Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 67-64

1967-1 C.B. 150

Sec. 537

IRS Headnote

A corporation may not include a fund equal to its depreciation reserves escalated for the economic factor of increased replacement costs in justifying the reasonable needs of its business pursuant to section 537 of the Internal Revenue Code of 1954. However, the reserve for depreciation itself may be considered and given appropriate weight as a part of the facts and circumstances in each case.

Full Text

Rev. Rul. 67-64

Advice has been requested whether, in justifying the reasonable needs of its business pursuant to section 537 of the Internal Revenue Code of 1954, a corporation may include a fund equal to its depreciation reserves escalated for the economic factor of increased replacement costs.

A corporation is engaged in the manufacturing business and has operated successfully since its inception. Over the years, the corporation has expanded its plant facilities and has made replacements of machinery and equipment. The expenditures with respect to such expansion and replacements were normal for a successful business. The corporation contends that, in justifying the reasonable needs of its business, it should be permitted to include a fund equal to its depreciation reserves escalated for the economic factor of increased costs of replacement regardless of whether it has any specific or definite plans to use the funds in its business.

Section 537 of the Code provides that the term `reasonable needs of the business' includes the reasonably anticipated needs of the business. Section 1.537-1(b) of the Income Tax Regulations provides that in order for a corporation to justify an accumulation of earnings and profits for reasonably anticipated future needs, there must be an indication that the future needs of the business require such accumulation, and the corporation must have specific, definite, and feasible plans for the use of such accumulation . Where the future needs of the business are uncertain or vague, where the plans for the future use of an accumulation are not specific, definite, and feasible, or where execution of such a plan is postponed indefinitely, an accumulation cannot be justified on the grounds of reasonably anticipated needs of the business. These regulations express the legislative intent as stated in Senate Report 1622, 83d Congress, 2d Session, 69, and House Report 1337, 83d Congress, 2d Session, A172-A173.

Although the reserve for depreciation itself may be considered and given appropriate weight as a part of the facts and circumstances in considering the reasonable needs of the business, the concept that a noncash deduction for depreciation based on historic costs requires the setting aside for an indefinite period a cash fund adjusted for economic fluctuations in order to provide for total replacement of plant assets is not within the meaning of the term `reasonable needs of the business.'

Accordingly, a corporation may not include a fund equal to its depreciation reserves escalated for the economic factor of increased replacement costs in justifying the reasonable needs of its business pursuant to section 537 of the Code. However, the reserve for depreciation itself may be considered and given appropriate weight as a part of the facts and circumstances in each case.