Rev. Rul. 70-83

Advice has been requested whether, under the circumstances described below involving the acquisition of assets of a corporation by another corporation in a transaction described in section 381(a) of the Internal Revenue Code of 1954, section 381(c)(4) of the Code requires that the transferee corporation continue to use the transferor's method of accounting for long-term contracts.

The taxpayer is a calendar year corporation engaged in long-term construction projects. It has consistently and properly reported its income on the completed contract method under section 451 of the Code and section 1.451-3(b)(2) of the Income Tax Regulations. On May 31, 1969, the taxpayer was merged with another corporation, also reporting its income on the completed contract method, in a transaction described in section 381 of the Code. The specific question presented is whether in its final return for the short period ended May 31, 1969, the taxpayer may compute its gains and losses on uncompleted contracts on the percentage of completion method rather than the completed contract method. This would result in a net operating loss for the short period. It has been determined that neither section 269 nor section 482 of the Code should be applied.

Section 381 of the Code provides that in the case of the acquisition of the assets of a corporation by another corporation, in a transaction described therein, the acquiring corporation shall succeed and take into account, as of the close of the day of distribution or transfer, the items described in section 381(c) of the Code of the distributor or transferor corporation, subject to certain conditions and limitations specified in section 381(b) and 381(c) of the Code.

Insofar as here pertinent, section 381(c)(4) of the Code provides that the acquiring corporation shall use the method of accounting used by the distributor or transferor corporation on the date of distribution or transfer.

Section 1.381(c)(4)-1(a)(i)(ii) of the regulations provides, in part, that the acquiring corporation shall take into its accounts the dollar balances of those accounts of the distributor or transferor corporation representing items of income or deduction which, because of its method of accounting, were not required to be included or deducted by the distributor or transferor corporation in computing taxable income for taxable years ending on or before the date of distribution or transfer.

Section 1.381(a)(4)-1(b)(4) of the regulations provides, in pertinent part, that the acquiring corporation is bound by any election made by it or any distributor or transferor corporation with respect to a method of accounting which is in effect on the date of distribution or transfer to the same extent as though the distribution or transfer had not occurred. Where, under other sections of the Code or regulations, a taxpayer is permitted to elect a method of accounting on a project-by-project, job-by-job, or other similar basis the method elected with respect to each project or job shall be deemed to be an established method of accounting only for the project or job for which it is elected and the method of accounting previously elected for each project or job must be continued.

The Committee Reports indicate that in enacting the carryover provisions of section 381 of the 1954 Code Congress clearly intended that the major tax benefits, privileges, elective rights, and obligations of one corporation will carry over to the successor corporation when the assets of two or more predecessor corporations are combined in a tax-free liquidation or reorganization. The successor corporation steps into the "tax shoes" of its predecessor. Senate Report No. 1622, Eighty-third Congress, at page 52. See also House Report No. 1337, Eighty-third Congress, at page 41.

A situation somewhat similar to the instant case exists in Revenue Ruling 67-103, C.B. 1967-1, 117, which holds, in effect, that the Commissioner can change the taxpayer's method of accounting by changing the value of the closing inventory on the last return of the corporation whose assets were transferred. However, the facts in Revenue Ruling 67-103 state, in part, that the taxpayer had been consistently computing its inventories in a manner which did not clearly reflect income. Thus, Revenue Ruling 67-103 is distinguishable from the instant case, because the taxpayer in this case used a method of accounting that is specifically authorized by the regulations and applicable to its trade or business, and, therefore, is considered as clearly reflecting income.

Furthermore, the decision in Standard Paving Company v. Commissioner, 13 T.C. 425 (1949), affirmed 190 F. 2d 330 (1951), certiorari denied 342 U.S. 860, is not applicable to the instant case. Although in that decision the court held that the Commissioner could change the transferor's method of accounting for its final period from the completed contract method to the percentage of completion method in order to clearly reflect income, that decision involved taxable years governed by the Internal Revenue Code of 1939 under which there was no counterpart to section 381 of the 1954 Code, the particular section of the Code involved in the instant case.

Accordingly, in the instant case and under the current Statutes and Regulations, the transferor's method of accounting for long-term contracts may not be changed for the short taxable year prior to the merger. Section 381(c)(4) of the Code requires that the accounting method of the transferor must be used by the transferee so that the transferee reports the gains or losses on the long-term contracts.

Revenue Ruling 67-103, is distinguished.