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The need for additional guidance on capitalization issues.

On March 25, 1997, Tax Executives Institute submitted the following comments to the Internal Revenue Service concerning the need for additional guidance on the number of capitalization issues that have arisen in the aftermath of the Supreme Court's 1992 decision in INDOPCO, Inc. v. United States. The comments supplement a position paper that TEI filed with the IRS on March 20, 1996, in response to Notice 96-7, as well as a letter that was sent to Secretary of the Treasury Robert Rubin on November 6, 1996, concerning the treatment of asbestos remediation expenditures. TEI's comments were prepared under the aegis of its Federal Tax Committee, whose chair is David L. Klausman of Westinghouse Electric Corporation.

On behalf of Tax Executives Institute, I am pleased to respond to the invitation extended during the TEI-IRS liaison meeting to provide additional comments on capitalization issues that we believe warrant public guidance in the aftermath of the decision in INDOPCO, Inc. v. United States. This letter hence supplements the Institute's previous submission on March 20, 1996, in response to Notice 96-7, as well as a letter dated November 6, 1996, to Treasury Secretary Rubin urging the issuance of public guidance confirming the deductibility of asbestos remediation expenditures. The issues discussed at the liaison meeting include (i) the costs of recoding computer software to prevent potential errors arising at the turn of the century from the use of zeroes in two-digit fields representing the year in a date record (sometimes referred to as the year 2000' problem, the "century date" issue, or the "millennium bug"), (ii) limiting the broad scope of the "plan of rehabilitation" doctrine to preclude revenue agents from denying deductions for routine maintenance costs pursuant to a cyclical repair or removal policy, and (iii) routine costs incurred to expand or retain a business's customer base.


Tax Executives Institute is the principal association of corporate tax executives in North America. Our more than 5,000 members represent the 2,700 leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike.


In Notice 96-7,(1*) the IRS invited public comment on the approaches it should consider to address issues raised under sections 162 and 263 particularly in light of the Supreme Court's decision in INDOPCO.(2) In its March 1996 submission in response to Notice 96-7, the Institute identified a number of expenditures that warrant additional public guidance. Among the expenses that TEI identified in its submission were training costs - an area where revenue agents were creating unnecessary conflict and confusion by challenging expenditures that are generally deductible. Hence, we are pleased by the issuance of Rev. Rul. 96-62(3) and commend the IRS for confirming that, except in highly unusual cases, training costs remain deductible.(4)

Taxpayers are currently incurring expenses in many other areas that we believe warrant public guidance similar to that promulgated Rev. Rul. 96-62. These expenditures affect taxpayers in nearly every industry. We believe that the legal principles that taxpayers have analyzed -- and from which they have concluded that the identified business expenditures may be deducted -- can and should be restated in public guidance. Such guidance will afford taxpayers much greater certainty than the nebulous more than incidental future benefit" test set forth in INDOPCO -- a test that can all-too-easily be misapplied to capitalize routine, on-going, or recurring expenditures.

As a general principle of tax administration, taxpayers deserve guidance before they file their returns rather than several years later on examination. Moreover, by issuing public guidance earlier rather than later, scarce government and taxpayer resources that would otherwise be devoted to the resolution of these issues through examinations, appeals, private rulings, and litigation would be freed for other uses. Hence, in the interest of sound tax administration, the government should issue additional public guidance confirming the deductibility of the expenses set out below.

Year-2000 Expenditures

Description. The so-called year-2000 problem arises because many business application and system software programs employ two rather than four digits to specify the year in a date field.' In the past, programmers often used two digits to designate the year in order to save then-expensive computer processing and storage memory. Unless software and data files containing such date formats are remedied, computers with time-sensitive software programs and data files will, on January 1, 2000, likely treat the year "00" as though it were 1900. This in turn will lead the computer to make incorrect calculations, to perform illogical comparisons, or otherwise cause the computer to shut down -- "to crash."

Hence, year-2000 expenditures may be described as the costs incurred to identify and repair computer software code and data files in order to eliminate mathematical or logical errors that result from the use of zeroes in a two-digit data field representing the year for a particular date. The functional costs to identify and repair the code include salaries, payroll taxes, and benefits for employees; supplies; equipment depreciation; consulting fees; and other allocable overhead expenses. Year-2000 expenditures may also include the cost of replacing off-the-shelf software with an entirely new, year-2000 compliant version of the same software. Finally, taxpayers may also purchase specialized software tools to identify and remedy the coding defect.(6)

On a program-by-program (or file-by-file) basis, the expenditures to repair a program will often be de-minimis. Estimates vary, but one source projects that the cost of repairing software ranges from $0.90 to $1.50 per line of code.(7) The dependency of business taxpayers on so many different programs and files and the complex interrelationship among the various programs and data files, however, substantially increase the magnitude and scope of the year-2000 problem. Variations in programming styles and the potential for problems owing to the exchange of electronic or magnetic media between customers and their suppliers also increase the burden of remedying the year-2000 problem.

From an accounting perspective, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) has declared that companies must expense costs incurred to fix the year-2000 problem. Under the EITF view, costs to remedy year-2000 problems are "incurred to keep the software updated and thus should be classified similar to repair and maintenance expenses."(8) Since the expenditures do not improve the software beyond the state in which it was intended to be used and do no more than restore it to its normal operating state, the EITF concluded that such costs -- being indistinguishable from other forms of repair and maintenance expenses -- are "period costs and should be expensed as incurred' rather than capitalized.(9) The EITF did not address the treatment of the purchase or licensing of a " year-2000 compliant" version of the same software to replace an existing version. Presumably, such costs will be accounted for under the taxpayer's normal policy for distinguishing between capital and period costs.

Analysis. Taxpayers are permitted deductions under section 162 for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Although not defined in the Internal Revenue Code, courts have interpreted "ordinary" to mean any expenditure that is common and accepted in a particular industry or line of business.(10) The term "necessary" imposes only the minimal requirement that the expense be helpful or appropriate for the development of the taxpayer's business."

Under section 263, taxpayers may not claim deductions for expenditures considered to be capital. Section 263(a)(1) provides that no deduction is permitted for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. Under section 263(a)(2), no deduction is allowed for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made for depreciation, amortization,. or depletion. Treas. Reg. [Sections] 1.263(a)(1)-(b) explains that the cost of capital expenditures are added to the basis of the underlying property and recovered through depreciation, amortization, cost of goods sold, or adjustments to basis ... in accordance with applicable Code sections and regulations." Under Treas. Reg. [Sections] 1.162-4, the cost of incidental repairs that neither materially add to the value of property nor appreciably prolong its life, but rather keep it in an ordinarily efficient operating condition, may be deducted as an expense.

TEI agrees with the reasoning of the EITF that most expenditures to remedy year-2000 problems are akin to repair and maintenance expenses and should be treated in like fashion for tax purposes.(12) The primary criteria for distinguishing whether a repair cost will be deductible under section 162 or capitalized under section 263 are whether the expenditure adds value, substantially prolongs the useful life of property, or adapts the property to a new use.(13) Under the Plainfield-Union test for determining whether a repair adds value, extends the life, or adapts property to a new use, the status of the repaired software immediately after the expenditure is compared with the status of the asset prior to the condition necessitating the expenditure."(14) In recoding software to eliminate potential errors arising from a two-digit year field, the expenditure merely permits the software to operate in the same fashion on January 1, 2000, as it will on December 31, 1999. Hence, the expenditures are costs incurred to ensure that taxpayers can operate their computer systems on the first day in the year 2000, not a cost to operate throughout the 21st century. There has been no increase in value, extension of the software's life beyond that for which the taxpayer originally acquired it, or adaptation of the property to a new use.

Moreover, in many respects the programming costs incurred to address the year-2000 issue "so closely resemble the kind of research and experimental expenditures that fall within the purview of section 174 ... as to warrant accounting treatment similar to that accorded such costs under that section."',, Hence, in Rev. Proc. 69-21 the IRS ruled that it would not disturb a taxpayer's treatment of costs of developing software, either for its own use or for sale or lease to others where:

1. All of the costs properly attributable to the development of software by the taxpayer are consistently treated as current expenses and deducted in full in accordance with the rules similar to those applicable under section 174(a) of the Code; or

2. All of the costs properly attributable to the development of software are consistently treated as capital expenditures that are recoverable through deductions for ratable amortization, in accordance with the rules similar to those provided by section 174(b) of the Code and the regulations thereunder, over a period of five years from the date of completion of such development or over a shorter period where such costs are attributable to the development of software that the taxpayer clearly establishes has a useful life of less than five years.(16)

Indeed, taxpayers that have consistently deducted software development costs under section 174(a) likely must treat year-2000 expenditures as deductions because section 6.01 of Rev. Proc. 69-21 states that "the costs of development of software ... will be treated as a method of accounting" requiring the consent of the Commissioner for a change to an alternative method.(17)

On several occasions, the IRS has confirmed that "taxpayers may continue to rely on Rev. Proc. 69-21" and treat software development costs as deductible expenses.(18) In addition, recently proposed regulations prescribing the conditions under which expenditures for internally developed software will constitute qualified research expenditures eligible for the research credit under section 41 do not disturb the general treatment of software development costs under Rev. Proc. 69-21.(19) As a result, we believe that Rev. Proc. 69-21 properly states the currently applicable rules concerning the treatment of software development costs and urge the IRS (i) to reaffirm Rev. Proc. 69-21 and (ii) to announce that in respect of the treatment of year-2000 expenditures, Rev. Proc. 69-21 supplies taxpayers an alternative method (apart from section 162) under which they may deduct expenditures to remedy year-2000 software problems.


Doctrine: Cyclical Repair

Policy and Equipment

Removal Costs

Description. Many large pieces of equipment -- including airplanes, ships, barges, locomotives, rail cars, cranes, bulldozers, and other construction, manufacturing, and mining equipment -- have extremely long useful lives. In order to use the asset for its full economic life, however, reasonably prudent taxpayers establish maintenance policies and perform cyclical repairs at periodic intervals. Rev. Rul. 88-57 provides guidance concerning the treatment of the repairs conducted pursuant to a program for major cyclical rehabilitation following a predetermined period of use in the taxpayer's business.(20) That ruling, together with the plan-of-rehabilitation doctrine,(21) was cited in a recent technical advice memorandum to require capitalization of routine aircraft engine inspections and overhauls.(22) In addition, the plan-of-rehabilitation doctrine has been cited by agents to deny deductions for the costs of removing equipment (costs of removal) pursuant to a "plan" to install new equipment.


1. Distinction Between Periodic Repair and Maintenance and Substantial Rehabilitation Should be Preserved. Rev. Rul. 88-57 provides guidance on the treatment of expenditures to substantially rehabilitate railroad cars. In that ruling, freight train cars are subjected to a substantial rehabilitation after a period of eight to ten years of continuous use. In particular, modifications are made to the car in order to upgrade various components to the latest engineering standards. The freight-train car essentially is stripped to the frame with, all of its structural components either reconditioned or replaced.... Absent these rehabilitations, the freight-train cars would have a service life of 12 to 14 years.(23) After the rehabilitation expenditures, the cars have the same service life as a new car. The ruling concludes that the expenditures are capital.

In the facts of the aircraft engine repair TAM, the parts are compared to specifications and only parts falling outside of tolerance ranges are reconditioned or replaced. More important, the aircraft engine inspection is repeated after 6,000 to 7,000 flight hours (approximately 4 years) of use, whereas the asset guideline class life (and applicable class life for the modified accelerated class-life recovery system (MACRS)) is 12 years.(24) Moreover, the economic life of a well-maintained engine is well in excess of the guideline class life. Hence, we do not believe that the rationale of Rev. Rul. 88-57 involving a substantial rehabilitation of an asset (i) near the end of its useful service life and (ii) following a period of continuous use without repairs can properly be extended to deny deductions for routine, periodic inspection and repair costs incurred during the expected service life of an asset. The economic life of any asset, and the corresponding asset guideline class and applicable MACRS class life in which the asset falls, is premised on the taxpayer undertaking periodic repairs in order to keep the asset in an ordinarily efficient operating condition. Indeed, following the TAM's reasoning to its logical extreme, periodic oil changes for automobiles or delivery trucks would be subject to capitalization. Establishing a prudent policy of periodic repairs and incurring expenses under that policy do not, in our view, transmogrify periodic repairs into a capital asset with a useful life beyond the year incurred.

Another fundamental error of the TAM is its refusal to apply the Plainfield-Union test for determining whether a repair enhances the value or extends the useful life of an asset. The TAM avers that there was "no condition necessitating the expenditure outside of the normal wear and tear attributable to the use of the engine...." That statement, however, is disproved by extending its logic: Every repair is directed at minimizing the wear and tear" attributable to the day-to-day use of an asset. If the comparison of the repair regulation's increase-in-value or extension-of-useful-life tests are applied to the status of an asset immediately prior to a repair, then every repair will increase value and extend the life of an asset. Under that false reasoning, all repairs would be capital expenditures and the TAM'S conclusion is a manifestation of that fallacy. The proper test to determine whether there has been an increase in useful life or value is set forth in Plainfield-Union: compare the status of the asset immediately before the condition necessitating the expenditure with the status of the asset after the expenditure. Only where the life or value of the asset has been increased is there a capital expenditure. Since the rationale of the TAM is being distended and applied broadly by agents in many other situations involving cyclical repairs of assets, we urge, that it be withdrawn. Even better, we recommend that the IRS issue a revenue ruling confirming that inspections and repairs conducted pursuant to cyclical maintenance policies remain fully deductible as repairs.

2. Costs of Removal. The cost of property with a useful life in excess of one year generally must be capitalized under section 263. Under section 167(a), a depreciation deduction is permitted as a reasonable allowance for the exhaustion and wear and tear of property used in a trade or business. If property is tangible property, section 168 sets forth various rules under the MACRS regime for computing the amount of the permitted depreciation deduction.

Under Treas. Reg. [Sections] 1.167(a)-11(d)(3)(x), the costs of dismantling, demolishing, or removing a Class Life Asset Depreciation Range (CLADR) asset are to be deducted in the year actually incurred. The rule described in that regulation has been the law since at least the enactment of the 1939 Code. Moreover, the enactment of the ACRS and MACRS regimes did not alter the general rule that the cost of removing an asset is part of the cost of the "old" asset regardless of whether a "new" asset replaces it.

Under the rules in effect prior to the enactment of CLADR (i.e., rules applicable to assets placed in service before 1971 and also for assets placed in service between 1971 and 1981 for which no CLADR election was made), estimated removal costs are recovered no later than the date the assets are disposed. Under Treas. Reg. [Sections] 1. 167(c), salvage value -- the estimated amount realized on disposition of an asset -- is taken into account in determining the taxpayer's allowance for depreciation. "Salvage, when reduced by the cost of removal, is referred to as net salvage."(25) Correspondingly, salvage, unreduced by removal costs, is referred to as gross salvage. Under the regulation, the treatment of the costs of removal are to be consistent with the treatment of salvage value. Indeed, the regulation draws heavily from Treasury Department's Bulletin "F," where the Bureau of Internal Revenue explained:

Salvage value is the amount

realizable from the sale or

other disposition of items

recovered when property has

become no longer useful in

the taxpayer's business and

is demolished, dismantled, or

retired from service. When

reduced by the cost of

demolishing dismantling, and

removal, it is referred to as net

salvage. In principle, the

estimated net salvage should

serve to reduce depreciation,

either through a reduction in

the basis on which

depreciation is computed or a

reduction in the rate. In either

instance the amount of net

salvage should actually, or in

effect, be a credit to the

depreciation reserve. Where

the basis or the rate for

depreciation is not reduced for

estimated salvage, all net

receipts from salvage should be

considered income.(26)

Indeed, the Bulletin clearly distinguishes installation costs, which are capitalized to replacement assets, from removal costs, which relate economically to the asset disposed. When CLADR was adopted, the regulations prohibited the net salvage method, which essentially permits recovery of the costs over the life of the asset, and instead permitted removal costs to be deducted when incurred.(27)

When Congress enacted the ACRS regime, the. model was the CLADR system, which the IRS had developed in response to section 167(m). Since Treas. Reg. [Sections[ 1.167(a)-11(d)(3)(x) supplied a sensible, symmetrical treatment for removal costs and salvage proceeds under CLADR, there was no need for Congress to address the treatment of removal costs specifically. When Congress replaced ACRS with MACRS, the statute and legislative history were similarly silent concerning changes to longstanding treatment of costs of removing equipment as deductions when incurred. Indeed, the National Office has recognized that removal costs remain distinct from installation costs, permitting deductions for the costs of removing a spillway that was replaced simultaneously with a new one.(28)

Revenue agents, however, seemingly believe that the plan-of-rehabilitation doctrine supports the conclusion that the costs of removal of an old asset must be capitalized along with the installation costs of a replacement asset. The plan-of-rehabilitation doctrine has been described by one court as having

.... superimposed upon the

criteria in the

[Commissioner's] air regulation an

overriding precept that an

expenditure made for an item

which is part of a "general

plan' of rehabilitation,

modernization, and improvement

of the property, must be

capitalized, even though

standing alone, the item may

appropriately be classified as

one of repair.(29)

Notwithstanding the foregoing broad generalization, a series of related repairs must also have the effect of increasing the value, extending the life, or adapting the property to a new use before the doctrine is properly invoked and the expenditures deemed capital. In other words, a series of repairs do not rise to the level of a plan of rehabilitation unless one of the three tests for capitalization is otherwise satisfied.(10) Moreover, the plan-of-rehabilitation expenditures must relate to the enhancement of the life, value, or use of the same asset. Capital improvements made to one asset do not change the character of expenditures made to a different asset, even where the separate assets are repaired or replaced pursuant to the same general plan.(31)

Since revenue agents persist in joining two amorphous judicial doctrines -- the more than incidental future benefit' test of capitalization under INDOPCO and the "plan of rehabilitation" doctrine -- to meld independent repair projects together and thereby capitalize removal costs to the replacement assets, we believe that the National Office should issue guidance confirming that removal costs relate to the disposition of the replaced asset and hence remain deductible.(32)

Expansion or Retention of a

Company's Customer Base

Description. Businesses expend substantial sums to attract and retain their customers. The expenditures take many forms and are generally industry specific, if not unique to the company itself. The most common example of such an expenditure is advertising, which Rev. Rul. 92-80 confirms is deductible even though there may be some future -- though incidental and speculative -- effect on business activities.(33) All routine marketing expenditures -- whether for product discounts, free use of service, advertising space or time, customer rebates or coupons, market research activities to identify customers and competitors, slotting payments for shelf or warehouse space, payments to dealers or distributors, bonus or premium awards to frequent or new customers, commissions to sales agents or employees for signing customers to short-term service or lease agreements -- are directed toward, and are intended primarily, to secure current sales revenue.(34)

Analysis. Marketing and promotional expenditures are undeniably critical to the long-term survival of any business. That relationship, however, is irrelevant to whether such expenditures should be capitalized or deducted. Treas. Reg. [Sections] 1. 162-1(a) provides that 'advertising and other selling expenses' are business expenses deductible under section 162. Under the regulation, selling expenses, such as marketing and promotional expenses, are purposefully linked with advertising expenditures and should be treated similarly since both result in customer patronage and sales. In other words, marketing and promotional expenditures are "directed toward" and "intended primarily to obtain" current revenues just as advertising expenditures are. Since the principal focus of marketing and promotional expenditures is the production of current income, the matching principle demands that such costs be deductible currently, notwithstanding the presence of an incidental, speculative, and impossible-to-measure future benefit.

Indeed, the INDOPCO decision, which the IRS National Office consistently says did not change the fundamental principles of capitalization, is grounded in the matching principle. Hence, the decision's rationale should not disturb taxpayers' consistent and longstanding treatment of marketing and promotional expenditures as deductible expenses.(35)

Nonetheless, revenue agents contend that such expenses should be capitalized under the rationale of INDOPCO. Agents seemingly believe that marketing costs, and other costs incidental to securing a customer's patronage, result in a long-term relationship that meets the decision's significant future benefit' test. In the absence of a long-term contract, however, no amount of advertising, marketing, or promotional expenditures alone, however, will ensure an enduring customer relationship or continuing future patronage. Indeed, the price and performance of a product, the quality of products or services offered, the speed to market (whether in terms of timeliness of products or services offered or the manner of delivery to customers), technological or regulatory constraints, innovation, and customer responsiveness, as well as general economic or market-specific conditions all contribute to the duration of a customer relationship.

Moreover, the value of any future benefit from marketing or promotional expenditures is highly speculative and incapable of being bifurcated from the immediate benefit of anticipated sales revenue.(36) Hence, any future benefit from marketing and promotional expenses is incidental and should, under the incidental future benefit test articulated in INDOPCO, continue to be deductible. Thus, selling expenses are generally deductible unless directed towards obtaining future benefits significantly beyond those traditionally associated with ordinary selling expenses. As a result, we urge the IRS to issue guidance similar to Rev. Rul. 92-80 confirming that expenditures for ordinary marketing and promotional activities are deductible.


The Institute's comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is David L. Klausman of Westinghouse Electric Corporation. If you should have any questions concerning the comments, please do not hesitate to contact Mr. Klausman at (412) 642-3354, or Jeffery P. Rasmussen of the Institute's legal staff at (202) 638-5601.

(1) 1996-1 C.B. 359.

(2) INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992).

(3) 1996-53 I.R.B. 6.

(4) As we discussed at the liaison meeting, the National Office's "message" has not been heeded by the field, where issues continue to be raised unnecessarily. Much of the confusion among revenue agents about the deductibility of training expenditures arose because TAM 954001 (July 21, 1995) concludes that training expenditures incurred to adopt just-in-time manufacturing techniques are capital. In a letter to the Commissioner and Chief Counsel dated September 21, 1995, the Institute analyzed the TAM and explained why its reasoning was erroneous. We continue to believe that the TAM is wrong and should be withdrawn. Unless training expenditures are directed toward and 'incurred primarily to obtain a [significant] future benefit," such as enabling the taxpayer to enter a new trade or business (akin to Cleveland Electric Illuminating Co. v. Commissioner, 7 Cl. Ct. 220 (1985)), there is not even a colorable basis on which to propose an adjustment to capitalize training expenditures. Hence, we urge the IRS to withdraw TAM 954001.

(5) The most common example of a two-digit year field is the MM/DD/YY format, where MM represents the month, DD the day, and YY the year of a particular date in the twentieth century (19YY). IRS computers often reverse this format, employing YY/MM/DD for dates.

(6) In addition, taxpayers may incur a plethora of non-software related expenditures to address business issues arising from the year-2000 issue. Such costs may include premiums for the purchase of insurance against business disruption or customer claims related to year-2000 software problems. As well, business taxpayers will likely incur legal and accounting fees to resolve claims by or against suppliers, creditors, or customers relating to year-2000 problems. The analysis and tax treatment of those issues is likely no different from the treatment of insurance premiums or legal and accounting fees arising in the context of other business risks. Those costs, however, are beyond the scope of these comments.

(7) See Bruce Caldwell, Beat the Clock -- Top-Down Management is the Key to Keeping the Lid on Year 2000 Conversion Costs, 599 INFORMATION WEEK (Sept. 30, 1996). The article is available on-line at ""

(8) See Switching Computers to Four-Digit Years in 2000 to Be an Expense, Not Capitalized, 139 Bureau of National Affairs Daily Tax Report G-3 (Jul. 19, 1996).

(9) Id.

(10) An ordinary expense means one that is normal, usual, or customary." Deputy v. Dupont, 308 U.S. 488, 495 (1940).

(11) Welch v. Helvering, 290 U.S. 111, 113 (1933).

(12) Thus, the purchase or license of a year-2000 compliant software program to replace an existing program may not be deductible where the functionality and features of the software program are substantially improved beyond converting two-digit year fields to four-digit year fields.

(13) Treas. Reg. [Sections] 1.263(a)-1(b).

(14) Plainfield-Union Water Co. v. Commissioner, 39 T.C. 333, 338 1962), nonacq. 1964-2 C.B. 8.

(15) Rev. Proc. 69-21, 1969-2 C.B. 303.

(16) Id.

(17) Id. at 304.

(18) See Preamble, T.D. 8482, 1993-2 C.B. 77, 81 promulgating final and temporary regulations under section 263A); Preamble, Notice of Proposed Rulemaking Research or Experimental Expenditures, PS-2-89, 1993-1 C.B. 904, 905. In both preambles, the IRS stated that it was studying the continuing vitality of Rev. Proc. 69-21.

(19) See Notice of Proposed Rulemaking and Notice of Hearing on Credit for Increasing Research Activities (Reg 209494-90), 1997-8 I.R.B. 24 (Feb. 24, 1997).

(20) 1988-2 C.B. 36.

(21) "The courts have superimposed upon the criteria in the repair regulation an overriding precept that an expenditure made for an item which is part of a "general plan" of rehabilitation, modernization, and improvement of the property, must be capitalized even though, standing alone, the item may appropriately be classified as one of "repair." . . . Whether [a) plan exists and whether a particular item is part of it are usually questions of fact ... [that depend on] a realistic appraisal of all the surrounding facts and circumstances, including, but not limited to, the purpose, nature, extent, and value of the work done." United States v. Wehrli, 400 F. 2d 686, 689-690 (10th Cir. 1968).

(22) Technical Advice Memorandum 9618004 (January 23,1996).

(23) 1988-2 C.B. 36.

(24) See Rev. Proc. 87-56, 1987-2 C.B. 674; Rev. Proc. 88-22, 1988-1 C.B. 785.

(25) Treas. Reg. [Sections] 1.167(a)-1(c).

(26) Bulletin F, 7 (1942) (emphasis supplied).

(27) See also Rev. Rul. 74-455, 1974-2 C.B. 63, requiring consistent treatment of salvage proceeds and the costs of removal.

(28) See Private Letter Ruling 9306005 (Nov. 2, 1992). In relying on Rev. Rul. 78-417, 1978-2 C.B. 120, to permit deductions for the removed spillway, the ruling states "[a]lthough the purpose of [Rev. Rul. 78-4171 was to clarify that the deduction of dismantling costs is not subject to the repair allowance limitations, it nevertheless demonstrates that dismantling, demolition and removal costs are not clearly within the section 263 sphere of influence."

(29) United States v. Wehrli, 400 F. 2d 686, 689 (10th Cir. 1968).

(30) The doctrine is generally invoked in cases involving a series of extensive repairs to rehabilitate dilapidated buildings. See, e.g., Jones v. Commissioner, 24 T.C. 563 1955), aff'd, 242 F. 2d 616 (5th Cir. 1957), and Home News Publishing Co., 18 B.T.A. 1008 (1930). There are a few cases outside of the building rehabilitation context where the rule has been applied. In Mountain Fuel Supply Co. v. United States, 449 F. 2d 816 (10th Cir. 1971), cert. denied, 405 U.S. 989 (1972), the Tenth Circuit applied the doctrine to a taxpayer that dug up 40 miles of a gas pipeline for straightening, cleaning, and spot-welding. A significant portion of the appellate decision, however, is devoted to the factual record establishing that the reconditioned pipe would have a substantially new period of expected life and an improved pressure capacity. In other words, two of the three independent prongs of testing a repair for capitalization were met. The Mountain Fuel Supply decision can be contrasted with Niagra Mohawk Power Corp. v. United States, 558 F. 2d 1379 (Ct. Cl. 1977), where a taxpayer undertook to repair leaks to approximately six percent of the joints on a pipeline. The Claims Court permitted the taxpayer to deduct the expenditures as repairs.

(31) See, e.g., Moss v. Commissioner, 831 F. 2d 833 (9th Cir. 1987); Kaonis v. Commissioner, 37 T.C.M. 792 (1978), aff'd, 639 F. 2d 788 (9th Cir. 1981); Keller Street Dev. Co. v. Commissioner, 37 T.C. 559 (1961), acq. 1962-2 C.B. 5, aff'd in part and rev'd in part on other grounds, 323 F. 2d 166 (9th Cir. 1963).

(32) Where equipment is removed from a building or structure," some agents have cited section 280B to require the costs of removal to be capitalized. Under Prop. Reg. [Sections] 1.280B-1(b), a "structure" means a building, as defined in Treas. Reg. [Sections] 1.48-1(e), and the structural components as defined in Treas. Reg. [Sections] 1.48-1(e)(2). Thus, under section 280B, a structure will include only a building and its structural components and not other inherently permanent structures such as oil and gas storage tanks, blast furnaces, and coke ovens. See Preamble, Prop. Reg. [Sections] 1.28OB-1, 1996-34 I.R.B. 27, 28.

(33) 1992-2 C.B. 57.

(34) The Institute's comments in response to Notice 96-7 relating to the costs to expand an existing business (e.g., costs related to adding products or services or serving additional geographic markets) will not be repeated here.

(35) Indeed, the legislative history of section 197 confirms that "there is no need at this time to change the federal income tax treatment of self-created intangible assets, such as goodwill that is created through advertising and other similar expenditures." H. R. Rep. No. 11, 103d Cong., 1st Sess. 323 (1993) (emphasis added). The emphasized language "other similar expenditures" is clearly intended to include marketing-related expenditures that are incurred to secure current revenues.

(36) See Sun Microsystems, Inc. v. Commissioner, 1993 T.C.M. (RIA) 93,467. In order to create a long-term contractual relationship with a customer and induce future sales, Sun Microsystems granted long-term stock warrants to a customer. On exercise of the warrants by the customer, the taxpayer deducted the difference between the fair-market value and the warrant price as a sales discount. The IRS disallowed the deduction and capitalized the bargain element of the warrants based, in part, on the theory that the differential constituted an expenditure to create a long-term relationship. The Tax Court disagreed, upheld the taxpayer's deduction of the differential as a sales discount, and found that the immediate benefit of the sales income supported the treatment as a current deduction.
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