Boeing Co. and other manufacturers, particularly those in the aerospace industry, are resisting a tax-law provision that may require them to pay more upfront tax on advance payments for products.
For most companies, the tax accounting change—part of the 2017 tax overhaul—is good news because it allows them to defer, for up to one year, taxes on all or a portion of payments customers make before goods or services are provided.
But for a narrow band of companies—primarily those in the manufacturing industry that produce expensive products like airplanes—it could accelerate the recognition of billions of dollars of income, translating into significantly higher upfront taxes.
Companies generally haven’t disclosed what the tax accounting change could mean for their bottom lines, but for some, “the dollars are very large,” said Alison Jones, a principal in Ernst & Young LLP’s National Tax office in Washington.
Businesses are facing this problem because they have lost the ability to rely on an old set of regulations—Treasury Regulations 1.451-5—that allowed for multi-year deferral in certain cases. The Internal Revenue Service in October 2018 proposed (REG-104872-18) revoking the rules in light of the tax law changes.
Many of the companies pushing back against the tax accounting change got big wins elsewhere in the tax law, including a lower corporate tax rate and a tax break afforded to companies that locate their operations in the U.S. and export goods and services abroad.
The one-year deferral provision, which codifies 2004 guidance, is included in amended tax code Section 451. The provision applies to companies that use the accrual method of accounting, which means they report income in the year it is earned rather than received and deduct expenses in the year they are incurred rather than paid off.
The loss of the multi-year deferral rules hits U.S. manufacturers in the defense, high-tech, and large consumer products industries especially hard, said Ellen McElroy, a partner at Eversheds Sutherland (US) LLP.
Affected companies are seeking regulatory relief or a safe harbor from the Treasury Department. Aerospace manufacturing companies like Boeing and United Technologies Co. have spent tens of thousands of dollars lobbying Treasury on issues that include Section 451, according to recent disclosures.
While not the only sector affected, aerospace is “definitely an industry that has one of the more expensive items that they produce under these advance payment-type arrangements,” Jones said.
In addition to higher upfront taxes, some companies could effectively face a gross receipts tax and permanent losses that they will never be able to use, said a tax lobbyist, who spoke to Bloomberg Tax on the condition of anonymity.
Companies are hoping that their concern will be short-lived and that Treasury will come to their aid.
“They’re hoping somebody can carve something out for them,” Jones said. Proposed guidance on Section 451(c) is currently being reviewed by the Office of Management and Budget’s Office of Information and Regulatory Affairs. The office began its review April 12, according to its website.
Baker & McKenzie LLP has previously said in letters to Treasury that—even absent the old rules permitting multi-year deferral—the new one-year deferral limit shouldn’t apply to payments customers make in advance of receiving aircraft or other products with reasonably certain delivery dates.
In industries like aerospace and defense, “performance obligations are tied to when the product is delivered to a customer,” McElroy said. As such, income hasn’t traditionally—under prior case law and Treas. Reg. 1.451-5—been considered as “earned” until the product is delivered, she said.
In addition, such amounts typically aren’t properly taken into account under financial accounting principles until delivery, Baker & McKenzie has previously said. So excluding them from the one-year tax deferral limit will ensure pre-delivery payments are treated consistently for tax and accounting purposes.
The firm, in support of its argument, has cited cases like a 1968 case, Artnell Company v. Commissioner, where a judge ruled that advance payments a sports team receives for season tickets or single-game tickets for future games should be included in income when earned—when the game is played—rather than when received.
Alexandra Minkovich, of counsel in Baker & McKenzie’s North American Tax Practice, requested an April 29 meeting with the White House’s Office of Information and Regulatory Affairs on behalf of Boeing to discuss the proposed advance payment rules.
Minkovich didn’t respond to a request for comment. United Technologies and Boeing declined to comment.
Companies facing more limited deferral want guidance and clarification that prior case law will continue to apply in situations where there is a set delivery date, said Kathleen Meade, firm director in the National Tax Services group at Baker Tilly Virchow Krause LLP.
McElroy noted that in addition to permitting multi-year deferral in certain cases, Treas. Reg. 1.451-5 also allowed a cost offset when a taxpayer was required to report an advance payment in income prior to delivery of the product.
If Treasury doesn’t provide any leeway in the upcoming proposed regulations, manufacturers will be required to report pre-delivery income in the year of receipt, even though they won’t be able to deduct the cost of goods sold until the year that the product is delivered to customers, she said.
So in addition to a more limited deferral, the mismatch between income and related expenses will grow, she said. “I appreciate that it’s a timing difference, however, when the timing difference is large enough the impact can be significant and it essentially becomes permanent.”
—With assistance from Jorge Uquillas in Washington.