Financial statements presented using IFRS LIFO conformity rules applied
INSIGHT ARTICLE |
The last-in, first-out (LIFO) method is one of the methods provided by the Internal Revenue Code (IRC) for taxpayers to value their inventories and cost of goods sold. Under LIFO, the inventory most recently acquired or manufactured is treated as having been sold during the year. The major objective of LIFO is to match current replacement costs with current sales. In order to use LIFO for tax purposes, a taxpayer must meet the LIFO conformity requirement under section 472. Specifically, under section 472(c), a taxpayer is prohibited from using a non-LIFO method of inventory to reflect inventory or compute income in a report other than the primary financial statements for the same taxable year. Under section 472(e)(2), the IRS may terminate the taxpayer's use of the LIFO method if the taxpayer uses any method other than LIFO in computing income for purposes of reports to shareholders, partners, other proprietors or beneficiaries, or to creditors in any year subsequent to the first year that the LIFO method is used.1
One of the issues faced by U.S. taxpayers that are now converting to International Financial Reporting Standards (IFRS) for book purposes is that IFRS does not allow the use of the LIFO method for financial reporting purposes. This causes concern with respect to meeting the conformity requirement for financial reporting and tax reporting, as highlighted by a recent legal memorandum from the IRS, FAA 20114702F (released Nov. 25, 2011), which addresses a LIFO taxpayer's provision of IFRS financial statements to a lending bank.
Under the facts of FAA 20114702F, the taxpayer became a wholly owned subsidiary of a consolidated group that filed a consolidated federal tax return. The U.S. consolidated group was wholly owned by a foreign parent that used IFRS to report its worldwide consolidated financial statements. As a result, the taxpayer was required to adopt IFRS and presented financial statements based on international standards to its foreign parent. The taxpayer also presented to its lending bank the IFRS-only balance sheet and income statement without a LIFO methodology. The taxpayer used LIFO to account for inventory for tax and U.S. GAAP financial reporting purposes during the year.
As previously noted, the disclosure of income, profit or loss for a tax year on a balance sheet issued to creditors, shareholders, parents, other proprietors or beneficiaries is considered at variance with the LIFO conformity requirements if such income information is (1) ascertained using an inventory method other than LIFO; and (2) is for a tax year for which the LIFO method is used for federal income tax purposes.2 However, a disclosure of income, profit or loss using an inventory method other than LIFO is not at variance if it is made in the form of either a footnote to the balance sheet or a parenthetical disclosure on the face of the balance sheet.3
The IRS concluded in FAA 20114702F that the taxpayer violated the LIFO conformity requirement by using an inventory method other than LIFO on financial statements that were not labeled as supplements to or explanations of the taxpayer's primary position. When it presented its financial statements to the foreign parent, it included amounts based on IFRS and adjustments used to arrive back at U.S. GAAP amounts. These same financial statements were presented to the lending bank for credit purposes. In addition, the financial statements did not meet any of the exceptions listed in Reg. section 1.472-2(e).
Even though the U.S. financial reporting system has not converted to IFRS, companies with foreign parents may be required to terminate their LIFO elections as a result of a required conversion to IFRS if an exception to the LIFO conformity requirement is not met, as illustrated by FAA 20114702F. It is important to note, however, that other exceptions to the LIFO conformity requirement are available in addition to the ones listed in Reg. section 1.472-2(e). See, e.g., Rev. Rul. 78-246 (holding that a U.S. subsidiary does not violate the LIFO conformity requirement by the issuance of consolidated financial statements on a non-LIFO basis by the foreign parent, as long as the foreign parent owns (either directly or indirectly through consolidated group members) operating assets of substantial value which are used in foreign operations).4
1See also, Reg. sections 1.472-2(e) and (g), which essentially restate the requirements of sections 472(c) and (e)(2).
2 See Reg. section 1.472-2(e).
3See Reg. sections 1.472-2(e)(3) and (e)(4).
4 For purposes of this test, operating assets are considered to be of substantial value if they constitute 30 percent or more of the total operating assets of the consolidated group, as determined annually and based on the asset valuation reflected in the consolidated financial statements of the group for the year. See also, PLRs 8707021 and 8621014. Under the exception to the conformity requirement provided by Rev. Rul. 78-246, a U.S. subsidiary may be able to use LIFO if its foreign parent issues non-LIFO consolidated financial statements as long as the requirements of Rev. Rul. 78-246 are met. However, the exception will not apply if the U.S. subsidiary issues standalone financial statements on an IFRS basis. In addition, the exception provided by Rev. Rul. 78-246 will not apply to the foreign subsidiary of a U.S. parent. See Rev. Rul. 89-41.