IRS Finalizes Regulations on Inventory Treatment of Sales-Based Royalties and Vendor Chargebacks

Jan. 16, 2014

On Jan. 13, the IRS issued final regulations regarding the capitalization of sales-based royalties and vendor chargebacks received for property produced or purchased for resale. The regulations finalize proposed regulations issued in December 2010. The final regulations apply for tax years ending on or after Jan. 13, 2014.

Under the uniform capitalization rules (UNICAP), the IRS requires manufacturers and resellers to capitalize certain costs to inventory. The proposed regulations suggested that royalty costs incurred for using trademarks or other contractual rights, which were calculated based on the price or quantity of product sold, should be capitalized as an additional UNICAP cost. In response to comments regarding the difficulty of allocating sales-based royalties under UNICAP, the final regulations make optional the capitalization of sales-based royalties.

The final regulations also address the treatment of sales-based vendor chargebacks. Sales-based vendor chargebacks are defined as discounts or rebates to which a taxpayer is unconditionally entitled as a result of selling a vendor’s merchandise to a specific customer at a vendor set price. Under the final regulations, sales-based vendor chargebacks are required to be treated as a reduction to cost of goods sold in the year they are earned.

Changes to comply with the final regulations might result in a change in a taxpayer’s method of accounting for UNICAP costs. Taxpayers should review their current UNICAP method and determine if a change in approach would be required. Taxpayers currently capitalizing sales-based royalties might benefit from making a change to treat all sales-based royalties as a current expense.

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