IRS Logo
Print - Click this link to Print this page

Telecommunication Carriers Change in Method of Accounting Relating to Conversion of Capitalized Assets to Repair Expense Under I.R.C. Section 263(a)

LB&I Control No: LB&I-4-1111-021
Impacted IRM 4.51.5

January 23, 2012

 

MEMORANDUM FOR INDUSTRY DIRECTORS
DIRECTOR, FIELD SPECIALISTS
DIRECTOR, PRE-FILING AND TECHNICAL GUIDANCE
DIRECTOR, INTERNATIONAL BUSINESS COMPLIANCE
FROM: Patricia C. Chaback /s/ Patricia C. Chaback
Large Business & International Division, Industry Director Communications, Technology, and Media Industry
SUBJECT: Large Business & International Directive Telecommunication Carriers Change in Method of Accounting Relating to Conversion of Capitalized Assets to Repair Expense Under I.R.C. Section 263(a)

This memorandum provides direction to the field in the examination of an issue arising from the conversion of previously capitalized expenditures to a deduction for repair expense claimed by a taxpayer that provides telecommunications services. This directive is intended to provide a uniform format and approach for examiners to evaluate potential compliance risk related to this issue.

Background

Taxpayers that provide telecommunications services incur significant expenditures to maintain, replace, and improve network property.  Whether these expenditures are deductible as repairs under I.R.C. Section 162 or must be capitalized as improvements under I.R.C. Section 263(a) depends on whether the expenditures materially increase the value of the property or substantially prolong its useful life.  See Treasury Regulation § 1.162-4.  Applying capitalization principles to telecommunications network assets can be particularly difficult, largely because the property consists of a network of interconnected items such as mobile telephone switching offices and property located at cell sites for wireless telecommunications services, or central office equipment, poles, copper wire, fiber optic cable and remote and network terminals for wireline telecommunications services.

To resolve this issue in a manner that conserves resources of both the Internal Revenue Service (Service) and taxpayers, the Service issued Revenue Procedure 2011-27, 2011-18 I.R.B. 1, which sets forth two alternative safe harbor approaches for taxpayers who provide wireline telecommunications services to use when determining whether expenditures to maintain, replace, or improve wireline network assets must be capitalized.  The two alternative safe harbor methods are a network asset maintenance allowance method or a “units of property” method.  The Service also issued Revenue Procedure 2011-28, 2011-18 I.R.B. 1, which provides similar safe harbor approaches for taxpayers who provide wireless telecommunication services.  Both Revenue Procedure 2011-27 and Revenue Procedure 2011-28 are effective for taxable years ending on or after December 31, 2010.

The use of the safe harbor approaches included in those Revenue Procedures is only permitted under the terms and conditions contained therein, and should not be considered for purposes of resolving capitalization issues in prior open exam years.  This directive provides the guidance for addressing prior open exam years.

Planning and Examination Guidance - Tax Years Ending Before December 31, 2010

For taxable years ending before December 31, 2010, examiners should discontinue any current examination of the conversion of previously capitalized expenditures to a deduction for repair expense issue.  This discontinuation only applies to positions taken on original returns filed for taxable years ending before December 31, 2010.  Please contact the LB&I Issue Practice Group for Deductible and Capital Expenditures for guidance on claims. 

The taxpayer will be allowed a two-year period to adopt one of the safe harbor methods provided in either Revenue Procedure 2011-27 for wireline carriers, or Revenue Procedure 2011-28 for wireless carriers.  If the taxpayer has not adopted a safe harbor method for its first or second taxable year ending after December 30, 2010, the examiner should follow the guidance under Planning and Examination Guidance – Tax Years Ending On or After December 31, 2010 as provided in the next section.

Discontinuing the examination of the repair expense should include the following steps:
 

  • Revoke any outstanding Form 4564, Information Document Request, relating to the development of the issue.
  • Revoke any outstanding Form 5701, Notice of Proposed Adjustment, which proposed an adjustment to repair expense related to a capital conversion.
  • Develop and issue a Form 886-A, Explanation of Adjustments, with the following language:

The Service neither accepts nor rejects the position stated in the tax return related to the method to determine the proper repair expense with respect to telecommunication network assets. [Insert taxpayer name] will be allowed a two-year period to adopt a safe harbor method as provided in Revenue Procedure 2011-27 for a wireline carrier, or Revenue Procedure 2011-28 for a wireless carrier.  If the safe harbor for units of property is adopted, a change in method of accounting can be made in accordance with Section 7 of the applicable revenue procedure for all of the assets, or for one or some of the assets, listed in Section 6 of that revenue procedure.  For those asset descriptions for which the safe harbor units of property are elected, the taxpayer’s method of accounting will be accepted without performing further examination procedures.  If a change in method of accounting is made to adopt the Network Asset Maintenance Allowance safe harbor method consistent with Section 5 of the applicable revenue procedure, and the computation method so described is properly applied, then the examiner should accept the reported repair expense as filed without performing further examination procedures.  If the [Insert taxpayer name] has not adopted a safe harbor method in its first or second taxable year ending after December 30, 2010, the repair expense will be subject to risk assessment and possible examination for taxable years ending on or after December 31, 2010.

  • If the taxpayer filed a Form 3115, Change in Method of Accounting, in the year under examination, then include a statement that the Service neither accepts nor rejects the method described in the Form 3115.  In the year the taxpayer adopts the safe harbor method of accounting, the I.R.C. Section 481(a) adjustment will be subject to risk assessment and possible examination.  The Form 886A should also include a statement that if the taxpayer has not adopted one of the safe harbor methods within the two-year adoption period, the taxpayer’s accounting method and determination of the proper I.R.C. Section 481(a) adjustment will be subject to risk assessment and possible examination.

  • After the taxpayer has signed the Form 886-A, Explanation of Adjustments, upload the document into the Information Management System (IMS) to substantiate for the subsequent examination team that the taxpayer was notified of the Service's position to discontinue the examination of the issue.

  • Complete a Form 5346, Examination Information Report, in accordance with the specific instructions provided for this issue located on the LB&I Issue Practice Group website for Deductible and Capital Expenditures. 

  • Confirm the issue was input into IMS as follows: UIL 263.14-01, and Issue Tracking Attribute Code 1400.

Planning and Examination Guidance – Tax Years Ending On or After December 31, 2010

When examining returns of telecommunication carriers for tax years ending on or after December 31, 2010, examiners should determine if a change in method of accounting was made to adopt a safe harbor method described in either Revenue Procedure 2011-27 for wireline carriers, or Revenue Procedure 2011-28 for wireless carriers.

The taxpayer may change its method of accounting to adopt the safe harbor for unit of property with respect to all of its assets or with respect to one or some of its assets.  If all of the taxpayer’s units of property are consistent with those found in Section 6 of the applicable revenue procedure, then the examiner should accept the repair expense as filed.  If only some, but not all, of the taxpayer’s units of property are consistent with those found in Section 6 of the applicable revenue procedure, then the examiner should perform a risk assessment to determine the materiality of the repair deduction claimed with respect to the network assets.  If the results of the risk assessment are deemed to be material, the examiner should examine the deduction.

If the taxpayer adopted the Network Asset Maintenance Allowance safe harbor method, the examiner should request that the taxpayer provide a breakdown of the computation that is required to be filed with the tax return, by legal entity, in order to conduct a risk analysis.  Once the examiner ascertains that the taxpayer computed the network asset additions in accordance with Section 5 of either Revenue Procedure 2011-27 for wireline carriers or Revenue Procedure 2011-28 for wireless carriers, the examiner should accept the additional repair expense as filed.

True-up Requirement.  When performing the risk assessment, the examiner should also consider if the I.R.C. Section 481(a) adjustment was computed accurately.  If, prior to the issuance of Revenue Procedure 2011-27 and Revenue Procedure 2011-28, the taxpayer had filed a Form 3115, Change in Accounting Method, to change the treatment of expenditures for network assets, then the I.R.C. Section 481(a) adjustment resulting from a change to the Rev. Proc. 2011-27 or Rev. Proc. 2011-28 safe harbor method (“new I.R.C. Section 481(a) adjustment”) should account for any previous I.R.C. Section 481(a) adjustment (“old I.R.C. Section 481(a) adjustment”).  The taxpayer should also ensure that the new I.R.C. Section 481(a) adjustment properly accounts for network asset repair expenses that were computed under the taxpayer’s prior method in the interim years between the old and new I.R.C. Section 481(a) adjustments and deducted under I.R.C. section 162.

If the taxpayer did not adopt a safe harbor method, then the agent should perform a risk assessment to determine the materiality of the repair deduction claimed with respect to the network assets.  If the result of the risk assessment is deemed to be material, the examiner should examine the deduction utilizing I.R.C. Section 263(a) and the Treasury Regulations thereunder.

Contacts

If you have any questions, please contact the LB&I Issue Practice Group for Deductible and Capital Expenditures. 

This Directive is not an official pronouncement of law, and cannot be used, cited, or relied upon as such.

cc:  Commissioner, LB&I
       Deputy Commissioner, Operations
       Deputy Commissioner, International
       Division Counsel, LB&I
       Chief, Appeals
       Directors, Field Operations
       Director, Pre-filing and Technical Guidance

 

Page Last Reviewed or Updated: 10-Feb-2014