Notice 2009-25

This notice invites public comments on how certain business practices in the retail industry have changed since the promulgation of the uniform capitalization regulations under § 263A of the Internal Revenue Code in the 1990s and whether certain definitions under the regulations should be modified in light of current business practices.

Section 263A, enacted by the Tax Reform Act of 1986, Public Law No. 99-514, 100 Stat. 2085, requires taxpayers to capitalize the direct and indirect costs properly allocable to (1) certain real property and tangible personal property produced by the taxpayer; and (2) real property and certain personal property that is acquired by the taxpayer for resale. Section 1.263A-1(e) of the Income Tax Regulations provides that resellers must capitalize the acquisition cost of property acquired for resale, as well as certain indirect costs that are properly allocable to property acquired for resale. Section 1.263A-3 sets forth detailed rules with respect to the proper treatment of purchasing, handling, and storage costs, which are the indirect costs most often incurred by resellers. Section 1.263A-3 was promulgated in 1993 and last amended in 1994.

The IRS and Treasury Department recognize that the retail industry has changed over the last fifteen years due to advancements in technology and service innovations. As a result of these changes, certain provisions in the regulations under § 263A, particularly in § 1.263A-3, may not take into account some present-day retail business practices; therefore, the existing regulations may have unintended consequences for some retailers.

More specifically, a significant number of retailers that sell merchandise directly to retail customers in on-site sales also sell merchandise from their sales facilities over the internet and by fax. The existing definitions of on-site storage facility, retail sales facility, on-site sales, and dual-function storage facility under § 1.263A-3(c)(5)(ii) did not contemplate the current volume and types of internet and fax sales that retailers transact from their sales facilities. An on-site storage facility is defined as a storage or warehousing facility that is physically attached to, and an integral part of, a retail sales facility. A retail sales facility is defined as a facility where a taxpayer sells merchandise exclusively to retail customers (final purchasers of the merchandise) in on-site sales. On-site sales are defined as sales made to retail customers physically present at a facility. A dual-function storage facility is defined as (1) a storage facility that serves as both an off-site storage facility (a storage facility that is not an on-site storage facility) and an on-site storage facility, or (2) any facility where sales are made to retail customers in on-site sales and to either (a) retail customers in sales that are not on-site sales, or (b) other customers.

Using the above definitions, certain retailers must treat facilities that would otherwise be treated as retail sales facilities and on-site storage facilities as dual-function storage facilities because internet and fax sales generally are not made to retail customers physically present at the facility and thus generally are not considered on-site sales. Retailers that operate dual-function storage facilities generally must capitalize a portion of their handling and storage costs based on the ratio of gross sales of the facility that are not on-site sales to total gross sales of the facility. See § 1.263A-3(c)(5)(iii)(B).

Similarly, retailers that enter into arrangements to lease their merchandise to customers and then sell the merchandise in conjunction with the underlying lease contracts to third-party finance companies are required to treat facilities that would otherwise be treated as retail sales facilities and on-site storage facilities as dual-function storage facilities because the retailers sell some merchandise to third-party finance companies that are not retail customers. Retailers that engage in these types of transactions also may be required under § 1.263A-3(c)(5)(iii)(B) to capitalize a portion of their handling and storage costs based on the ratio of gross sales of the facility that are not on-site sales to total gross sales of the facility.

The IRS and Treasury Department request comments concerning the following issues:

1. How have changed retail business practices, including those resulting from technological advances and current trends, affected the application and administrability of the existing regulations under § 263A to retailers that transact both on-site sales and sales that are not on-site sales from the same sales facility? The IRS and Treasury Department would like to receive descriptions of both common and unique retail business models, operations, and practices, where retailers conduct on-site sales as well as internet or fax sales at a sales facility. The IRS and Treasury Department would also like examples of other types of sales that do not meet the existing definition of on-site sales.

2. How, if at all, should the definitions of on-site sales, a retail customer, a retail sales facility, a dual-function storage facility, and other terms in § 1.263A-3(c)(5)(ii) be modified to reflect current business practices of retailers that transact both on-site sales and sales that are not on-site sales from the same sales facility?

Comments should be submitted in writing on or before July 13, 2009, and should include a reference to Notice 2009-25. Send submissions to: CC:PA:LPD:PR (Notice 2009-25), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2009-25), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, comments may be submitted electronically directly to the IRS via the following e-mail address: Notice.comments@irscounsel.treas.gov. Please include “Notice 2009-25” in the subject line of any electronic communication. All materials submitted will be available for public inspection and copying.

The principal author of this notice is Kari Fisher of the Office of the Associate Chief Counsel (Income Tax and Accounting). For further information concerning this notice, contact Ms. Fisher at (202) 622-4970 (not a toll-free number).