (2011-37 IRB 318), see
[[Page 48036]]
Sec. 601.601(d), in conjunction with any of the three methods. A
retail LCM taxpayer using statistical sampling must use it for all
margin protection payments and related markdowns associated with the
inventory items valued by a particular cost complement. However, a
retail LCM taxpayer that calculates more than one cost complement is
not required to use statistical sampling for all cost complements. A
change from using to not using statistical sampling, or from not using
to using statistical sampling, to identify margin protection payments
and related markdowns is not a change in method of accounting.
The proposed regulations provided that a taxpayer may apply the
retail inventory method to a department, a class of goods, or a stock-
keeping unit. A commenter suggested that the final regulations specify
that a taxpayer may use the retail inventory method to value ending
inventory for a sub-class of goods, style of goods, or other similar
category of goods to avoid the implication that the scope of the retail
inventory method is limited to those groupings specifically identified
in the proposed regulations. The categories suggested by the commenter
are already encompassed by the terms department, class of goods, or
stock-keeping unit. Accordingly, the final regulations do not adopt
this comment.
A commenter suggested that the final regulations should allow
taxpayers to calculate their cost complements using a measurement
period shorter than the entire taxable year and should clarify whether
beginning inventory may or must be eliminated from the cost complement
of a last-in, first-out (LIFO) taxpayer using the retail inventory
method. These issues were not addressed in the proposed regulations and
therefore are not addressed in the final regulations. However, the
final regulations do not reflect a change in established administrative
practice regarding whether LIFO taxpayers using the retail inventory
method may exclude beginning inventory from the cost complement.
Effective/Applicability Date
These regulations apply to taxable years beginning after December
31, 2014. For taxable years beginning before January 1, 2015, see Sec.
1.471-8 as contained in 26 CFR part 1, revised April 1, 2014.
Special Analyses
This Treasury decision is not a significant regulatory action as
defined in Executive Order 12866, as supplemented by Executive Order
13563. Therefore, a regulatory assessment is not required. Section
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations and, because the 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, the notice of proposed
rulemaking that preceded these final regulations was submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business. No comments were received from
the Small Business Administration.
Drafting Information
The principal author of these regulations is Natasha M. Mulleneaux
of the Office of Associate Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and the Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
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
(as determined under Sec. 1.471-3, except as otherwise provided in
this section) of goods purchased during the taxable year.
(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) Vendor allowances required to reduce only cost of goods sold.
A taxpayer may not reduce the numerator of the cost complement by the
amount of an allowance, discount, or price rebate that is required
under Sec. 1.471-3(e) to reduce only cost of goods sold.
(3) Additional rules for cost complement for retail LCM method--(i)
In general--(A) Margin protection payments. A taxpayer using the retail
LCM method 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 (a margin protection payment).
(B) Markdowns. A taxpayer using the retail LCM method does not
adjust the denominator of the cost complement for markdowns (and
markdown cancellations or corrections). Markups must be reduced by the
markdowns made to cancel or correct them.
(ii) Alternative methods for computing cost complement--(A) In
general. In lieu of the method described in paragraph (b)(3)(i) of this
section, a taxpayer using the retail LCM method may compute the cost
complement using one of the alternative methods described in this
paragraph (b)(3)(ii). A taxpayer using an alternative method under this
paragraph (b)(3)(ii) must use that method for all cost complements.
(B) Adjust numerator and denominator. A taxpayer using the retail
LCM method may reduce the numerator of the cost complement by the
amount of all margin protection payments if the taxpayer also reduces
the denominator of the cost complement by the amount of the permanent
reduction in retail selling price to which the margin protection
payments relate (related markdowns).
[[Page 48037]]
(C) Deemed adjustment to denominator. A taxpayer using the retail
LCM method that is able to determine the amount of all margin
protection payments but cannot determine the amount of the related
markdowns may reduce the numerator of the cost complement by the amount
of all margin protection payments if the taxpayer also reduces the
denominator by the amount that, in conjunction with the reduction of
the numerator for the margin protection payments, maintains what would
have been the cost complement percentage before taking into account the
margin protection payment and the related markdown. A taxpayer that can
determine the amount of a related markdown but not the associated
margin protection payments may not use this method to compute an
adjustment to the numerator.
(iii) Statistical sampling. A taxpayer using the retail LCM method
may use statistical sampling in accordance with Rev. Proc. 2011-42 or
any successor (see Sec. 601.601(d) of this chapter), in conjunction
with any method of computing the cost complement described in this
paragraph (b)(3), to determine the amount of margin protection payments
and related markdowns. A taxpayer using statistical sampling must use
it for all margin protection payments and related markdowns associated
with the inventory items valued by a particular cost complement, but is
not required to use it for every cost complement.
(4) 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 cost method. 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 LCM
method and uses a calendar taxable year, has no beginning inventory
in 2012. R purchases 40 tables during 2012 for $60 each for a total
of $2,400. R offers the tables for 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 2012 and has 15 tables in ending inventory at
the end of 2012.
(ii) Under paragraph (b)(2)(i)(A) of this section, the numerator
of the cost complement is the aggregate cost of the tables, $2,400.
Under paragraph (b)(3)(i)(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,
$4,000. Under paragraph (b)(3)(i)(B) of this section, R does not
adjust the denominator of the cost complement for the markdown.
Therefore, R's cost complement is $2,400/$4,000, or 60%.
(iii) Under paragraph (b)(4) 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% *
$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. The additional $40 markdown is
unrelated to a margin protection payment or other allowance.
(ii) Under paragraph (b)(3)(i)(B) of this section, R does not
adjust the denominator of the cost complement for the markdown.
Therefore, R's cost complement is $2,400/$4,000, or 60%.
(iii) Under paragraph (b)(4) of this section, R includes the
permanent 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% * $750).
Example 3. (i) The facts are the same as in Example 1, except
that R computes the cost complement using the alternative method
under paragraph (b)(3)(ii)(B) of this section.
(ii) R reduces the numerator of the cost complement by the
margin protection payments of $240 ($6 * 40) and reduces the
denominator of the cost complement by the related markdowns of $400
($10 * 40). Therefore, R's cost complement is $2,160/$3,600, or 60%.
(iii) Under paragraph (b)(4) 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% *
$1,350).
Example 4. (i) The facts are the same as in Example 1, except
that R cannot determine the amount of its related markdowns and
computes the cost complement using the alternative method under
paragraph (b)(3)(ii)(C) of this section.
(ii) R reduces the numerator of the cost complement by the
margin protection payments of $240 ($6 * 40). R reduces the
denominator of the cost complement by the amount that, in
conjunction with the reduction in the numerator, maintains the cost
complement percentage before taking into account the margin
protection payments and the related markdowns. R's original cost
complement was 60% ($2,400/$4,000). The numerator of R's new cost
complement is $2,160 ($2,400-$240). Therefore, R reduces the
denominator by $400, which maintains the cost complement of 60%
($2,160/$3,600).
(iii) Under paragraph (b)(4) of this section, R includes the
permanent markdowns 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% *
$1,350).
Example 5. (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 cost
method.
(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 permanent markdown in the denominator of the cost
complement. Therefore, R's cost complement is $2,160/$3,600, or 60%.
(iii) Under paragraph (b)(4) 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
inventory is $1,350 (15 * $90). Approximating cost under the retail
method, the value of R's ending inventory is $810 (60% * $1,350).
(f) Effective/applicability date. This section applies to taxable
years beginning after December 31, 2014. For taxable years beginning
before January 1, 2015, see Sec. 1.471-8 as contained in 26 CFR part
1, revised April 1, 2014.
John Dalrymple,
Deputy Commissioner for Services and Enforcement.
Approved: July 30, 2014
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-19275 Filed 8-14-14; 8:45 am]
BILLING CODE 4830-01-P