SECTION 2. BACKGROUND

.01 In both Hewlett-Packard Co.. v. United States, 71 F.3d 398 (Fed. Cir. 1995), rev’g Apollo Computer, Inc. v. United States, 32 Fed. Cl. 334 (1994), and Honeywell, Inc. v. Commissioner, T.C. Memo. 1992–453, aff’d per curiam, 27 F.3d 571 (8 ^th Cir. 1994), the courts held that the taxpayers properly treated their pools of rotable spare parts as depreciable assets, rather than as inventory. The taxpayers in Hewlett-Packard and Honeywell were engaged in the trade or business of manufacturing computers and computer parts, and also in the business of repairing and servicing computers purchased or leased by their customers. Most of the taxpayers’ computer maintenance operations were conducted pursuant to standardized maintenance agreements that obligated the taxpayers to provide all parts and labor, product upgrades, preventive maintenance, and telephone assistance necessary to keep a customer’s computer

operational for the duration of the contract (usually one year) in exchange for a predetermined fee. In conducting their computer maintenance operations, the taxpayers sent repair technicians to a customer’s location to diagnose and repair the customer’s computer. The taxpayers’ repair technicians used a supply of rotable spare parts to diagnose problems in a customer’s equipment, and then would exchange a working part for any malfunctioning part. The malfunctioning part removed from the customer’s equipment would then be repaired and placed in the taxpayers’ rotable spare parts pools for continued use in the maintenance operation. The taxpayers followed this practice of exchanging their rotable spare parts for malfunctioning parts in a customer’s computer to avoid rendering a customer’s computer inoperative while the original part was being repaired.

The parts in the taxpayers’ rotable spare parts pools were obtained from the taxpayers’ manufacturing facilities. However, the taxpayers operated their computer maintenance operations separate from their manufacturing operations and at all times the rotable spare parts were physically segregated from the taxpayers’ regular manufacturing inventories.

.02 In Rev. Rul. 2003–37, the Internal Revenue Service announced that it will follow the judgments in Hewlett-Packard and Honeywell, and that a taxpayer may treat rotable spare parts as depreciable assets, provided the taxpayer’s facts are substantially similar to the facts in those cases.

.03 The Service and Department of the Treasury are aware that the treatment of rotable spare parts as depreciable assets has continued to be the subject of controversy in situations when a taxpayer, as part of its maintenance operations, sells rotable spare parts from the taxpayer’s pool of rotable spare parts that are treated as depreciable assets. For reasons of administrative convenience, and to reduce further controversy, if a taxpayer within the scope of this revenue procedure maintains one or more pools of rotable spare parts that it treats as depreciable assets and sells rotable spare parts from these pools, the Service will not challenge the taxpayer’s treatment of the pools of rotable spare parts as depreciable assets for a particular taxable year if, for that year, the taxpayer uses

2007–29 I.R.B. 110 July 16, 2007

property (as set forth in § 168(e)) in which the rotable spare parts are included, or (b) the rotable spare parts are required to be depreciated under the alternative depreciation system in § 168(g). Rotable spare parts required to be depreciated under the alternative depreciation system include rotable spare parts in a class of property (as set forth in § 168(e)) for which the taxpayer made a timely valid election under § 168(g)(7). In addition, the applicable recovery period for the rotable spare parts is determined under § 168(c) or 168(g), as applicable, by including the rotable spare parts in the following asset class of Rev. Proc. 87–56:

(a) the asset class in Rev. Proc. 87–56 applicable to the taxpayer’s manufacturing activity if the taxpayer, under warranty or maintenance agreements, repairs only customer-owned (or customer-leased) equipment that is manufactured only by the taxpayer; or

(b) asset class 57.0, Distributive Trades or Services, if: (i) the taxpayer, under warranty or maintenance agreements, repairs both customer-owned (or customer-leased) equipment that is manufactured by the taxpayer and customer-owned (or customer-leased) equipment that is manufactured by others; (ii) the taxpayer is not a manufacturer of the type of customer-owned (or customer-leased) equipment that is being repaired; or (iii) the taxpayer (including a taxpayer described in section 4.03(1)(a) of this revenue procedure) charges the customer a nominal service fee (that is unrelated to the actual cost of parts and labor provided) to repair customer-owned (or customer-leased) equipment under warranty or maintenance agreements.

(2) Additional first year depreciation deduction . In determining the amount of the § 481(a) adjustment as described in section 5.04 of this revenue procedure, the additional first year depreciation deduction allowable under § 168(k), 1400L(b), or 1400N(d) is taken into account for any qualifying rotable spare part. However, the deemed placed-in-service date referred to in section 5.04(2)(b) of this revenue procedure for the rotable spare part is not the acquisition date of the rotable spare part for purposes of the acquisition date requirement in § 168(k), 1400L(b), or 1400N(d).

.08 Section 446(e) and § 1.446– 1(e)(2)(i) state that, except as otherwise 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 limitations, terms, and conditions necessary to obtain the Commissioner’s consent to effect the change in method of accounting and to prevent amounts from being duplicated or omitted. The terms and conditions the Commissioner may prescribe include the year of change, whether the change is to be made with a § 481(a) adjustment or on a cut-off basis, and the § 481(a) adjustment period.

.09 Rev. Proc. 2002–9, 2002–1 C.B. 327 (as modified and amplified by Rev. Proc. 2002–19, 2002–1 C.B. 696, modified and clarified by Announcement 2002–17, 2002–1 C.B. 561, and amplified, clarified, and modified by Rev. Proc. 2002–54, 2002–2 C.B. 432), provides procedures by which a taxpayer may obtain automatic consent to change to a method of accounting described in the Appendix of Rev. Proc. 2002–9.

.10 Section 481(a) requires adjustments necessary to prevent amounts from being duplicated or omitted by reason of a change in method of accounting.