Rev. Rul. 88-69

1988-2 C.B. 124, 1988-35 I.R.B. 22.

                       Internal Revenue Service

                                 Revenue Ruling

        INVENTORIES; LIFO; CONFORMITY; CONSOLIDATED FINANCIAL STATEMENTS

                           Published: August 29, 1988

26 CFR 1.472-2: Requirements incident to adoption and use of LIFO inventory method

  Inventories; LIFO; conformity; consolidated financial statements. Section 472(g) of the Code does not require a taxpayer that uses the LIFO inventory method for federal income tax purposes to report the inventories of its subsidiary in consolidated financial statements under the LIFO inventory method if the subsidiary uses a non-LIFO inventory method for federal income tax purposes.

  A corporation, which used the last-in, first-out (LIFO) inventory method for Federal income tax purposes, had two subsidiaries, one that used LIFO and one that used a non-LIFO method. The parent, on its consolidated financial statements, reports its inventories and the inventories of its LIFO-based subsidiary under the LIFO method. On those same statements, however, the parent reports the second subsidiary's inventories under a non-LIFO method.

  ISSUE. At issue is whether the LIFO conformity requirements of section 472(g) require the parent to use the LIFO method on its consolidated financial statements when reporting the non-LIFO subsidiary's inventories.

  HOLDING. The Service has held that section 472(g) does not require the parent to report the inventories of the non-LIFO subsidiary in consolidated financial statements under the LIFO method.

  ANALYSIS. The Service's holding was based primarily on its reading of the congressional intent behind section 472(g). That provision, the Service noted, effectively overruled Insilco Corp. v. Commissioner, 73 T.C. 589 (1979), nonacq., 1982-2 C.B. 3, nonacq. withdrawn, 1987-1 C.B. 1, aff'd in unpublished opinion, 659 F.2d (2d Cir. 1981), and treats all members of a group of financially related corporations as a single taxpayer, thus precluding the issuance of nonconforming financial statements to the shareholders of any member of the group. Citing section 472(g)'s legislative history, the Service said that '[t]he purpose of the LIFO conformity requirement is to ensure that taxpayers not use the LIFO method for tax purposes unless that method conforms as nearly as possible to the best accounting practice in the taxpayer's trade or business.' Continuing, the Service said that section 472(g) presents 'no inference' that the LIFO method is the best accounting practice for a business that does not use LIFO.

  With respect to the non-LIFO subsidiary, the Service concluded that the conformity requirement is applicable 'only to the extent that such requirement would apply to a separate trade or business of a single taxpayer.' Therefore, the Service said, the parent must use the LIFO method to report its inventories and those of its LIFO-based subsidiary, but may use a non-LIFO method to report the other subsidiary's inventory in the consolidated financial statement.

                                     ISSUE

  If a taxpayer uses the last-in, first-out (LIFO) inventory method for federal income tax purposes and a subsidiary uses a non- LIFO inventory method for federal income tax purposes, does section 472(g) of the Internal Revenue Code require that taxpayer to use the LIFO inventory method for reporting the inventories of the subsidiary in consolidated financial statements?

                                     FACTS

  P and its subsidiaries, X, and Y, are domestic corporations that manufacture and sell various goods. Both P and X use the LIFO inventory method for federal income tax purposes. Y, however, uses a non-LIFO inventory method for federal income tax purposes, and its inventories are reported on a non-LIFO method in P's consolidated federal income tax return. In the consolidated financial statements of the group, P reports its own inventories and the inventories of X under the LIFO method, but reports the inventories of Y under a non- LIFO method.

                                LAW AND ANALYSIS

  Section 472(a) of the Code authorizes the use of the LIFO method in inventorying goods.

  Under section 472(c) of the Code, the LIFO method may only be used if the taxpayer establishes that no method other than the LIFO method has been used in valuing inventory to ascertain the income, profit, or loss of the first tax year for which the method is used, for the purpose of a report or statement for such tax year to shareholders, partners, or other proprietors, or to beneficiaries, or for credit purposes. Section 472(e)(2) imposes similar requirements for subsequent tax years. The obligations imposed by section 472(c) and section 472(e)(2) are referred to as the 'LIFO conformity requirement.'

  Section 1.472-2(e)(1) of the Income Tax Regulations provides that a taxpayer using the LIFO method in valuing inventory must establish to the satisfaction of the Commissioner that the taxpayer has not used any inventory method other than the LIFO method in ascertaining the income, profit, or loss for the tax year for which the LIFO method is first used, or for any subsequent tax year, for credit purposes or for purposes of reports to shareholders, partners, or other proprietors, or to beneficiaries.

  Section 472(g)(1) of the Code generally provides that all members of the same group of financially related corporations shall be treated as one taxpayer for purposes of sections 472(c) and (e)(2). Section 472(g)(2) defines the term 'group of financially related corporations' as (A) any affiliated group as defined in section 1504 determined by substituting '50 percent' for '80 percent' each place it appears in section 1504(a) and without regard to section 1504(b), and (B) any other group of corporations that consolidate or combine for purposes of financial statements.

  Insilco Corp. v. Commissioner, 73 T.C. 589 (1979), nonacq., 1982-2 C.B. 3, nonacq. withdrawn, 1987-1 C.B. 1, aff'd in unpublished opinion, 659 F.2d 1059 (2d Cir. 1981), considered the LIFO conformity requirement before the enactment of section 472(g). In that case, three subsidiaries used the LIFO inventory method for federal income tax purposes and issued financial reports to their parent on the same basis. The parent company, however, reported the subsidiaries' earnings in its consolidated financial statement using a non-LIFO method. The Tax Court rejected the Government's argument that a parent corporation's shareholders are shareholders of the parent's subsidiaries for purposes of the LIFO conformity requirement, and held that the issuance of the consolidated report was not a violation of the LIFO conformity requirement. One of the reasons for the decision was the absence of a statutory provision that attributed stock ownership in the subsidiaries to the parent's shareholders for purposes of the LIFO conformity requirement.

  Congress effectively overruled the decision in Insilco by adding subsection (g) to section 472 of the Code. See section 95(a) of the Tax Reform Act of 1984, 1984-3 (Vol. 1) C.B. 124. By treating all members of a group of financially related corporations as a single taxpayer, section 472(g) precludes the issuance of nonconforming financial statements to the shareholders of any member of the group.

  The purpose of the LIFO conformity requirement is to ensure that taxpayers not use the LIFO method for tax purposes unless that method conforms as nearly as possible to the best accounting practice in the taxpayer's trade or business. See H.R. Rep. No. 432, 98th Cong., 2d Sess. 1380 (1984). Thus, if a taxpayer does not use the LIFO method for tax purposes for a particular trade or business, there is no inference that the LIFO method is the best accounting practice for that trade or business, and the LIFO conformity requirement does not apply to that trade or business. This remains true even if the taxpayer conducts one or more other trades or businesses for which the LIFO method is used for tax purposes (and thus for which the LIFO method must be the best accounting practice, as shown by compliance with the LIFO conformity requirement).

  Under section 472(g) of the Code, all members of the same group of financially related corporations shall be treated as one taxpayer for purposes of the LIFO conformity requirement. Thus, the conformity requirement is applicable to a subsidiary only to the extent that such requirement would apply to a separate trade or business of a single taxpayer. Accordingly, P must use the LIFO method to report its own inventories and the inventories of X. The inventories of Y, however, may be reported under a non-LIFO method in the consolidated financial statements of the affiliated group.

                                    HOLDING

  Section 472(g) of the Code does not require a taxpayer that uses the LIFO inventory method for federal income tax purposes to report the inventories of its subsidiary in consolidated financial statements under the LIFO inventory method if the subsidiary uses a non-LIFO inventory method for federal income tax purposes.

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Carol Conjura of the Corporation Tax Division. For further information regarding this revenue ruling contact Ms. Conjura on (202) 566-3024 (not a toll-free call).

Rev. Rul. 88-69, 1988-2 C.B. 124, 1988-35 I.R.B. 22.