Analysis Found in 2002 PLR Represents Proper Treatment of ERP Software Costs in the View of the IRS Chief Counsel's Office

The IRS took the interesting step of formally “blessing” a private letter ruling as “still valid” with regard to other taxpayers in Chief Counsel Advice 201549024.  That is interesting because a private letter ruling is only binding with regard to the taxpayer who requested it, but it illustrates the fact that this “somewhat but not quite formal” guidance is still important to understand.

The issue in this case relates to how enterprises deal with expenses related to Enterprise Resource Planning (ERP) software.  The IRS had issued PLR 200236028 that provided information on what the IRS position was the requirements to capitalize such costs and the periods over which the costs could be recovered. 

The Chief Counsel advice noted that the ruling took the following positions:

  • The cost of the purchased ERP software (including the sales tax) is to be capitalized under § 263(a) of the Internal Revenue Code and amortized under § 167(f) ratably over 36 months, beginning with the month the software is placed in service by the taxpayer;
  • The employee training and related costs (maintenance, troubleshooting, and running reports during the training; such costs did not include any reorganizational expenditures) are deductible as current expenses under § 162. However, the pre-paid training expenses are deductible as a current expense in the year in which incurred under the requirements of § 461;
  • The separately stated computer hardware cost is to be capitalized under § 263(a) and depreciated under § 168 over a 5-year recovery period;
  • If the taxpayer is solely responsible for the creation and performance of the software project covered by the consulting contracts, the costs of writing machine readable code software (and its allocable portion of the costs of modeling and design of additional software) under the taxpayer's consulting contracts are self-developed computer software and are allowed to be deductible as current expenses pursuant to section 5.01(1) of Rev. Proc. 2000-50, 2000-2 C.B. 601; and
  • The costs of option selection and implementation of templates (and its allocable portion of the costs of modeling and design of additional software) under the taxpayer's consulting contracts are installation/modification costs that are to be capitalized and amortized as part of the purchased ERP software ratably over 36 months, beginning with the later of the month the purchased software is placed in service by the taxpayer or the month the template work is available for use by the taxpayer. The undefined miscellaneous costs under the taxpayer's consulting contracts are also capitalized as a part of the underlying purchased ERP software and amortized over the same 36 month period described in the preceding sentence.

In December of 2002 the IRS issued proposed regulations dealing with intangible assets.  While these proposed regulations did not specifically address dealing with ERP costs, the preamble stated the IRS expected the final regulations would address these costs, and do so in a manner similar to that detailed in PLR 200236028. 

However when the final regulations were issued in 2004, they did not contain provisions related to ERP costs.  The IRS notes that the preamble those final regulations stated:

The preamble indicated that the issue of the treatment of ERP implementation costs was more appropriately addressed in separate guidance dedicated exclusively to computer software issues and, until such separate guidance was issued, that taxpayers may continue to rely on Rev. Proc. 2000-50. The preamble to the final intangible regulations did not cite to PLR 200236028. To date, no separate guidance has been issued.

The IRS has noted that some taxpayers, reading those comments and noting the lack of specific guidance, have taken the position that the guidance in PLR 200236028 is no longer valid and that Revenue Procedure 2000-50 allows for the current deduction of all ERP related costs.

The CCA takes the position that this is not an appropriate way to either read the regulations or interpret Revenue Procedure 2000-50.  The advice notes:

Rev. Proc. 2000-50 provides guidelines on the treatment of the costs of computer software. Section 2 of Rev. Proc. 2000-50 defines the term "computer software" as any program or routine (that is, any sequence of machine readable code) that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine.

Section 5.01 of Rev. Proc. 2000-50 provides, in part, that the cost of developing computer software in many respects so closely resemble the kind of research and experimental expenditures that fall within the purview of § 174 as to warrant similar accounting treatment. Accordingly, the Service will not disturb a taxpayer's treatment of costs paid or incurred in developing software for any particular project where all of the costs properly attributable to the development of software by the taxpayer are consistently treated as current expenses and deducted in full in accordance with rules similar to those applicable under § 174.

Section 6.01(2) of Rev. Proc. 2000-50 provides that with respect to the costs of acquired computer software, the Service will not disturb the taxpayer's treatment of costs that are separately stated if the costs are consistently treated as capital expenditures for an intangible asset the cost of which is to be recovered by amortization deductions ratably over a period of 36 months beginning with the month the software is placed in service, in accordance with the rules under § 167(f)(1). See § 1.167(a)-14(b)(1).

Section 4 of Rev. Proc. 2000-50 provides that this revenue procedure applies to all costs of computer software as defined in section 2 of Rev. Proc. 2000-50. Accordingly, Rev. Proc. 2000-50 applies only to the costs for computer software as that term is defined in section 2 of Rev. Proc. 2000-50.

Accordingly, the principles and conclusions contained in PLR 200236028 continue to apply. However, PLR 200236028 may not be used or cited as precedent. See § 6110(k)(3).

The last sentence is particularly interesting, though absolutely correct under the law.  But it should be clear that although it is not precedent in and of itself, the National Office clearly expects agents to move forward with the analysis of the law found in PLR 200236028—and the analysis does itself contain references to sources that are binding on taxpayers.  This means taxpayers who take positions inconsistent with that ruling should be ready to demonstrate their own analysis and why their analysis of the matter is superior to that found in the PLR.