Accounting Methods & Periods

Service Updates Automatic Approval Procedures for Accounting-Period Changes

In Rev. Proc. 2006-45, the Service updated its automatic consent procedures for certain eligible corporations to change their annual accounting periods. The procedure clarifies, modifies, amplifies and supersedes Rev. Proc. 2002-37, and is generally effective for accounting-period changes for which the first effective year ends after Oct. 17, 2006.

Overview

Rev. Proc. 2006-45 makes several changes to Rev. Proc. 2002-37, addressing eligibility, terms and conditions, and filing requirements. In dealing with eligibility for automatic consent, it includes the following changes:

A passthrough entity (as well as a controlled foreign corporation (CFC)) that does not have a required tax year, is disregarded solely for purposes of determining whether a corporation owns an interest in a passthrough entity or CFC in applying certain scope limits under Rev. Proc. 2006-45.

Neither an S corporation nor a terminating S corporation is eligible for automatic consent under Rev. Proc. 2006-45. An S corporation seeking automatic approval to change its accounting period should follow Rev. Proc. 2006-46.

A corporation that leaves a consolidated group before the end of the short period effecting a change in tax year by the consolidated parent cannot obtain automatic consent to change its tax year using Rev. Proc. 2006-45. The procedure also clarifies that a consolidated group consists of the parent and any subsidiary that is a member of the group on the last day of the short period required to make the change in tax year.

A consolidated group member changing to or from a 52-53-week tax year is not eligible for automatic consent for such change, unless the requested year is identical to the consolidated group’s tax year.

A CFC is generally ineligible for automatic consent, unless (1) it does not have a required tax year under Sec. 898; (2) it is changing to a required tax year, a 52-53-week tax year referencing such required year, the one-month deferral year or a 52-53-week year referencing the one-month deferral year; or (3) for post-July 10, 1989 tax years of the CFC, no U.S. shareholder has been required to include subpart F income.

Terms and Conditions

Rev. Proc. 2006-45 also revised and clarified certain terms and conditions for receiving automatic consent to change a tax year. These include:

A corporation generally must comply with the terms and conditions for the first effective year, even if it is a short period. However, the book-conformity requirement need not be satisfied for the short period if the corporation is not required to issue financial statements for it, provided the corporation’s financial statements already conform to the requested year or it is concurrently changing its financial accounting year.

The book-conformity requirement does not require a corporation to close and conform books and records that must be maintained for foreign-law purposes on the basis of a different tax year. Similarly, a noncontrolled Sec. 902 corporation is not required to close and conform books and records maintained for foreign-law purposes, whether or not foreign law requires such books and records to be maintained on the basis of a different year.

Although a taxpayer generally must file a return for the tax year the change is to be effective, a CFC or Sec. 902 corporation not required to file Form 1120F, U.S. Income Tax Return of a Foreign Corporation, need not file a first-effective-year tax return.

A corporation that generates a net operating loss or net capital loss during the short period cannot carry back the loss, but generally must carry it forward in accordance with Secs. 172 and 1212 (as applicable). Special rules apply for losses of $50,000 or less, or if the short-period loss is less than the loss generated for the 12-month period that begins with the first day of the short period.

A CFC that revokes its one-month deferral election under Sec. 898 is not eligible to change its tax year (unless to conform to a new required tax year under Sec. 898) during the 48-month period following the first day of the first tax year for which such revocation is effective.

Filing Requirements

Finally, Rev. Proc. 2006-45 clarifies and simplifies the filing requirements for obtaining automatic consent, including:

Generally conforming the filing requirements for CFCs and noncontrolled Sec. 902 corporations to the guidance provided in Temp. Regs. Sec. 1.964-1T(c). The requirements set forth in Temp. Regs. Sec. 1.964-1T(c)(3) must be met; further, the designated shareholder must complete and file Form 1128, Application to Adopt, Change, or Retain a Tax Year, on behalf of the foreign corporation, with its tax return for its tax year with or within which the foreign corporation’s effective year ends. Other controlling U.S. shareholders must also attach a copy of Form 1128 to their returns for the appropriate tax year.

A CFC changing to the required tax year, a 52-53-week tax year referencing such required year, the one-month deferral year or a 52-53-week year referencing the one-month deferral year, is not required to file Form 1128. Instead, the controlling U.S. shareholder must indicate the change in tax year on the Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, filed for the CFC’s first effective tax year.

The due date for filing an application on behalf of a CFC or noncontrolled Sec. 902 corporation is the due date (including extensions) of the filing shareholder’s (or its common parent’s) Federal income tax return for the tax year with or within which the foreign corporation’s effective year ends.

Implications

With the issuance of Rev. Proc. 2006-45, the Service continues to simplify the procedures for corporations to obtain automatic consent to change a tax year. The revisions in Rev. Proc. 2006-45 reflect several issues identified by practitioners and the IRS in applying the procedural guidance in the accounting-period area. Taxpayers should also be aware of the effective date. They may apply the provisions of Rev. Proc. 2006-45 for an effective year ending before Oct. 18, 2006, provided they include the required disclosure and satisfy the procedure’s other requirements.

From Diane Herndon, CPA, Washington, DC