SECTION 2. BACKGROUND

.01 In General. (1) Remanufacturers acquire inventories of used motor vehicle parts ( e.g., wiper motors, engines, transmissions, and alternators for automobiles, trucks, buses, etc.) for use in remanufacturing. These used parts are frequently referred to within the remanufacturing industry as “cores.” Remanufacturers rebuild motor vehicle parts from cores through use of new and used component parts and sell the resulting products as remanufactured replacement parts. Resellers acquire cores in conjunction with their resale activity and sell the cores to a remanufacturer or another reseller in the distribution chain.

(2) Remanufacturers and resellers acquire cores from customers (“customer cores”) who purchase remanufactured replacement parts. To encourage a customer to return the core, remanufacturers and resellers generally offer the customer a credit (offset against the purchase price). Remanufacturers and resellers also acquire cores from third-party suppliers of cores (businesses that specialize in supplying cores to meet specific needs, referred to within the industry as “core suppliers” or “core brokers”) and occasionally acquire cores directly from other sources.

(3) Controversy exists as to the proper market valuation of cores under the LCM method. See Consolidated Manufactur- ing, Inc. v. Commissioner, 249 F.3d 1231 (10 ^th Cir. 2001), rev’g in part, 111 T.C. 1 (1998). In order to reduce controversy and minimize disputes, the Service has determined that it is appropriate to provide a safe harbor procedure for the LCM valuation of cores in inventory.

.02 Section 471 of the Internal Revenue Code, which governs the treatment of inventories, provides two tests to which each inventory must conform: (1) it must conform as nearly as may be to the best accounting practice in the trade or business; and (2) it must clearly reflect income. Section 1.471–2(c) of the Income Tax Regulations provides that the bases of valuation most commonly used by business concerns and which meet the requirements of § 471 are (1) cost and (2) cost or market,

2003–6 I.R.B. 445 February 10, 2003

F.3d 1231 (10th Cir. 2001), aff’d on this is- sue, 111 T.C. 1 (1998).

(2) Service may redetermine appropri- ate cost. As a general rule, the taxpayer must follow the form that the taxpayer used for the transaction. See, for example, In re Steen, 509 F.2d 1398, 1402 n.4 (9th Cir. 1975) and Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967). If the Service determines, however, that the taxpayer’s use of the credit amount as the invoice price does not clearly reflect income (for example, because the taxpayer artificially inflated both the price of the remanufactured core and the credit amount solely to manipulate gross receipts for tax avoidance), the Service may examine the substance of the transaction to determine the appropriate cost for a core. See, for example, Gregory v. Helvering, 293 U.S. 465, 55 S. Ct. 266, 79 L. Ed. 596 (1935). .03 Determination of Market Value. (1) In general . Under the CAV method, the market value under § 1.471–4 of each core in ending inventory is the “allowable supplier price” adjusted, as appropriate, for other direct and indirect costs properly allocable to the core as described in §§ 1.471–4 and 1.263A–1. The allowable supplier price will be considered to be the replacement cost for purposes of §§ 1.471–4 and 1.263A–1.

(2) Allowable supplier price. For purposes of this revenue procedure the “allowable supplier price” is the amount the taxpayer would pay in an arm’s length transaction to acquire a particular core from a core supplier or core broker, plus the related transportation cost that would be incurred to acquire possession of the core from the core broker or supplier at yearend. If the taxpayer has purchased a particular type of core from several core suppliers or core brokers during the tax year, the allowable supplier price for that core type will be deemed to be the weightedaverage price, including transportation cost, the taxpayer would have to pay in an arm’s length transaction to acquire the particular core type at year-end from the core suppliers or core brokers from whom the cores were purchased during the tax year. If the taxpayer has not purchased a particular core type from a core supplier or core broker during the tax year, the taxpayer must identify its largest (in dollar terms) supplier of cores during the current tax year that also sells the particular core type in the ordi

those costs, including but not limited to the cost of purchasing, handling, and storage activities conducted by the taxpayer, both prior to and subsequent to acquisition or production of the goods.

.05 Section 1.471–4(c) provides that if inventory is valued upon the basis of cost or market, whichever is lower, the market value of each article on hand at the inventory date shall be compared with the cost of the article, and the lower of such values shall be taken as the inventory value of the article.

.06 Section 1.471–2(f) provides deducting from inventory a reserve for price changes, or an estimated depreciation in the value of the inventory, is not in accord with the regulations underlying § 471.

.07 Section 472(b) and § 1.472–2 require taxpayers using the last-in, first-out (LIFO) method to inventory their goods at cost.

.08 Section 446(e) and § 1.446–1(e)(2)(i) require that, except as otherwise expressly provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446– 1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the terms and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting in accordance with § 446(e).