Rev. Rul. 78-352

Whether the gas in the taxpayer's pipeline is merchandise in transit that must be included in inventory.

FACTS

The taxpayer is a regulated public utility that derives part of its income from the sale of natural gas. By means in the present situation. All the gas the of a pipeline distribution system the taxpayer obtains gas from an independent supplier and then delivers the gas to its customers. The taxpayer obtains title to the gas from its supplier as the gas crosses the state line in the pipeline. The taxpayer's customers obtain title to the gas as it is consumed, based on meter readings. The taxpayer always has a supply of gas in the pipeline.

LAW AND ANALYSIS

The applicable section of the Internal Revenue Code of 1954 and Income Tax Regulations are 471 and 1.471-1 pertaining to when inventories are required in order to clearly reflect income.

Section 1.471-1 of the regulations provides that in order to clearly reflect income, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. It further provides that merchandise should be included in inventory only if title thereto is vested in the taxpayer, and should exclude from inventory goods sold and title to which has passed to the purchaser.

Rev. Rul. 68-620, 1968-2 C.B. 199, is concerned with an interstate gas transmission company that sells gas to distributors for further resale to customers. The taxpayer maintained a certain volume of gas in its pipeline at all times. This volume of gas referred to as a "line pack" was treated as an expense item and never included in inventory at the end of the year. Because the "line pack" is an integral part of the merchandise available for sale to customers, Rev. Rul. 68-620 concludes that the "line pack" is merchandise in transit and must be included in the taxpayer's inventory pursuant to section 1.471-1 of the regulations.

The principles of Rev. Rul. 68-620 are also applicable to the distribution taxpayer sells must be delivered through its distribution system. The gas presently in the system is constantly being moved to customers for consumption and is being replaced by new gas delivered by the taxpayer's supplier. The fact that the taxpayer needs a basic supply of gas to operate should not relieve it of its obligation to inventory its goods held for sale in the ordinary course of its business.

HOLDING

Because the gas retained in the pipeline is purchased by the taxpayer for resale and title is vested in the taxpayer, the gas must be included in the taxpayer's inventory.

Any change in the taxpayer's treatment of the gas in the pipeline to including it in inventory is a change in accounting method to which sections 446 and 481 of the Code apply.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 68-620 is amplified.