Large Business & International Directive for Determining Units of Property and Major Components in the Mining Industry

September 11, 2017

LB&I Control No. LB&I-04-0917-004
Impacted IRM 4.51.2

MEMORANDUM FOR ALL LARGE BUSINESS AND INTERNATIONAL DIVISION EMPLOYEES

From: Douglas W. O’Donnell  
Commissioner, Large Business & International Division
Subject: Large Business & International Directive for Determining Units of Property and Major Components in the Mining Industry

This memorandum is intended to provide technical guidance to effectively reduce exam time and taxpayer burden. The matrix contained in Attachment A is intended only to assist agents in determining the units of property and major components frequently used in the mining industry as addressed in Treas. Reg. § 1.263(a)-3(e). The tangible property regulations must then be applied to determine whether expenditures replace or improve tangible property and must be capitalized under I.R.C. § 263(a).

Background

Taxpayers in the mining industry incur significant expenditures to repair, maintain, replace, and improve mining property. Whether these expenditures are deductible as repairs under I.R.C. § 162 or must be capitalized as improvements under I.R.C. § 263(a) depends on whether the expenditures improve or repair a unit of property (“UOP”). The regulations under I.R.C. § 263(a) generally require taxpayers to capitalize as improvements expenditures that constitute a betterment to a UOP, restore a UOP, or adapt a UOP to a new or different use.

Mining property is composed of numerous functionally interdependent items of machinery and equipment, and it can be difficult to identify which items constitute discrete units of property, major components, or something else under the tangible property regulations. Consequently, taxpayers and the Internal Revenue Service may disagree about whether the cost to replace a particular item is a capital expenditure or a deductible expense.

Planning and Examination Risk Analysis – Tax Years Beginning on or after January 1, 2014.

The final regulations are applicable to taxable years beginning on or after January 1, 2014. A taxpayer also had the option to apply the regulations to taxable years beginning on or after January 1, 2012, and before January 1, 2014.

The final regulations provide rules for determining whether a taxpayer must treat amounts related to tangible property as improvements to property, and as a result, whether a taxpayer must capitalize the costs of such improvements under I.R.C. § 263(a), and recover such costs in accordance with I.R.C. §§ 167 and 168. Under Treas. Reg. § 1.263(a)-3(d), amounts are characterized as improvements if they are for betterments to the UOP or adapt the UOP to a new or different use. In order to apply these criteria, a taxpayer must first identify the UOP that is the subject of this analysis.

The final tangible regulations under Treas. Reg. § 1.263(a)-3(e), provide new rules for identifying the UOP to which the improvement analysis must be applied. For tangible real or personal property other than buildings, Treas. Reg. § 1.263(a)-3(e)(3) defines a UOP as all the components that are functionally interdependent. Under this “functional interdependence test,” components are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of another component. However, if the non-building property is comprised of “plant property,” a taxpayer must do further analysis to identify the UOP.

For plant property (i.e., machinery or equipment used to perform an industrial process, such as manufacturing, generation, warehousing, distributions, automated materials handling, or other similar activities), the UOP is determined by first applying the functional inter-dependence test and then dividing the functionally interdependent property into each component (or group of components) that perform a discrete and major function or operation within such functionally interdependent property. See Treas. Reg. § 1.263(a)-3(e)(3)(ii)(B).

In determining whether an amount is paid for an improvement to a UOP, another important inquiry is whether the expenditure is for the replacement of a major component of a UOP. Under Treas. Reg. §§ 1.263(a)-3(k)(1)(vi) and (k)(6), an amount is paid for a restoration of a UOP, and therefore, is considered an improvement to that UOP, if it is paid for the replacement of a part or combination of parts that is a major component. A major component is further defined under Treas. Reg. § 1.263(a)-3(k)(6)(i)(A) as a part that is not incidental and that performs a discrete and critical function in the operation of the UOP. Thus, once the taxpayer identifies the appropriate UOP, to apply the restoration criteria for improvements, the taxpayer may have to complete another analysis of the UOP by then identifying its major components.

The tangible property regulations contain a “routine maintenance safe harbor.” Expenditures falling within this safe harbor are deemed to not improve the UOP. The safe harbor definition for routine maintenance on property other than buildings is provided in Treas. Reg. § 1.263(a)-3(i)(1)(ii). Aside from determining the appropriate UOP upon which to apply the routine maintenance safe harbor, nothing in this directive changes the application of the routine maintenance safe harbor in accordance with the regulations.

Taxpayer Under Examination

When examining returns of mining industry taxpayers for taxable years beginning on or after January 1, 2012, examiners should determine if the taxpayer filed a Form 3115, Application for Change in Accounting Method, to change its method of identifying the UOP for purposes of deducting amounts paid or incurred for repair and maintenance or for purposes of capitalizing amounts paid or incurred for improvements to tangible property in compliance with Rev. Proc. 2014-16, 2014-9 I.R.B. 606, Rev. Proc. 2015-14, 2015-5 I.R.B. 450, Rev. Proc. 2016-29, 2016-21 I.R.B. 880, or Rev. Proc. 2017-30, 2017-18 I.R.B. 1131 (whichever applicable).

If the taxpayer changed its method for taxable years on or after January 1, 2012, the examiner should determine if the change (including the IRC § 481(a) adjustment) is consistent with the categorization in the Mining Industry UOP and Major Component Matrix – Attachment A. If so the examiner should not make adjustments to the UOP or major components for purposes of applying the tangible property regulations.

If the taxpayer did not change its method for taxable years on or after January 1, 2012, or the change is not consistent with the categorization in Attachment A, and

  1. The mining industry taxpayer wants to apply the provisions of this Directive, LB&I examiners, in consultation with the taxpayer, will decide whether the most appropriate way to implement this Directive is to make a Service-imposed change to the taxpayer’s method of accounting for the UOP and major components or for the taxpayer to file a Form 3115 to change its method of accounting to be consistent with this Directive. The examiner may consult with the Deductible and Capital Expenditure Practice Network for further assistance.
  2. The mining industry taxpayer does not want to apply the provisions of this Directive, LB&I examiners should risk assess the issue and consult with the Deductible and Capital Expenditure Practice Network if necessary. 

Taxpayer Not Under Examination

A taxpayer that chooses to change the definition of its UOP and major components as described in this directive must follow the automatic change in method of accounting provisions contained in section 11.08 of Rev. Proc. 2017-30, 2017-18 I.R.B. 1131. Such a change constitutes a change in method of accounting to which the provisions of I.R.C. §§ 446 and 481, and the associated regulations thereunder, apply.

Application

This directive is intended only to clarify the definition of a UOP or major component. A taxpayer may not rely on the UOP definitions provided in this directive for any other purpose of the Code or Regulations, including but not limited to, determining the UOP under other Code sections (for example, I.R.C. § 263A), or determining the asset for depreciation purposes (including placed in service dates, retirement, disposition, or classification), under I.R.C. § 168(e) or Rev. Proc. 87-56, 1987-2 C.B. 674, for the same or similar type of assets used in the mining industry.

Contact Information

If you have any questions, please contact the Deductible and Capital Expenditures Practice Network for assistance.

This Directive is not an official pronouncement of law and cannot be used, cited, or relied upon as such. In addition, nothing in this Directive should be construed as affecting the operation of any other provision of the Internal Revenue Code, Treasury Regulations, or guidance thereunder.

Attachment A

cc: Division Counsel, LB&I Chief, Appeals


Attachment A

Mining Industry Units of Property and Major Components

This matrix is intended to assist in determining the unit of property (“UOP”) and major components as described in Treas. Reg. §§ 1.263(a)-3(e)(2), (3) and 1.263(a)-3(k)(6).

For purposes of this matrix, the term “mine” means any excavation or other workings or series of related excavations or related workings for extracting any known mineral deposit except oil and gas deposits. The terms “excavations” and “workings” include quarries, pits, shafts, underground excavations, and wells (except oil and gas wells).

Each UOP or major component that is driven by a motor (e.g., electric, gas, hydraulic, or diesel) includes the motor with that UOP unless otherwise indicated below. Units of property unique to a mine are considered separately. Units of property that are shared jointly with two or more mines are considered one UOP.

Not all of the units of property discussed below are necessarily present at all mines; for example, some mines do not have a dragline. Similarly, not all of the identified major components are necessarily present in a UOP; for example, a continuous miner may or may not contain an integrated bolter.

Further, in certain circumstances, the regulations and other guidance published in the Internal Revenue Bulletin provide special UOP rules or alternative methods of accounting for some types of property referenced in this matrix. Specifically, Treas. Reg. § 1.263(a)-3(e)(5) provides that certain tangible building and non-building components must be treated as separate units of property if the taxpayer properly utilizes a different asset class or method of depreciation for a particular component.

Similarly, Rev. Proc. 2002-27 provides a safe harbor method of accounting for the costs of original and replacement tires for certain qualifying vehicles property if the taxpayer chooses to utilize such method for all such property. Thus, to the extent that a mining industry taxpayer has property that qualifies under Treas. Reg. § 1.263(a)-3(e)(5) or properly utilizes the accounting methods authorized under Rev. Proc. 2002-27, the identification of units of property or major components in this matrix do not affect the determinations or treatment under those provisions. For example, if this matrix identifies “tire sets” as a major component of a UOP for certain mining vehicles, but the taxpayer properly utilizes the original tire capitalization method under Rev. Proc. 2002-7 for those tires or the properly classifies those tires as having a different recovery period than the underlying property under Treas. Reg. § 1.263(a)-3(e)(5), then the UOP determinations and/or treatment afforded under those specific provisions will be respected. See also Treas. Reg. § 1.263(a)-3(e)(6), Example 16.

Subsurface Mining Property

Longwall System. Each longwall system consists of the following units of plant property (shearer through electrical distribution panel).

Shearer
Each shearer is a single UOP. Each shearer contains/may contain the following major components:
a. Gear case including motor;
b. Cutting heads including motor; and
c. Shearer undercarriage, including tram system and motors.

Hydraulic Roof Support
Each hydraulic roof support (shield) is a single UOP. Each hydraulic roof support contains/may contain the following major components:
a. Hydraulic cylinder/legs including valve;
b. Canopy; and
c. Base.

Armored Face Conveyor/Panline
Each armored face conveyor/panline is a single UOP. Each armored face conveyor/panline contains/may contain the following major components:
a. Drive Motor;
b. Conveyor chain; and
c. Frame including pan.

Stage Loader
Each stage loader is a single UOP (transfer point between the panline and conveyors). Each stage loader contains/may contain the following major components:
a. Drive motor;
b. Conveyor chain;
c. Crusher; and
d. Frame.

Hydraulic Pump
Each Hydraulic pump (including motor) is a single UOP.

Electrical Distribution Panel
Each electrical distribution panel comprises a single UOP.

Continuous Miner. Each continuous miner is a single UOP. Each continuous miner contains/may contain the following major components:
a. Drive motor;
b. Conveyor;
c. Drum;
d. Gathering arm (pot);
e. Integrated bolter;
f. Hydraulic system;
g. Undercarriage; and
h. Track set.

Roof Bolter. Each roof bolter is a single UOP. Each roof bolter contains/may contain the following major components:
a. Electric Motor;
b. Hydraulic system;
c. Undercarriage; and
d. Tire set.

Rotary & Percussion Drills. Each rotary or percussion drill is a single UOP. Each rotary or percussion drill contains/may contain the following major components:
a. Motor;
b. Hydraulic system;
c. Boom;
d. Undercarriage;
e. Track set; and
f. Tire set.

Track Haulage/Rail System. Each track haulage/rail system within a set capacity comprises a single UOP. Track haulage/rail systems of different capacities comprise separate units of property, (for example, an 80 pound track haulage/rail system would be a separate UOP from a 40 pound track/rail system).

Locomotive. Each locomotive constitutes a single UOP (includes electric motor locomotives). Each locomotive contains/may contain the following major components:
a. Each diesel engine;
b. Each generator;
c. Each battery set;
d. Each traction motor;
e. Control system;
f. Each truck set;
g. Body; and
h. Frame.

Rail Car. Each rail car constitutes a single UOP. Each rail car contains/may contain the following major components:
a. Each coupler system;
b. Truck set; and
c. Body.

Shuttle Car. Each shuttle car is a single UOP. Each shuttle car contains/may contain the following major components:
a. Drive motor;
b. Conveyor;
c. Hydraulics;
d. Undercarriage; and
e. Tire set.

Scoop/Ram Car/Mucker. Each scoop, ram car, or mucker is a single UOP. Each scoop, ram car, or mucker contains/may contain the following major components:
a. Drive motor;
b. Battery packs;
c. Bucket;
d. Hydraulic system;
e. Undercarriage; and
f. Tire set.

Loading Machine. Each loading machine is a single UOP. Each loading machine contains/may contain the following major components:
a. Drive motor;
b. Gathering arms including motor;
c. Conveyor including motor;
d. Undercarriage; and
e. Track set.

Primary Ventilation System. Each primary ventilation system is a single UOP. Each primary ventilation system includes/may include the following major components:
a. Each primary ventilation fan (including booster and bleeder fans) and the respective fan blades, housings, and motors is a major component. Auxiliary fans in the nature of portable supplemental ventilation equipment are not considered part of the primary ventilation system.

Pump. Each pump is a single UOP.

Elevator. Each elevator, skip or hoist is a single UOP.

Conveyor System. Each conveyor system is a single UOP. Each conveyor system contains/may contain the following major components:
a. Each belt drive including head frame, controls, motor drive including take up is a major component; and
b. Each conveyor belt section, excluding the belt drive is a major component. A conveyor belt section includes all components of the belt section, including the belt feeder, the frame, guides, and rollers, but excluding the belt drive.

Power/Lighting System. Each power/lighting system including the main cabling for each mine is a single UOP.

Substation. Each substation contains/may contain the following units of property (transformer through electrical devices).

Transformer
Each transformer at a substation is a single UOP.

Rectifier
Each rectifier at a substation is a single UOP.

Substation Surround
All fencing, walls, enclosures, or other structures surrounding each substation or supporting the substation’s electrical devices (excluding enclosures or buildings suitable for occupation), and land improvements that are not properly capitalized to land is a single UOP.

Electrical Devices
All other electrical devices at each substation, such as load centers, fuses, breakers, other switches, regulators, insulators, meters, and the pad on which the equipment is installed collectively is a single UOP.

Transformer. Each transformer is a single UOP.

Load Centers. Each load center is a single UOP.

Surface Mining Property

Highwall Miner. Each highwall miner is a single UOP. Each major component of the highwall miner includes the motor(s) associated with that major component. Each highwall miner contains/may contain the following major components:
a. Power head drive;
b. Cutting machine;
c. Control System;
d. Reel and Chain;
e. Conveyor system;
f. Push beam;
g. Undercarriage; and
h. Track set.

Auger. Each auger is a single UOP. Each major component of the auger includes the motor(s) associated with that major component. Each auger contains/may contain the following major components:
a. Power head drive;
b. Cutting head;
c. Gathering arms;
d. Control system;
e. Conveyor system;
f. Undercarriage; and
g. Track set.

Bucket Wheel Excavator (BWE). Each BWE is a single UOP. Each major component of the BWE includes the motor(s) associated with that major component. Each BWE contains/may contain the following major components:
a. Bucket wheel;
b. Control system;
c. Conveyor system;
d. Undercarriage; and
e. Track set.

Dragline. Each dragline is a single UOP. Each dragline contains/may contain the following major components:
a. Tub or base (includes circle rail, swing rack, and center pin);
b. Rotating frame, machinery housing, and operators cab;
c. Swing machinery (includes motors, gear cases, and swing pinions);
d. Hoist and Drag machinery (includes motors, gear cases, hoist pinions, hoist drum with bull gear, drag pinions and drag drum with bull gear);
e. Bucket;
f. Walking mechanism (includes cam assembly, shoes, propel motors, and gear cases);
g. AC Synchronous motors;
h. DC Generators;
i. Boom, mast, and A-frame (including boom support ropes, and rigging);
j. Electrical operating and control systems (transformers, rectifiers, motor control room and equipment, and computerized controls);
k. Diesel engines;
l. Undercarriage (crawler mounted draglines); and
m. Tracks (crawler mounted draglines).

Shovel. Each Shovel is a single UOP. This UOP includes both hydraulic front shovels and electric rope shovels. Each shovel contains/may contain the following major components:
a. Hoist machinery (includes motors, gear cases, hoist pinions, and hoist drum with bull gear);
b. Swing machinery (includes motors, gear cases, and swing pinions);
c. Engine electric/diesel;
d. Drive train (including transmission, torque converter, driveline, and final drive);
e. Hydraulic system;
f. Electrical system with controls;
g. Boom and bucket arm;
h. Bucket;
i. Undercarriage; and
j. Track set.

Dredger. Each dredger is a single UOP. Each dredger contains/may contain the following major components:
a. Dredge pump;
b. Control system;
c. Suction equipment including head; and
d. Vessel.

Rotary & Track Drill. Each rotary or track drill is a single UOP. Each rotary or track drill contains/may contain the following major components:
a. Motor/engine;
b. Hydraulic system;
c. Control system;
d. Mast;
e. Undercarriage;
f. Drive train (including transmission, torque converter, and driveline);
g. Track set; and
h. Tire set.

Track or Wheel Dozer. Each track or wheel dozer is a single UOP. Each track or wheel dozer contains/may contain the following major components:
a. Engine;
b. Drive train including transmission, torque converter, driveline, and final drive;
c. Hydraulic system;
d. Control system;
e. Blade;
f. Ripper carriage;
g. Frame or undercarriage;
h. Track set; and
i. Tire set.

Front-End Loader. Each front-end loader is a single UOP. Each front-end loader contains/may contain the following major components:
a. Engine;
b. Drive train including transmission, torque converter, driveline, and final drive;
c. Hydraulic system;
d. Control system;
e. Bucket;
f. Ripper carriage;
g. Frame and suspension; and
h. Tire set.

Bowl Scraper. Each bowl scraper is a single UOP. Each bowl scraper contains/may contain the following major components:
a. Engine;
b. Drive train including transmission, torque converter, driveline, and final drive;
c. Hydraulic system;
d. Control system;
e. Bowl;
f. Frame and suspension; and
g. Tire set.

Grader. Each grader is a single UOP. Each grader contains/may contain the following major components:
a. Engine;
b. Drive train including transmission, torque converter, driveline, and final drive;
c. Hydraulic system;
d. Control system;
e. Blade;
f. Frame and suspension; and
g. Tire set.

Hauler. Each hauler is a single UOP. This UOP includes both haul trucks and articulated haul trucks. Each hauler contains/may contain the following major components:
a. Engine or diesel electric motors;
b. Drive train, including transmission, torque converter, driveline, and final drive;
c. Hydraulic system;
d. Control system;
e. Bed;
f. Each wheel and motor set;
g. Frame and suspension; and
h. Tire set.

Pump. Each pump is a single UOP.

Conveyor System. Each conveyor system is a single UOP. Each conveyor system contains/may contain the following major components:
a. Each belt drive, including head frame, controls, motor drive including take up; and
b. Each conveyor belt section excluding belt drive. A conveyor belt section includes all components of the belt section including belt feeder except for the belt drive. A conveyor belt section major component includes the frame, guides, and rollers.

Track Haulage/Rail System. Each track haulage/rail system within a set capacity is a single UOP. Track haulage/rail systems of different capacities comprise separate units of property, (for example, an 80 pound track haulage/rail system would be a separate UOP from a 40 pound track/rail system).

Locomotive. Each locomotive is a single UOP. Each locomotive contains/may contain the following major components:
a. Each diesel engine;
b. Each generator;
c. Each traction motor;
d. Control system;
e. Each frame;
f. Each truck set; and
g. Each body.

Rail Car. Each rail car is a single UOP. Each rail car contains/may contain the following major components:
a. Each truck set;
b. Each coupler system; and
c. Each body.

Mining Processing Plant Property

Crusher. Each crusher is a single UOP. This UOP includes, but is not limited to, ball mills, roller mills, impact crusher, rotary breakers, cone crushers, and jaw crushers. This UOP includes both mobile or stationary and primary, or secondary crushers. However, in certain circumstances, crushers may function together and be functionally interdependent. In this case, two or more crushers together may be a single UOP. The facts and circumstances need to be considered in each case. Each crusher contains/may contain the following major components:
a. Drive mechanism for the crushing equipment, and
b. Transport mechanism for portable crushers.

Separator Equipment. Each separator is a single UOP. Separation machinery and equipment is used to sort material by size and separate desirable materials from non-desirable materials. The equipment includes but is not limited to heavy-media vessels, screens, Deister tables, and froth-flotation devices. However, in certain circumstances, separators may function together and be functionally interdependent. In this case, two or more separators together may be a single UOP. The facts and circumstances need to be considered in each case.

Cleaning/Washing Equipment. Each cleaning unit is a single UOP.

Wastewater/Recycling Water System. Each wastewater/recycling water system is a single UOP. A wastewater/recycling system that integrates multiple treatment processes into one system is a single UOP. Wholly separate and discrete wastewater/recycling water systems are treated as separate units of property. The wastewater system is the equipment that treats and disposes of wastewater. The recycling water system is the equipment that treats and recycles water used in the mining process. The wastewater/recycling water system contains/may contain the following major components:
a. Each treatment tank;
b. Each wastewater conveyance system;
c. Each barge;
d. Each pump; and
e. Instrumentation and controls.

Solid Waste Disposal System. Each solid waste disposal system is a single UOP. A solid waste disposal system that integrates multiple treatment processes into one system is a single UOP. Wholly separate and discrete solid waste disposal systems are treated as separate units of property. The solid waste disposal system does not include land improvements. The solid waste disposal system contains/may contain the following major components:
a. Each slurry line (pipes);
b. Each pump;
c. Each belt drive, including head frame, controls, motor drive including take up;
d. Each conveyor belt section excluding belt drive. A conveyor belt section includes all components of the belt section including belt feeder except for the belt drive. A conveyor belt section major component, (includes the frame, guides, and rollers; and
e. Each cyclone.

Settling Pond (waste impoundment). Each settling pond, including liners and blankets, is a single UOP. Each settling pond contains/may contain the following major components:
a. Each channel leading to or from the pond; and
b. Banks, berms, dams, and/or retaining walls, liners and blankets.

Dust Collection System. Each dust collection system is a single UOP. Wholly separate and discrete dust collection systems are treated as separate units of property. The dust collection system is a bag house, including bags and blowers.

Dryer. Each dryer is a single UOP. The dryer equipment is the equipment that removes water from the mined product. This UOP includes different forms of dryers, such as vacuum filters, belt filters, and thermal dryers.

Sampling System. Each sampling system is a single UOP. The sampling system is the equipment and instrumentation used to measure attributes such as size, composition, and heat content of the mined product

Scale Facility. Each scale facility is a single UOP. The scale facility is the equipment that measures the weight of the mineral passing this point.

Product Storage & Management System. Each product storage and management system is a single UOP. The product storage management system receives and stores the product that has been mined. This UOP also includes the loading facilities. Each product storage and management system contains/may contain the following major components:
a. Each shed;
b. Each stacker;
c. Tipple structure and control system;
d. Loading apparatus;
e. Each silo; and
f. Product conveyance system, including reclaim tunnels.