SECTION 4. SCOPE

.01 Except as provided in sections 4.03 and 4.04 of this revenue procedure, the

use of the service warranty income method is available to any accrual method manufacturer, wholesaler, or retailer of motor vehicles or other durable consumer goods with respect to qualified advance payment amounts received on service warranty contracts:

(1) that are fixed-term service arrangements with respect to a motor vehicle or other durable consumer good purchased by a customer;

(2) that are separately priced, such that customers have the option to purchase the service warranty contracts for an expressly stated amount separate from the price of the underlying motor vehicle or other durable consumer good;

(3) for which the service period begins in the taxable year the advance payment is received or upon expiration of a fixed-term manufacturer’s warranty beginning in the taxable year the advance payment is received;

(4) for which the taxpayer purchases a policy that constitutes insurance for federal income tax purposes from an unrelated third party to insure its obligation under the service warranty contract; and

(5) for which the taxpayer makes payment to the unrelated third party insurer within 60 days after receipt of the advance payment for the entire amount of the insurance costs associated with the policy insuring its obligations under the service warranty contract.

.02 For purposes of section 4.01 of this revenue procedure, a service warranty contract will be treated as a fixed-term arrangement even if the contract provides for a reasonable mileage or other usage cap that is generally commensurate with average consumer mileage or usage over the term of the contract and which causes termination of the fixed-term arrangement when exceeded. Also for purposes of section 4.01 of this revenue procedure, a taxpayer has not made payment to an unrelated third party insurer if the taxpayer and the payee are related persons within the meaning of § 267(b) or 707(b)(1). .03 A taxpayer is not within the scope of this revenue procedure unless the taxpayer either (1) has never previously received advance payments under service warranty contracts prior to the taxable year of an adoption under this revenue procedure, or (2) uses the proper method

1997–33 I.R.B. 43 August 18, 1997

.04 Applicable interest rate. The applicable interest rate to be applied to the qualified advance payment amount received for a particular contract in a particular taxable year under the service warranty income method is the applicable federal rate in effect for purposes of § 1274(d) (compounded annually) for the month with or within which the taxable year ends. For purposes of this revenue procedure, the applicable federal rate is rounded to the nearest full percent (or if a multiple of 1/2 of 1 percent, such rate shall be increased to the next highest full percent).

.05 Effects of the imputed income. Any income imputed on a qualified advance payment amount under this service warranty income method must not be taken into account for any purpose under the Internal Revenue Code other than the determination of a taxpayer’s income. Thus, for example, the income imputed on a qualified advance payment amount may not increase the basis of any asset held by the taxpayer and may not be recovered as a deduction in any taxable year. Additionally, any income imputed on a qualified advance payment amount may not be taken into account, for example, in determining:

(1) the earnings and profits of any corporation under § 312;

(2) the adjustments to a shareholder’s stock basis in an S corporation under § 1367;

(3) the adjustments to a partner’s interest in a partnership under § 705; or

(4) the investment adjustments (or adjustments to an excess loss account) under § 1.1502–32 of the Income Tax Regulations with respect to the stock of any consolidated group member owned by another member of the group.

.06 Special rules for customer cancel- lations of service warranty contracts and terminations of service warranty con- tracts because of mileage or usage limita- tions.

(1) Customer cancellations. If a customer cancels a service warranty contract during the taxable year of sale and, in that year, receives a refund of amounts paid, the amount refunded is not included in the taxpayer’s income for the year of the sale. If a customer cancels a service warranty contract after the year in which the taxpayer sold the contract, the taxpayer must

of accounting for advance payments under its service warranty contracts ( see Schlude v. Commissioner, 372 U.S. 128 (1963), 1963–1 C.B. 99).

.04 A taxpayer also is not within the scope of this revenue procedure unless the taxpayer uses the proper method of accounting for amounts paid or incurred for insurance costs that cover the taxpayer’s risks under service warranty contracts. See section 5.03 of the APPENDIX of Rev. Proc. 97–37 for a description of that proper method.