Inflation can lead to tax savings for automotive suppliers
INSIGHT ARTICLE |
The automotive sector continues to battle rising costs due to inflation and the impact of section 232 tariffs on aluminum and steel, but there may be an unexpected benefit. Last in, first out (LIFO) is an inventory valuation method that assumes the most recently purchased items (that is, the “last in”) placed into inventory are the first sold during the tax year. During periods of inflation and rising costs, this effectively results in allowing the taxpayer to expense the higher cost inventory first, while the lower input costs attached to older inventory remain in ending inventory.
The election to use LIFO is an automatic method change for income tax reporting but, once elected, the LIFO inventory method must also be used in computing income for purposes of reports to shareholders, partners, other proprietors or beneficiaries, as well as for credit purposes (i.e., the LIFO conformity rule). This rule is strictly enforced by the IRS, and violation of this rule could result in the taxpayer being taken off LIFO, resulting in a large taxable gain.
The increase in multinational companies (and foreign ownership of domestic entities) has added to the complexity of satisfying the LIFO conformity rule. LIFO is allowed under U.S. GAAP, but it is not provided for under IFRS. As such, this should raise concern for many automotive suppliers in the United States that are foreign-owned or have foreign operations, and thus report under IFRS rather than U.S. GAAP for financial statement reporting.
To help alleviate conformity issues associated with the disparity in financial reporting standards among countries, the tax regulations do provide an exception to the conformity rule that allows taxpayers to use a method other than LIFO in reports that are considered a “supplement to” or “explanation of” the primary presentation of income, profit or loss. However, specific rules must be met for the information to be considered supplemental and not violate the conformity standard.
Proceed with caution
The LIFO conformity rule requires the primary financial statements to be prepared on a U.S. GAAP and LIFO basis, but supplemental statements (or appendices) can be included in order to disclose IFRS or other non-LIFO conforming financial data. A limited exception to this rule exists when issuing the consolidated financial statements of a foreign-controlled consolidated group with substantial foreign operations.
The conformity guidance is very specific, but tax regulations and multiple IRS rulings exist that provide assistance and explanation on how to issue financial statements to end users that do not violate the LIFO conformity rule. With proper planning and guidance, companies can still satisfy financial reporting requirements and take advantage of LIFO in the current inflationary environment in order to reduce income taxes.
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