Depreciation, capitalization of precious metals used in manufacturing

Depreciation, capitalization of precious metals

The IRS today released an advance version of Rev. Rul. 2015-11 that examines three factual situations involving the use of precious metals in manufacturing, and concludes that:

Related content

  • The capitalized cost of the portion of unrecoverable precious metals that is used in various manufacturing processes is depreciable under sections 167 and 168.
  • However, the capitalized cost of the portion of a precious metal that is recoverable and can be reused is not depreciable under section 167 and 168.

 

Read the text of Rev. Rul. 2015-11 [PDF 27 KB]

Three situations considered

The three factual situations examined in Rev. Rul. 2015-11 are as follows:

  • In Situation 1, the taxpayer—a contract jeweler—fabricates jewelry to customers’ specifications using gold supplied by the customers. The taxpayer fashioned sample gold jewelry items, to display currently available jewelry styles. These samples are not held for sale. Every three years, the taxpayer melts down the sample jewelry, recovering 100% of the gold content of the jewelry, and uses it to fashion new sample jewelry items. The recovered gold is indistinguishable from any other gold of jewelry quality.
  • In Situation 2, the taxpayer is a petroleum refiner. As part of its refining process, the taxpayer uses a catalyst or “prills” fabricated from platinum and other chemicals. Based on its engineering studies, the taxpayer determines that approximately 10% of the platinum initially used to fabricate prills is lost over the reasonably expected useful life of the platinum in the refining process. The remaining 90% is recoverable and becomes available for other uses.
  • In Situation 3, the taxpayer manufactures flat glass using the float manufacturing process involving the use of molten tin. During the manufacturing process, the tin declines in purity and volume due to chemical reactions and vaporization. Additional tin is added, as needed, to maintain the level required for the production of the glass. After approximately seven years, all of the original tin is lost due to chemical reactions and vaporization. The taxpayer capitalizes the cost of the initial tin installed in the tin bath.

Background

Property is depreciable, under section 167, if it is subject to exhaustion, wear and tear, or obsolescence, and has a determinable estimated useful life.

The IRS had previously ruled on the depreciation treatment of precious metals used in situations similar to those in Rev. Rul. 2015-11.

In Rev. Rul. 75-491, the taxpayer placed a specific amount of molten tin in service in a glass production process. About 10% of the tin was lost each year, and was replaced. The IRS characterized the original amount of tin as a fungible commodity that did not lose its identity, did not suffer exhaustion, wear and tear, or obsolescence. It ruled that the tin was not depreciable. The IRS did allow a current deduction under section 162 for the amount of tin that was consumed each year (and replaced with other, fungible tin).

Rev. Rul. 90-65 addressed two situations. The first situation was the same as Situation 1 in today’s revenue ruling. The IRS said that the gold in the jewelry should be accounted for separately from the other physical portions of the jewelry because it represented more than 50% of the cost of the item and was recoverable. The IRS ruled that the gold was not depreciable because the utility of the gold did not diminish as a result of its fabrication into sample jewelry, and could not be considered to suffer exhaustion, wear and tear, or obsolescence. The other items and costs of producing the sample jewelry could be depreciated separately.

The second situation in Rev. Rul. 90-65 dealt with platinum used as a catalyst in prills, similar to Situation 2 in Rev. Rul. 2015-11. Approximately 15% to 20% of the platinum was lost during use as a catalyst. The spent catalyst is sent to a reclaimer, where approximately 80% to 85% of the platinum initially contained in the prills is recovered and refabricated into prills. The IRS noted that the platinum represented more than 50% of the cost of the item and was recoverable, so it needed to be accounted for separately from the rest of the prill. The IRS characterized the platinum similarly to the tin in Rev. Rul. 75-491, as nondepreciable, and said the cost of any replacement platinum could be currently deducted.

Several court decisions over the years applied different analyses of the tax treatment of precious metals than had the IRS. The Eighth Circuit in a 2003 decision (O’Shaughnessy v. Commissioner) allowed molten tin in a situation similar to Rev. Rul. 75-491, to be depreciated. The Fifth Circuit in a 1985 case (Arkla, Inc. v. United States) held that cushion gas used in a pipeline could be depreciated if it would be permanently kept in the pipeline, even though it would not deteriorate or be exhausted, but that any recoverable cushion gas was not depreciable.

Rev. Rul. 2015-11

In today’s revenue ruling, the IRS adopted a factual analysis approach, generally following the approach applied by the Eighth Circuit and the Fifth Circuit. Because the factual analysis approach permits depreciation of initial installations of certain precious metals, the IRS abandoned the standard provided by Rev. Rul. 90-65 concerning whether the cost of the precious metals is more than half the cost of the overall fabricated property. Accordingly, Rev. Rul. 90-65 is revoked.

The IRS also revoked Rev. Rul. 75-491, abandoning the rationale that the cost of precious metal that replenished the original amount was a current deduction.

Therefore, the IRS reached the following conclusions in Rev. Rul. 2015-11:

  • In Situation 1, the gold used to manufacture sample jewelry can be recovered and reused by the taxpayer in a manner that is indistinguishable from other gold that has never been fabricated, used, and recovered. The utility of the gold does not diminish as a result of its having previously been fabricated into sample jewelry. Accordingly, the cost of the gold in the sample jewelry is not subject to exhaustion, wear and tear, or obsolescence and as a result, is not depreciable.
  • In Situation 2, approximately 10% of the platinum is lost over the course of its expected useful life and is not recoverable for reuse. Accordingly, the IRS considered that portion of the platinum to be subject to exhaustion, wear and tear, or obsolescence over a determinable useful life, and ruled that the taxpayer may depreciate the capitalized cost of that portion of the platinum under section 167 and 168. The platinum that is recoverable for reuse may not be depreciated.
  • In Situation 3, all of the original tin used in the glass manufacturing process is lost due to chemical reactions and evaporation after about seven years. Therefore, all of the original tin will undergo exhaustion, wear and tear, or obsolescence over a determinable useful life, and the taxpayer may depreciate the capitalized cost of all the entire original tin under sections 167 and 168.

Change in method of accounting

Today’s revenue ruling provides that any change in a taxpayer's treatment of the cost of precious metals to conform with Rev. Rul. 2015-11 is a change in method of accounting that must be made in accordance with sections 446 and 481 and the related regulations and applicable administrative procedures. This would generally be allowed as an automatic accounting method change. The amount of the section 481(a) adjustment must account for the proper amount of the depreciation allowable that is required to be capitalized under any provision of the Code (for example, section 263A) as of the beginning of the year of change.

© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.

Connect with us

 

Request for proposal

 

Submit

KPMG's new digital platform

KPMG International has created a state of the art digital platform that enhances your experience, optimized to discover new and related content.