May, 2001
CONTACT: William Gager
(703) 968-2772
gager@BuyReman.com

Appeals Court Says No to IRS Core Valuation

Washington DC – In a unanimous decision, a three judge panel of the United States Court of Appeals for the Tenth Circuit validated the rebuilding industry position that the core supplier price for a core is the proper measure of its value for tax accounting purposes.

In a succinct and well-reasoned opinion the Court dismissed the IRS position that the only proper inventory value for a customer core is the core credit given to the customer when it returns the core and held that the core supplier price was the true indication of the market value of the core. The decision was rendered in the case of Consolidated Manufacturing, Inc. v Commissioner of Internal Revenue.

The core valuation issue arose in the early nineties when the U.S. Internal Revenue Service decided that it didn’t approve of the way rebuilders were valuing the cores they took back from customers when determining their income tax. Although practices varied throughout the industry, customer cores were generally valued at the price the core could be bought from a core supplier or less. However, IRS insisted that the only proper value was the core credit that the rebuilder allowed his customer when the core was returned, even though that figure bore no relation to the actual value of the core and was an artificial amount determined solely by the rebuilder.

IRS audited Consolidated’s tax returns for 1990 and 1991 and found that it owed tax for those years, in part because it had valued its customer core inventory at a value less than the core credit given to its customers for those cores. Consolidated fought this decision through the IRS appeals process and the U.S. Tax Court without success. Consolidated decided to make one last appeal to the Tenth Circuit and its persistence was rewarded.

The Appeals Court could not have been stronger in its support of the industry position. Because most rebuilders value their core inventory for tax purposes by using a valuation method which allows them to use the lower of the cost of the core or its market price, the issue before the court was whether the customer core credit was the true measure of both the cost and the market price for the cores.

While the Appeals Court affirmed the Tax Court’s finding that the customer credit was the true cost of the core, it reversed the Tax Court on the market value issue by holding that the customer credit was not the market price of the core for tax purposes.

The Appeals Court rejected the IRS position that the market price for a customer core could only be determined in the "market" between the rebuilder and its customers. Under the law, market price can only be established in an "open" market. The Court held that an open market is "…a freely competitive market in which any buyer or seller may trade and in which prices are determined by competition."

Because the customer core market had only one buyer, the rebuilder, and the seller could only sell a core in that market if he bought a rebuilt part first, the Court found that this was not an open market. After examining the core supplier market it decided that "[t]he market price of a used core, its replacement cost, should be determined by looking to the price that Consolidated would have to pay a professional supplier, not the price that it would pay to a customer."

The Automotive Parts Rebuilders Association has been at the forefront of the fight with IRS over the core issue since 1994. APRA, with the support of the Automotive Engine Rebuilders Association (AERA) and the Production Engine Remanufacturer’s Association (PERA), has spent much time promoting rebuilder concerns about valuation to IRS policymakers and attempting to negotiate an acceptable solution to the valuation problem with them. Unfortunately, IRS was not receptive to any compromise on the issue.

"This is a great victory for all rebuilders," says APRA’s General Counsel, Michael Conlon. "We hope that this decision will finally put an end to the IRS attempting to change established industry practices in this area. The industry should be grateful for the hard work and persistence of Consolidated and its attorneys, especially because of the unyielding and uncompromising position which the IRS took on this issue. And the decision also is a fitting reward for the efforts of all the rebuilders and their trade associations who spent countless hours developing the information and arguments to support this case and the industry position."