Rev. Rul. 80-18
1980-1 C.B. 103, 1980-3 I.R.B. 7.
Internal Revenue Service
Revenue Ruling
CONTRACTS; LONG-TERM; ENGINEERING SERVICES
Published: January 21, 1980
26 CFR 1.451-3: Long-term contracts.
(Also Section 446; 1.446-1.)
Contracts; long-term; engineering services. A taxpayer providing engineering services is not entitled to adopt or use either the completed contract or percentage of completion method of accounting.
ISSUE
Is a taxpayer that is engaged in providing engineering services entitled to adopt or use either the completed contract or the percentage of completion method of accounting provided under section 1.451-3 of the Income Tax Regulations in reporting its income?
FACTS
The taxpayer is engaged in the business of providing engineering and related services and has entered into a contract with a foreign government that provides for payment on an agreed fixed rate basis. The contract was not completed in the taxable year in which it was entered into, and the method of payment to the taxpayer is an amount based on a fixed-rate per person-month. This amount was negotiated for each type of employee needed by the taxpayer to perform under the contract. This negotiated fixed rate included the taxpayer's labor cost, overhead, and profit. During the life of the contract the taxpayer billed the foreign government at the negotiated fixed rate for labor performed, subject to a specified overall limitation as to the total amount which can be billed on the contract.
The services required of the taxpayer under this contract were divided into three categories: pre-design operations, design services, and supervision of the construction. The pre-design operations included drilling operations, soil sampling and testing, aerial photogrammetric operations, and oceanographic operations. The supervision of construction on this contract included training and supervision of the contractors who perform the actual construction on the projects. The allocation by the taxpayer of the total contract price to be paid between these three categories of services was approximately as follows: 15 percent for pre-design, 35 percent for design, and 50 percent for supervision of construction.
LAW AND ANALYSIS
Section 451 of the Internal Revenue Code provides that the amount of any item of gross income shall be included in gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for in a different period.
Section 1.446-1(a)(2) provides that no uniform method of accounting can be prescribed for all taxpayers and that each taxpayer shall adopt such forms and systems as are, in the taxpayer's judgment, best suited to the taxpayer's needs. However, no method of
accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income.
Section 1.451-3(a)(1) of the regulations provides that income from a long- term contract may be included in gross income in accordance with one of the two long-term contract methods, namely, the percentage of completion method or the completed contract method.
Section 1.451-3(b)(1)(i) of the regulations provides that the term 'long-term contract' means a building, installation, construction or manufacturing contract which is not completed within the taxable year in which it is entered into.
Rev. Rul. 70-67, 1970-1 C.B. 117, holds that an architect is not entitled to report income on the completed contract method. The basis of this ruling is that the architect's contracts do not qualify as long-term contracts because an architect does not build or construct anything, but simply draws the plan and supervises the work of construction. Rev. Rul. 70-67 also explains that one of the reasons why permission to report on a completed contract basis is given in the case of building, installation, and construction contracts is the fact that there are changes in the price of articles to be used, losses and increased cost due to strikes, weather, etc., penalties for delay, and unexpected difficulties in laying foundations which makes it impossible for any construction contractor, no matter how carefully the contractor may estimate, to tell with any certainty whether the contractor has derived a gain or sustained a loss until a particular contract is completed. This situation, however, does not apply to the taxpayer in the instant case. The taxpayer is not affected by the foregoing problems affecting the contractor.
The services which the taxpayer in the present situation performs under its contract are primarily engineering services and
supervision of construction. Like the architect's services in Rev. Rul. 70-67, the contract the taxpayer entered into did not require the taxpayer to actually construct or build anything even though the taxpayer's services are functionally related to activities which may be the subject of long-term contracts as defined in section 1.451-3(b)(1)(i) of the regulations.
HOLDING
The taxpayer's engineering contract does not qualify as a long-term contract within the meaning of section 1.451-3(b)(1)(i) of the regulations, and the taxpayer is not entitled to adopt or use either the completed contract or percentage of completion method provided under section 1.451-3.
Rev. Rul. 80-18, 1980-1 C.B. 103, 1980-3 I.R.B. 7.