Subsidiary’s Nonconforming Inventory Method Will Not Violate Group’s Conformity

In Letter Ruling 200239032, the Service ruled that a parent can compute and report (on its consolidated financial statements) a subsidiary’s inventory method change, to a method different from that of other group members, without violating the Sec. 472(e) and (g) conformity requirements.

Under the facts, the parent, a C corporation, uses the LIFO method for Federal income tax purposes. Its operations are included in consolidated financial statements. Each group member included in the statements files its own separate Federal return and reports its inventory under the LIFO method. A subsidiary wants to change to the FIFO method for both Federal income tax and consolidated financial statement purposes.

Discussion

Even though a taxpayer may elect the LIFO method (as long as it clearly reflects income), Sec. 472(c) requires the taxpayer to then also use LIFO for financial-reporting purposes. This conformity provision was the subject of Insilco Corp., 73 TC 589 (1979), aff’d by unpublished op., 659 F2d 1059 (2d Cir. 1981), nonacq., 1982-2 CB 3, withdrawn, 1987-2 CB 1, in which Insilco’s subsidiaries used the LIFO method for both their separate financial statements and Federal income tax returns. However, in its consolidated financial statements, the parent used a non-LIFO method to report the subsidiaries’ inventories. The Tax Court concluded that the consolidated financial statements issued to shareholders did not violate the Sec. 472(e) LIFO conformity rules.

In response to this decision, Congress enacted Sec. 472(g), which generally provides that any group of corporations "consolidating or combining for purposes of financial statements" is treated as one taxpayer for LIFO-conformity purposes. Thus, under Sec. 472(e) and (g), if a subsidiary uses the LIFO method, the parent must use LIFO for reporting the subsidiary’s inventory in its consolidated financial statements issued to shareholders.

Subsequent to the enactment of Sec. 472(g), the Service addressed the question of whether conformity should apply at the individual group-member level or to the group as a whole. In Rev. Rul. 88-69, a parent filed a consolidated Federal return for itself and its two subsidiaries. For both Federal income tax return and financial-reporting purposes, it reported its inventory and one subsidiary’s inventory using LIFO, but reported the other subsidiary’s inventory using a non-LIFO method. The Service concluded that Sec. 472(g) did not require the parent to report that subsidiary’s inventory in its consolidated financial statements under the LIFO method, if the subsidiary used a non-LIFO method for Federal income tax purposes.

Specifically, it noted:

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 method is the best accounting practice under the circumstances. This will be true even if the taxpayer conducts one or more other trades or businesses for which it uses the LIFO method 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).

The Service applied the rationale of Rev. Rul. 88-69 to the facts in the letter ruling to conclude that the subsidiary may change to the FIFO method without violating the conformity requirement. The fact that other group members filing consolidated financial statements use the LIFO inventory method does not preclude the subsidiary from changing to another method for both Federal income tax and financial-statement-reporting purposes.

Implications

Letter Ruling 200239032 illustrates the continuing validity of Rev. Rul. 88-69. In addition, it shows the importance of considering the effect of the conformity rules when seeking a change involving a taxpayer using, or wanting to change to, the LIFO inventory method.

From Diane P. Herndon, Washington, DC