Consolidated Manufacturing, Inc., M. P. Long Living Trust, Merl Philip Long, Trustee, Tax Matters Person v. Commissioner

111 T.C. No. 1

• Court: United States Tax Court
• Decided: July 20, 1998
• Docket: 6176-96
• Status: Unknown

Opinion

111 T.C. No. 1

UNITED STATES TAX COURT

CONSOLIDATED MANUFACTURING, INC., M. P. LONG LIVING TRUST, MERL PHILIP LONG, TRUSTEE, TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6176-96. Filed July 20, 1998.

Company C (C), an automobile parts remanufacturer required to take inventories pursuant to sec. 471,1 elected under sec. 472 to apply the last-in, first-out (LIFO) inventory method of accounting with respect to certain raw materials (raw materials one), labor, and overhead included in its inventories, but not with respect to certain other raw materials (raw materials two) included therein as to which C continued to use the first-in, first-out (FIFO) inventory method and the lower of cost or market (LCM) basis of valuation (C's method of valuing raw materials two).

1 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure. -2-

Respondent determined that C's method of reporting only raw materials one, labor, and overhead on the LIFO inventory method (C's LIFO method) does not clearly reflect income because it is contrary to the require- ments of sec. 472 and the regulations thereunder and that therefore C's election to use that method should be terminated.

Respondent further determined that C's method of valuing raw materials two did not reflect the proper amounts for those raw materials under the FIFO inventory method and the LCM basis of valuation permitted by sec. 471.

Held: Respondent did not abuse respondent's discretion in determining that C's LIFO method does not clearly reflect income because it is contrary to the requirements of sec. 472 and the regulations thereunder and that therefore C's election to use that method should be terminated.

Held, further: Respondent did not abuse respondent's discretion in determining that C's method of valuing raw materials two does not clearly reflect income because it did not reflect the proper amounts for those raw materials under the FIFO inventory method and the LCM basis of valuation permitted by sec. 471.

Eric S. Namee and James Scott MacBeth, for petitioner.

Michael J. O'Brien, David G. Hendricks, Karen J. Goheen, and

Jeffery G. Mitchell, for respondent.

CHIECHI, Judge: Respondent determined the following S

corporation adjustments to the ordinary, distributable net, or

taxable income of Consolidated Manufacturing, Inc.

(Consolidated): -3-

Adjustments to Ordinary, Distributable Net, or Year Taxable Income

1990 $3,730,862 1991 123,596

The issues remaining for decision are:

(1) Did respondent abuse respondent's discretion in

determining that Consolidated's method of reporting certain raw

materials, labor, and overhead on the LIFO inventory method and

certain other raw materials on the FIFO inventory method does not

clearly reflect income because it contravenes the requirements of

section 472 and the regulations thereunder and that therefore

Consolidated's election to use that method should be terminated?

We hold that respondent did not.

(2) Did respondent abuse respondent's discretion in

determining that Consolidated's method of valuing certain raw

materials does not clearly reflect income because it did not

reflect the proper amounts for those raw materials under the FIFO

inventory method and the LCM basis of valuation permitted by

section 471? We hold that respondent did not.

FINDINGS OF FACT2

Most of the facts have been stipulated and are so found.

2 Unless otherwise indicated, our Findings of Fact and Opinion pertain to 1990 and 1991, the years at issue. -4-

Consolidated, an S corporation, had its principal place of

business in Hutchinson, Kansas, at the time the petition was

filed. The M.P. Long Living Trust is Consolidated's tax matters

person.

Consolidated's Business

Consolidated engaged in the recovery, reconditioning, and

restoration to salable condition of used and worn automobile

parts, including engines, crankshafts, cylinder heads,

transmissions, and various smaller parts, which it sold as

remanufactured automobile parts to its customers. (We shall

refer to the foregoing activities in which Consolidated engaged

as remanufacturing.) Consolidated was authorized by Ford Motor

Company (Ford) to produce specified remanufactured automobile

parts and sell them within certain counties in Kansas, Missouri,

and Arkansas to Ford-authorized dealers (Consolidated's Ford

customers) as Ford remanufactured automobile products.

Consolidated's Ford customers sold the remanufactured automobile

parts that they had purchased from Consolidated to wholesale and

retail consumers.

Consolidated also produced and sold remanufactured engines,

crankshafts, and cylinder heads under its own private label known

as Four Star Engine & Parts (Four Star label) to certain

warehouse distributors and to Ford-authorized dealers

(Consolidated's Four Star label customers). Consolidated's Four

Star label customers sold the remanufactured automobile parts -5-

that they had purchased from Consolidated to jobbers and garages

who, in turn, sold such products at retail. (We shall refer

collectively to Consolidated's Ford customers and Consolidated's

Four Star label customers as customers.)

In addition, Consolidated served as a Ford-authorized

distributor of Ford-authorized remanufactured automobile parts

produced by other automobile parts remanufacturers, including

clutch discs and pressure plates. Consolidated did not use any

of the used and worn clutch discs and pressure plates that it

obtained in its capacity as a Ford-authorized distributor to

produce remanufactured clutch discs and pressure plates, but

instead delivered those used and worn parts to the remanufac-

turers of those products.

The portion of a used and worn automobile part that is

utilized to produce a remanufactured automobile part is known in

the automobile parts remanufacturing industry as a core (core).

In order to recondition and restore to salable condition a used

and worn engine, transmission, cylinder head, crankshaft, or

small automobile part, Consolidated needed a used and worn engine

(engine core), transmission (transmission core), cylinder head

(cylinder head core), crankshaft (crankshaft core), or small

automobile part (small part core) to place into the

remanufacturing process.

Consolidated's remanufacturing business depended on a supply

of two materials: cores and new parts. It maintained inventories -6-

of, inter alia, cores (unprocessed cores raw material inventory)

and new parts (unprocessed new parts raw material inventory) upon

which it drew throughout the remanufacturing process.

During Consolidated's remanufacturing process, Consolidated

incurred expenditures for labor and overhead and transformed

those raw materials into its finished goods or products (viz,

remanufactured automobile parts). During that process for

certain automobile parts, new parts were physically affixed to

and incorporated into a core in order to produce a remanufactured

automobile part. The new parts used by Consolidated in the

remanufacturing process included pistons and rings, rockers and

lifters, springs, bearings, chains, gears, plugs, pins, and other

miscellaneous assembly parts. Consolidated purchased the new

parts that it used in its remanufacturing business from the

manufacturers of such parts.

Consolidated generally obtained cores from two sources.

Consistent with customary and established practice in the

automobile parts remanufacturing industry, Consolidated acquired

most of its cores from its customers (customer cores), whose

source for those cores was their respective customers.

Consolidated also acquired cores, except small part cores,

from persons engaged in the business of selling cores and known

in the automobile parts remanufacturing industry as core

suppliers or core brokers (core suppliers). (We shall refer to

the cores obtained from core suppliers as core supplier cores.) -7-

Consolidated obtained core supplier cores only on a special order

basis in order to satisfy a specific or temporary demand that had

arisen for a particular remanufactured automobile part. Although

there were hundreds of individuals and businesses operating as

core suppliers, Consolidated purchased core supplier cores from

six major core suppliers, one of which was Bishop Engine and

Automatic, Inc. (Bishop Engine).

Bishop Engine was Consolidated's largest core supplier from

which it purchased 44 percent and 38 percent of its core supplier

cores during 1990 and 1991, respectively. Bishop Engine acquired

80 percent of the cores that it sold to automobile parts

remanufacturers from salvage yards (salvage yard cores). Bishop

Engine acquired the balance of such cores from individual

peddlers and from manufacturers of automobile parts (e.g.,

General Motors, Ford, and Chrysler) which sold Bishop Engine

automobile parts that had been returned to them pursuant to the

warranties they had issued to their respective customers. Bishop

Engine acquired approximately 20 percent of its salvage yard

cores from bins that it placed in salvage yards in its local area

and in which salvage yard employees placed cores (bin salvage

yard cores). Bishop Engine acquired the balance of its salvage

yard cores by sending its employees to salvage yards throughout

the United States for the purpose of inspecting the cores in

those yards and buying those cores that those employees believed

were in rebuildable condition (non-bin salvage yard cores). -8-

Bishop Engine determined the amounts that it was willing to

pay for non-bin salvage yard cores and reflected those amounts in

price sheets (price sheets) provided to its employees and

distributed to salvage yards approximately every 3 months.

Bishop Engine paid the same amounts for bin salvage yard cores

that passed inspection at its place of business and for cores

acquired from individual peddlers as those listed in the price

sheets for the same types of cores. Bishop Engine adjusted those

price sheets weekly as necessary to reflect any changing market

conditions, such as an increase in prices due to increased demand

from automobile parts remanufacturers and a decrease in prices,

but in no event below scrap value, due to decreased demand from

those remanufacturers. Bishop Engine distributed those weekly

adjusted price sheets every Monday morning to its employees, who

informed the salvage yard operators of changes in the price

sheets. (We shall refer to the amounts that Bishop Engine paid

for non-bin salvage yard cores and for bin salvage yard cores

that passed inspection at its place of business as the salvage

yard cost.) Bishop Engine paid scrap value for the bin salvage

yard cores that did not pass inspection at its place of business

and for the types of cores acquired from individual peddlers that

were not listed on the price sheets.

Bishop Engine generally paid the cost of shipping the

salvage yard cores that it had purchased to its place of

business. At Bishop Engine's place of business, its employees -9-

reinspected the non-bin salvage yard cores, inspected the bin

salvage yard cores, and removed any unwanted components of such

cores. As a result of the inspection process at Bishop Engine's

place of business, Bishop Engine determined that 15 to 20 percent

of the non-bin salvage yard cores and approximately 80 percent of

the bin salvage yard cores which it had purchased were not in

rebuildable condition. Bishop Engine sold the salvage yard cores

that did not pass inspection at its place of business as scrap

metal and offered the balance of its salvage yard cores that did

pass such inspection for sale to, inter alia, automobile parts

remanufacturers.

Bishop Engine determined the amounts to charge automobile

parts remanufacturers for the various types of core supplier

cores that it offered for sale to them by taking account of the

amounts being charged by its competitors for those types of core

supplier cores and market factors relating to supply and demand.

Whenever Consolidated purchased core supplier cores from Bishop

Engine, it paid the amounts that Bishop Engine was charging for

those cores.

Bishop Engine and the other core suppliers from which

Consolidated purchased core supplier cores guaranteed those cores

to be in rebuildable condition (core supplier guarantee). If

Consolidated discovered during the remanufacturing process that a

core supplier core had to be scrapped because it was not in

rebuildable condition, that core was removed from that process -10-

and returned to the core supplier, and Consolidated received a

credit from that core supplier for the amount that Consolidated

had paid for that core. Approximately 3 percent of the cores

sold by Bishop Engine to automobile parts remanufacturers were

not in rebuildable condition and were subsequently returned by

them to Bishop Engine in return for which they received such

credits.

Core supplier cores purchased by Consolidated entered into

its production line almost immediately upon acquisition and

remained in its unprocessed cores raw material inventory for only

a brief period of time. As a consequence, that inventory

consisted almost entirely of customer cores, and not core

supplier cores.

By way of illustration of the remanufacturing process by

which Consolidated produced reconditioned engines in salable

condition, engine customer cores were torn down, stored in its

unprocessed cores raw material inventory, and subsequently placed

into production. If a customer had delivered to Consolidated a

short-block engine customer core, which was an engine customer

core without the heads, Consolidated's employees cleaned off the

casting number, consulted the identification manual to determine

the engine type and core lot number, wrote the core lot number on

the top of that core, and wheeled it into the yard (core yard)

where Consolidated stored its unprocessed cores raw material

inventory. If a customer had delivered to Consolidated a long- -11-

block engine customer core, which was a short-block customer core

with the heads, that core underwent some initial disassembly by

Consolidated's employees in order to convert it into a short-

block engine customer core (i.e., the cylinder heads, related

valve train assembly, and the oil pump were removed), at which

point it was marked and wheeled into the core yard. Short-block

engine customer cores that were not sufficiently stripped down so

as to permit detection of irreparable latent defects remained in

the core yard until they were brought into production, at which

time they were further disassembled, inspected for defects, and

reconditioned into salable condition. During the disassembly and

cleaning process, engine customer cores and engine core supplier

cores were subjected to numerous visual and mechanical

examinations and procedures. Only if an engine core passed all

of those examinations and procedures could it become a remanu-

factured automobile engine.

During the disassembly process, the cylinder heads, the

crankshaft, the camshaft, and rods were removed from the engine

core, retained by Consolidated, and subjected to separate

remanufacturing processes. These parts were, if in usable

condition, remanufactured in separate areas of Consolidated's

remanufacturing facility. Those remanufactured automobile parts

were then incorporated into remanufactured engines and, in the

case of crankshafts, heads, and rods, were sold as separate

remanufactured automobile parts. -12-

The following tables show the number of remanufactured

automobile parts produced by Consolidated, the number of such

remanufactured automobile parts produced from customer cores, and

the number of such remanufactured automobile parts produced from

core supplier cores:

1990 Total Total Type of Production Production Automobile Total From Customer From Core Part Production Cores Supplier Cores

Engines 26,864 20,407 6,457 Transmissions 1,549 1,220 329 Crankshafts 22,029 18,004 4,025 Cylinder heads 39,365 30,011 9,354 Small parts 103,537 103,537 -0-

1991 Total Total Type of Production Production Automobile Total From Customer From Core Part Production Cores Supplier Cores

Engines 21,360 15,559 5,801 Transmissions 1,818 1,326 492 Crankshafts 19,942 16,211 3,731 Cylinder heads 34,785 25,047 9,738 Small parts 91,286 91,286 -0-

Consolidated's Sale of Remanufactured Automobile Parts and Acquisition of Customer Cores

Consistent with standard and customary practice in the

automobile parts remanufacturing industry, Consolidated sold each

remanufactured automobile part for, and each of its customers was

obligated to pay, an amount (remanufactured automobile part sales

price) that consisted of an exchange amount and a core amount.

The remanufactured automobile part sales price was determined by -13-

market-related factors, including supply and demand. The

exchange amount, the core amount, and the total of those two

amounts (i.e., the remanufactured automobile part sales price)

for each remanufactured automobile part sold by Consolidated were

separately stated on each of Consolidated's sales invoices for

each such sale (remanufactured automobile part sales invoice).

Each automobile parts remanufacturer established its own

remanufactured automobile part sales price consisting of an

exchange amount and a core amount. Consolidated determined the

exchange amount that it charged as part of its remanufactured

automobile part sales price based on market-related factors. In

making that determination, Consolidated, inter alia, examined the

jobber price exchange amounts for remanufactured automobile parts

(i.e., the exchange amounts that automobile retail parts stores

determined should be part of the total prices charged their

respective customers for remanufactured automobile parts) that

were produced by those competitors of Consolidated which were

comparable to it in terms of, inter alia, quality of products and

service and warranty policy.

The core amount included as part of the remanufactured

automobile part sales price charged for any given remanufactured

automobile part varied among remanufacturers. Consolidated

determined that core amount based on several market-related

factors, including the supply and demand of customer cores. One

such factor was the location of the customer core within its -14-

anticipated life cycle as conceptualized by Consolidated.

Consolidated viewed the life cycle of a core as consisting of

three phases. Throughout the first phase of that cycle during

which new automobile parts were being introduced into the market,

customer cores were scarce; Consolidated might have purchased

those parts from manufacturers and cores from core suppliers in

order to have cores from which it was able to produce an

inventory of finished goods; and Consolidated's core amounts

generally were increasing. Throughout the second phase of the

life cycle of a core as conceptualized by Consolidated, customer

core availability increased; Consolidated's inventory need for

customer cores was satisfied through transactions with its

customers and on a special order basis from core suppliers; and

Consolidated's core amounts leveled out and remained relatively

constant. Throughout the third phase of that life cycle,

customer core availability was at its maximum; Consolidated

regularly sold as scrap metal overstocked customer cores in its

unprocessed cores raw material inventory; and Consolidated's core

amounts ordinarily were decreasing.

Other market-related factors that Consolidated considered in

determining the core amount which was part of the remanufactured

automobile part sales price that it charged a customer for a

remanufactured automobile part included the supply of a

particular type of customer core in Consolidated's inventories,

the probability that its customers would decide to provide it -15-

with customer cores, the ratio between sales of a particular type

of remanufactured automobile part and acquisitions of the

corresponding type of customer core, and the amounts that core

suppliers were charging for certain types of core supplier cores

that Consolidated anticipated purchasing in order to satisfy a

specific or temporary demand for particular types of automobile

parts.

At the time Consolidated sold each remanufactured automobile

part to each of its customers, it offered to purchase from each

such customer, subject to the requirements established by

Consolidated for its acceptance of a customer core

(Consolidated's requirements for acceptance of a customer core),

a customer core of the same type as each such part sold.

Consolidated offered to purchase each such customer core for an

amount (customer core purchase offer amount) that generally was

equal to the core amount which was separately stated on the

remanufactured automobile part sales invoice as part of the

remanufactured automobile part sales price for each such part.

The customer core purchase offer amount was, like the core

amount, based on market-related factors, including supply and

demand. The customer core purchase offer amount could have been

less than the core amount shown on the remanufactured automobile

part sales invoice. That could have occurred because of the

condition of the customer core upon its delivery to Consolidated.

For example, Consolidated's customer core purchase offer amount -16-

for an engine core with a hole in it was equal to 50 percent of

the core amount which was separately stated on the remanufactured

automobile part sales invoice as part of the remanufactured

automobile part sales price for a corresponding remanufactured

automobile engine. The customer core purchase offer amount for

each customer core was set at an amount that the marketplace in

which Consolidated acquired customer cores demanded.

At no time were Consolidated's customers under any

obligation to accept Consolidated's offer to purchase customer

cores from them or otherwise to provide such cores to

Consolidated. However, most of those customers did decide to

accept Consolidated's offer and provided it with customer cores.

In the event that a customer of Consolidated decided to accept

Consolidated's offer to purchase a customer core and that

customer met Consolidated's requirements for acceptance of a

customer core, instead of that customer's receiving a check or

cash from Consolidated in the customer core purchase offer amount

for that customer core, that customer became entitled to a credit

by Consolidated in that amount (core credit amount) against the

amount which was due from that customer (viz, the remanufactured

automobile part sales price) for such customer's purchase of a

remanufactured automobile part from Consolidated and which was

reflected in Consolidated's books as an account receivable from

that customer. (We shall refer to such an account receivable in

Consolidated's books as the customer account receivable.) Like -17-

the customer core purchase offer amount on which it was based,

the core credit amount generally was equal to the core amount and

was based on market-related factors, including the supply and

demand of customer cores, although, as discussed above, the

customer core purchase offer amount and therefore the core credit

amount could have been in an amount less than the core amount

because of the condition of the customer core upon its delivery

to Consolidated. The core credit amount for each customer core

was set at an amount that the marketplace in which Consolidated

acquired customer cores demanded.

Consolidated's customers did not guarantee the cores that

they decided to provide to it. However, Consolidated's

requirements for acceptance of a customer core had to be

satisfied before Consolidated was willing to accept a customer

core. Those requirements were: (1) The customer desiring to

deliver the customer core had purchased a remanufactured

automobile part from Consolidated; (2) the remanufactured

automobile part sales price charged for that part included a core

amount; (3) the customer core satisfied Consolidated's customer

core policy (Consolidated's customer core policy) relating to,

inter alia, the type and condition of the core that Consolidated

was willing to accept (e.g., Consolidated's customer core policy

for Four Star label cylinder head cores stated that those cores

were not acceptable if they were "obviously broken, cracked, or

welded"); and (4) the customer followed Consolidated's procedures -18-

for delivery of a customer core to Consolidated (Consolidated's

procedures for delivery of a customer core).

The following table shows the aggregate number of the

different types of Ford-authorized and Four Star label

remanufactured automobile parts sold by Consolidated and the

aggregate number of the different types of corresponding Ford-

authorized and Four Star label customer cores that Consolidated's

customers decided to provide to Consolidated and that were

delivered to it:

1990 1991 Aggregate Aggregate Aggregate Aggregate Type of Number of Number of Number of Number of Remanufactured Remanufactured Customer Remanufactured Customer Automobile Part Automobile Cores Automobile Cores Sold Parts Sold Delivered Parts Sold Delivered Engines 26,677 24,391 22,130 20,534 Transmissions 1,572 1,365 1,793 1,505 Crankshafts 24,050 23,425 19,658 19,088 Cylinder heads 6,928 5,188 7,172 5,603 Small parts 90,128 75,450 89,040 76,356

In anticipation that Consolidated's customers would decide

to accept its offer to purchase and deliver customer cores to it,

even though they were under no obligation to do so, Consolidated

provided each of those customers with a form known as a request

for core credit at the time that it delivered to them the

remanufactured automobile parts that they had purchased. The

request for core credit was a preprinted form generally con-

sisting of three copies: One for Consolidated's customer, a

transportation copy, and a copy that was to be returned to

Consolidated in the event and at the time that a customer -19-

delivered customer cores to it. In the case of Four Star label

remanufactured engines, the request for core credit preprinted

form consisted of the foregoing three copies and a fourth copy

for the person, usually a jobber, who purchased such an engine

from Consolidated's customer.

Consolidated's customer core policy established a period of

time during which any of its customers who decided to provide it

with customer cores was required to deliver such cores (delivery

period). That period commenced on the date of the installation

of the remanufactured automobile part sold by Consolidated. The

delivery period varied depending on the type of customer core

from 30 days for Consolidated's Four Star label customer

crankshafts to 2 years for Consolidated's Ford customer small

automobile parts. Despite Consolidated's policy regarding the

delivery period, Consolidated accepted customer cores from its

customers after that period had expired, even if those cores were

determined not to be in rebuildable condition, and credited each

customer account receivable with the core credit amounts.

Consolidated followed this practice regardless whether the

customer cores provided by its customers after the delivery

period had become overstocked or obsolete due to the passage of

time or whether the core amounts that were part of the

remanufactured automobile parts sales prices that those customers

were charged had changed. -20-

Consolidated's procedures for delivery of a customer core

were: (1) The customer presented the transportation copy of the

request for core credit to the person who picked up the core from

the customer's place of business and who usually was an employee

of Consolidated making a delivery of remanufactured automobile

parts to that customer (Consolidated's driver); (2) a copy of the

request for core credit was physically tagged to the customer

core that Consolidated's driver picked up from that customer; and

(3) Consolidated's driver made a visual inspection of that core

and, based solely on that inspection, determined whether the

customer was in compliance with Consolidated's customer core

policy, including the requirements, if any, in that policy that

the type and style of the customer core delivered to Consolidated

correspond to the type and style of the remanufactured automobile

part purchased by that customer.

In addition to accepting customer cores from its customers

that corresponded to the remanufactured automobile parts that

those customers had purchased from Consolidated, Consolidated

also accepted delivery from those customers of customer cores

that did not correspond to those parts. In the latter event, for

each such customer Consolidated credited the customer account

receivable in an amount that was less than the core amount which

was part of the remanufactured automobile part sales price for

each of the remanufactured automobile parts purchased by that

customer. -21-

In the event that one of Consolidated's customers decided to

accept its offer to purchase and delivered customer cores to it,

Consolidated generated and provided to each such customer a sales

invoice (customer core sales invoice) at or about the time of the

delivery of those cores. That invoice was prepared from

information in a file that Consolidated maintained for each of

its customers with respect to sales to each such customer of its

remanufactured automobile parts. The customer core sales

invoice, inter alia, identified the type and the number of

customer cores of each type that each of Consolidated's customers

delivered to it. That invoice also had, inter alia, a column

headed "CORES", and under that column was, inter alia, a column

headed "PRICE EACH". Listed under the column headed "PRICE EACH"

on the customer core sales invoice was the core credit amount for

each of the customer cores identified on that invoice as having

been delivered to Consolidated. (We shall refer to the column on

the customer core sales invoice reflecting the price of each

customer core that a customer decided to deliver to Consolidated

as the column headed "Cores--Price Each".) Attached to each

customer core sales invoice was a completed copy of a request for

core credit and a document generated by Consolidated's customer

showing the date on which such customer received from such

customer's customer the core that it decided to deliver to

Consolidated. -22-

A customer core could have remained in Consolidated's

unprocessed cores raw material inventory for months or years

before Consolidated drew upon it for use in Consolidated's

remanufacturing process. When demand for a type of

remanufactured automobile part was sufficiently limited (e.g., if

the vehicle for which such a type of part was to be used was an

obsolete, early model vehicle), the customer core corresponding

to that type of remanufactured automobile part might have been

put out for bid as scrap metal and sold by Consolidated at scrap

metal prices without ever having entered into production.

The following percentages of customer cores that were

delivered to Consolidated and that entered into its

remanufacturing process were subsequently determined not to be in

rebuildable condition and were scrapped:

1990 Percentage of 1991 Percentage of Customer Cores Not Customer Cores Not Type of in Rebuildable in Rebuildable Customer Core Condition Condition

Engine cores 16.44 18.45 Transmission cores 14.34 23.38 Crankshaft cores 37.97 37.59 Cylinder head cores 19.00 26.13 Small part cores 10.06 6.46

Consolidated's Accounting

Consolidated used the calendar year and the accrual and

inventory methods of accounting for financial and Federal income

tax (tax) reporting purposes. Until the close of its taxable

year 1980, Consolidated reported its inventories (at least for -23-

tax purposes) by using the FIFO method of inventory accounting,

and it chose to apply the LCM basis of valuation.

Consolidated submitted Form 970, Application to Use LIFO

Inventory Method, with its 1980 tax return (1980 Form 970). As

completed by Consolidated, the 1980 Form 970 stated in pertinent

part:

The taxpayer named above [Consolidated] hereby applies to adopt and use the LIFO inventory method provided by section 472. This method is to be applied for the first time as of the close of the taxable year ending December 31, 1980, to the following specified goods * * *: Reconditioning costs[3] and new parts inventories, not including the cost of used core inventory.

* * * * * * *

4. (a) List goods subject to inventory but which are not to be inventoried under the LIFO method Used engines and parts (cores).

7. Method used in valuing LIFO inventories 9 Unit method : Dollar-value method 8. (a) If pools are used, list and describe the contents of each pool One pool consisting of raw material, purchased parts and remanufacturing costs.

(c) Method used in computing LIFO value of dollar- value pools

3 As we understand it, the term "reconditioning costs" as used in the 1980 Form 970 means the costs of direct labor and of overhead incident to and necessary for the production of remanufactured automobile parts that Consolidated incurred in remanufacturing those parts. We shall refer to Consolidated's reconditioning costs as labor and overhead. -24-

The index method has been used by the company in computing the value of the dollar value pool. * * *

(We shall refer to the LIFO inventory method that Consolidated

elected in the 1980 Form 970 as Consolidated's LIFO method.)

Consolidated submitted another Form 970 with its 1982 tax return

(1982 Form 970). As completed by Consolidated and as pertinent

here, the 1982 Form 970 differed from the 1980 Form 970 only with

respect to the following questions and answers:

8. (a) If you use pools, list and describe contents of each pool[:] Two pools are used; motor vehicle parts; and machine shop products. Pools include raw material, purchased parts and remanufacturing costs.

(c) Method used in computing LIFO value of dollar- value pools

Simplified LIFO per Reg. Sec. 1.472-8(e)(3) [i.e., inventory price index (IPI) computation method]

Taxpayer initially elected LIFO for the tax year ending December 31, 1980. Form 970 was timely filed for such election and the taxpayer consistently followed such dollar value method. However, due to changes made by the Economic Recovery Tax Act of 1981, which allows a change to the use of published indexes, taxpayer hereby elects to compute LIFO inventories by using such Government published indexes as prescribed in Reg. 1.472-8(e)(3). Per Reg. 1.472-8(e)(3)(v), prior consent of the Commissioner is not required if the change is made for the first or second taxable year ending after 1981.

* * * * * * * -25-

Taxpayer elects to use the October Producer Price Index report as a representative month for selecting indexes. Such election is allowed under Reg. 1.472- 8(e)(3)(iii)(C).

Except for the IPI computation method that Consolidated

elected to use in the 1982 Form 970 in calculating its dollar-

value LIFO pools since the end of its taxable year 1982,

Consolidated has consistently applied Consolidated's LIFO method

(i.e., the LIFO inventory method described in the 1980 Form 970)

during all relevant periods.

At the time of a sale of remanufactured automobile parts to

one of its customers, for each such part, Consolidated made an

entry increasing (1) its "sales (exchange amount)" by the

exchange amount that was part of the remanufactured automobile

part sales price, (2) its "sales (core amount)" by the core

amount that was the remaining part of that sales price, and

(3) its "customer account receivable" by the remanufactured

automobile sales price (i.e., the sum of those two amounts). At

the time at which that customer decided to and did deliver

customer cores to Consolidated, for each such core, Consolidated

made an entry decreasing its "sales (core amount)" and its

"customer account receivable" by the core credit amount.

At the time Consolidated purchased a core supplier core, it

charged the cost of that core directly to cost of goods sold.

Deloitte & Touche and Pierce, Faris & Co., Chartered audited

Consolidated's 1990 financial statements and 1991 financial -26-

statements, respectively, and issued unqualified opinions that

those respective financial statements presented fairly, in all

material respects, the financial position of Consolidated and the

results of its operations and cash flows for 1990 and 1991 in

conformity with generally accepted accounting principles (GAAP).

For financial reporting purposes, Consolidated calculated

its inventories by using LCM and (1) the LIFO method for new

parts, labor, and overhead and (2) the FIFO method for customer

cores. For such purposes, Consolidated reflected customer cores

in its inventories at the amounts (core supplier amounts) that

core suppliers were charging for similar types of core supplier

cores.

For tax purposes, in determining its yearend inventories,

Consolidated included (1) customer cores in its finished goods

inventory at the core supplier amounts and (2) customer cores in

its unprocessed cores raw material inventory and its goods in

process inventory at scrap value (Consolidated's FIFO-LCM

method).

For purposes of this case, both cores and new parts used by

Consolidated to produce remanufactured automobile parts are

treated as raw materials under GAAP and subchapter E, chapter 1,

subtitle A of the Code relating to accounting periods and methods

of accounting, and they shall be referred to herein as raw

materials. -27-

Respondent's Determinations

Respondent mailed notices of final S corporation

administrative adjustment (notices) for 1990 and 1991,

respectively, to Merl Philip Long, grantor and trustee of the

M.P. Long Living Trust, the tax matters person. Respondent

determined in the notices that Consolidated improperly excluded

customer cores from the calculation of its inventories under

Consolidated's LIFO method for each of those years and that,

consequently, Consolidated's LIFO election should be terminated.

Respondent also determined in the notices that Consolidated did

not reflect the proper amounts for customer cores in its

inventories under Consolidated's FIFO-LCM method for each of

those years.4

OPINION

This case presents several inventory accounting issues that

implicate sections 446, 471, and 472. Section 446 provides in

pertinent part:

(a) General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.

(b) Exceptions.--If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.

4 Petitioner conceded the remaining determination in the notice for 1990. -28-

Section 471(a) provides:

(a) General Rule.--Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

Section 1.471-2(c) and (d), Income Tax Regs., provides in

(c) The bases of valuation most commonly used by business concerns and which meet the requirements of section 471 are (1) cost and (2) cost or market, whichever is lower. * * *

(d) * * * Goods taken in the inventory which have been so intermingled that they cannot be identified with specific invoices will be deemed to be the goods most recently purchased or produced * * *. But see section 472 as to last-in, first-out inventories. * * *

Section 472(a) and (b) provides:

(a) Authorization.--A taxpayer may use the method provided in subsection (b) (whether or not such method has been prescribed under section 471) in inventorying goods specified in an application to use such method filed at such time and in such manner as the Secretary may prescribe. The change to, and the use of, such method shall be in accordance with such regulations as the Secretary may prescribe as necessary in order that the use of such method may clearly reflect income.

(b) Method Applicable.--In inventorying goods specified in the application described in subsection (a), the taxpayer shall:

(1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof; and second, those acquired in the taxable year; -29-

(2) Inventory them at cost; and

(3) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.

Sections 446 and 471 and the regulations thereunder vest the

Commissioner of Internal Revenue (Commissioner) with wide

discretion in determining whether a method of inventory

accounting should be disallowed because it does not clearly

reflect income. Thor Power Tool Co. v. Commissioner, 439 U.S.

522, 532-533 (1979); Hamilton Indus., Inc. v. Commissioner, 97

T.C. 120, 128 (1991). The Commissioner's interpretation of the

clear-reflection standard under sections 446 and 471 may not be

disturbed unless it is clearly unlawful or plainly arbitrary.

Thor Power Tool Co. v. Commissioner, supra; Hamilton Indus., Inc.

v. Commissioner, supra at 129. The Commissioner's discretion

under sections 446 and 471 is not unbridled, however. Thor Power

Tool Co. v. Commissioner, supra at 533; Hamilton Indus., Inc. v.

Commissioner, supra at 128. We must decide whether respondent

abused respondent's discretion in determining (1)(a) that

Consolidated's LIFO method for 1990 and 1991 does not clearly

reflect income because that method pertained only to new parts,

labor, and overhead, and not also to customer cores, and (b) that

therefore Consolidated's election to use that method should be

terminated and (2) that Consolidated's FIFO-LCM method for the -30-

years at issue does not clearly reflect income because that

method did not reflect the proper amounts for customer cores.5

Before turning to the issues presented in this case, we note

that we have given due consideration to all of the parties'

arguments and contentions with respect to those issues, even

though we do not attempt to address each of them herein.

Consolidated's LIFO Method

For all relevant periods until the close of its taxable year

1980, Consolidated chose to report its inventories in its tax

returns on the basis of the FIFO inventory method and LCM. In

the 1980 Form 970 that it filed, Consolidated elected to apply

the LIFO inventory method as of the close of its taxable year

1980 to "Reconditioning costs and new parts inventories, not

including the cost of used core inventory" and to use the dollar-

value LIFO inventory method.6 In the 1982 Form 970 that it

5 Respondent does not object to Consolidated's method of accounting for core supplier cores. We shall address only Consolidated's inventory method of accounting for customer cores. 6 Sec. 1.472-8(a), Income Tax Regs., provides in pertinent part:

Any taxpayer may elect to determine the cost of his LIFO inventories under the so-called "dollar-value" LIFO method, provided such method is used consistently and clearly reflects the income of the taxpayer in accordance with the rules of this section. The dollar- value method of valuing LIFO inventories is a method of determining cost by using "base-year" cost expressed in terms of total dollars rather than the quantity and price of specific goods as the unit of measurement. Under such method the goods contained in the inventory (continued...) -31-

filed, Consolidated elected under section 472 to apply as of the

close of its taxable year 1982 the IPI computation method in

calculating its dollar-value LIFO pools. Pursuant to that

method, Consolidated elected to use the October Producer Price

Index report as allowed by section 1.472-8(e)(3)(iii)(C), Income

Tax Regs.

Petitioner contends, and respondent does not dispute,

(1) that Consolidated's LIFO method conforms to GAAP and that it

therefore satisfies the requirement of section 471 and the

regulations thereunder that that method conform "as nearly as may

be to the best accounting practice in the trade or business" and

(2) that Consolidated has consistently applied that method. The

dispute between the parties with respect to Consolidated's LIFO

method is whether respondent abused respondent's discretion in

determining that that method does not clearly reflect income

because it contravenes the requirements of section 472 and the

regulations thereunder and that, consequently, Consolidated’s

election to use that method should be terminated.

We shall begin our consideration of the parties’ dispute by

summarizing the history of the inventory method of tax

(...continued) are grouped into a pool or pools as described in para- graphs (b) and (c) of this section. The term "base- year cost" is the aggregate of the cost (determined as of the beginning of the taxable year for which the LIFO method is first adopted, i.e., the base date) of all items in a pool. * * * -32-

accounting, the FIFO inventory method, and the LIFO inventory

method. The use of inventories was first required by the Revenue

Act of 1918 (1918 Act), ch. 18, sec. 203, 40 Stat. 1060,

whenever, in the opinion of the Commissioner, such use was

necessary in order to determine clearly the income of any

taxpayer.7 Where goods taken in inventory were so intermingled

that they could not be identified with specific invoices, Article

1582 of Regulations 45, promulgated under the 1918 Act, deemed

such goods to be the goods most recently purchased or produced.

In other words, in such circumstances, taxpayers were to use the

FIFO inventory method as a matter of convenience.8 See Ozark

Mills, Inc. v. Commissioner, 6 B.T.A. 1179, 1183-1184 (1927).

It was not until the Revenue Act of 1938 (1938 Act), ch.

289, 52 Stat. 447, that Congress first allowed certain taxpayers

(viz, producers and processors of certain nonferrous metals and

tanners) who were required to use the inventory accounting method

to elect the LIFO inventory method for certain goods included in

their inventories. 1938 Act, sec. 22(d)(1) through (3), 52 Stat.

459. Effective for taxable years that began after December 31,

1938, producers and processors of certain nonferrous metals

7 Sec. 203 of the Revenue Act of 1918, ch. 18, sec. 203, 40 Stat. 1060, was the original predecessor of sec. 471. 8 The FIFO inventory method is expressly permitted by sec. 1.471-2(d), Income Tax Regs., when goods taken in inventory are so intermingled that they cannot be identified with specific invoices. -33-

generally were permitted to elect the LIFO inventory method for

raw materials not yet included in goods in process or in finished

goods, i.e., for unprocessed raw materials, 1938 Act, sec.

22(d)(1) and (2), 52 Stat. 459, and tanners generally were

allowed to elect the LIFO inventory method for "raw materials

(including those included in goods in process and in finished

goods)", 1938 Act, sec. 22(d)(3), 52 Stat. 459. Section 22(d)(1)

through (3) of the 1938 Act was reenacted as section 22(d)(1)

through (3) of the 1939 Code. 1939 Code, ch. 2, sec. 22(d)(1)

through (3), 53 Stat. 11.

Congress amended section 22(d) of the 1939 Code, effective

for taxable years that began after December 31, 1938, to provide

in pertinent part:

(d)(1) A taxpayer may use the following method * * * in inventorying the goods specified in the application required under paragraph (2):

(A) Inventory them at cost;

(B) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof, and second, those acquired in the taxable year; and

(C) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.

(2) The method described in paragraph (1) may be used-- -34-

(A) Only in inventorying goods * * * specified in an application to use such meth- od filed at such time and in such manner as the Commissioner may prescribe * * *

(3) The change to, and the use of, such method shall be in accordance with such regulations as the Commissioner, with the approval of the Secretary, may prescribe as necessary in order that the use of such method may clearly reflect income.

Revenue Act of 1939 (1939 Act), ch. 247, sec. 219, 53 Stat. 877.

(We shall refer to section 22(d) of the 1939 Code as amended by

section 219 of the 1939 Act as section 22(d) of the 1939 Code as

amended.)

The regulations promulgated under section 22(d) of the 1939

Code as amended provided in pertinent part:

Sec. 19.22(d)-1. Inventories under elective method.--Any taxpayer permitted or required to take inventories * * * may elect with respect to those goods specified in his application and properly subject to inventory to compute his opening and closing inventories in accordance with the method provided by section 22(d), as amended. * * *

Sec. 19.22(d)-2. Requirements incident to adoption and use of elective method.--* * *

(1) The taxpayer shall file an application to use such method specifying with particularity the goods to which it is to be applied;

Secs. 19.22(d)-1 and -2, Regs. 103. In 1943, sections 19.22(d)-1

and -2 of Regulations 103 were repromulgated with changes not

pertinent here as sections 29.22(d)-1 and -2 of Regulations 111. -35-

In 1944, section 29.22(d)-1 of Regulations 111 was amended

to add in pertinent part the following language:

A manufacturer or processor who has adopted the elective [LIFO] inventory method as to a class of goods may elect to have such method apply to the raw materials only (including those included in goods in process and in finished goods) expressed in terms of appropriate units. * * *

This election may also apply to any one raw material, when two or more raw materials enter into the composition of the finished product * * *

9 Fed. Reg. 12336, 12337 (Oct. 11, 1944). (We shall refer to the

amendment in 1944 to section 29.22(d)-1 of Regulations 111 as the

1944 amendment to section 29.22(d)-1 of Regulations 111.)

Section 22(d)(1) through (3) of the 1939 Code as amended was

reenacted with changes not pertinent here as section 472(a) and

(b) of the 1954 Code, ch. 736, sec. 472(a) and (b), 68A Stat.

159, and the latter section was reenacted with no changes as

section 472(a) and (b) of the 1986 Code, see Tax Reform Act of

1986, Pub. L. 99-514, sec. 2, 100 Stat. 2095. Sections 29.22(d)-

1 and -2 of Regulations 111, including the 1944 amendment to

section 29.22(d)-1 of Regulations 111, were repromulgated with

changes not pertinent here as regulations under section 472.

With this history as background, we shall address the

disagreement between the parties over whether Consolidated's LIFO

method contravenes the requirements of section 472 and the

regulations thereunder and therefore does not clearly reflect -36-

income. Consolidated’s remanufacturing business depended on a

supply of two raw materials: cores and new parts. During the

remanufacturing process, Consolidated incurred expenditures for

labor and overhead and transformed those raw materials into its

finished goods or products (viz, remanufactured automobile

parts). Thus, cores, new parts, labor, and overhead all entered

into the production of those finished goods or products.

Pursuant to section 1.471-1, Income Tax Regs., Consolidated

maintained inventories for each of the two unprocessed raw

materials that it used in its remanufacturing business, for

partly finished goods, i.e., goods in process of remanufacture

(goods in process), and for finished remanufactured goods

(finished goods).9 Virtually all of the cores included in

Consolidated’s inventories were, and we shall hereinafter refer

to them as, customer cores. See supra note 5.

Consolidated elected in the 1980 Form 970 to use the LIFO

inventory method with respect to new parts, labor, and overhead,

but not customer cores. Thus, under Consolidated's LIFO method,

Consolidated used (1) the LIFO inventory method for (a) new parts

that were included in its inventories for unprocessed new parts,

9 Although it is not altogether clear from the record, it appears that Consolidated maintained separate unprocessed new parts raw material inventories, unprocessed cores raw material inventories, goods in process inventories, and finished goods inventories in respect of the different types (e.g., remanufactured automobile engines) of goods or products that it produced (viz, remanufactured automobile parts). -37-

for goods in process, and for finished goods and (b) labor and

overhead that were included in Consolidated's inventories for

goods in process and for finished goods and (2) the FIFO

inventory method for customer cores that were included in its

inventories for unprocessed customer cores, for goods in process,

and for finished goods.

Respondent contends that section 472 and the regulations

thereunder require a taxpayer who wants to elect the LIFO

inventory method (1) to make that election with respect to a good

or goods subject to inventory and specified in the application

prescribed by the Secretary of the Treasury (Secretary) for

electing that method (viz, Form 970) and (2) to make that

election with respect to such entire good or goods and not a

portion thereof.10 According to respondent,

It is critical to note that the statute and the regulations specify that the election is to be made as to "goods". The goods produced by Consolidated are remanufactured automobile parts, such as remanufactured engines. Under the general rule, if Consolidated elected LIFO as to remanufactured automobile engines, the LIFO election would apply to raw materials, i.e. cores and new parts, and the reconditioning costs, i.e. labor and overhead. However, Consolidated elected as to only a portion of each type of good by excluding cores. * * * For each type of goods, such as remanufactured engines, this left a portion of the

10 Respondent concedes that a taxpayer may elect the LIFO inventory method with respect to a type or class of goods, such as remanufactured automobile engines, but contends that that election must be as to the "entire good", and not a portion of a good, within a type or class of goods. For convenience, generally we shall refer only to a good or goods, and not to a type or class of goods. -38-

goods (new parts and reconditioning costs) on LIFO, and a portion of the goods (cores) on FIFO.

A permissible variance to the inclusion of the total goods in LIFO is provided by Treas. Reg. § 1.472- 1(c) which allows the LIFO election to be restricted to raw materials. * * *

* * * Consolidated has fashioned a method of accounting that factors out inflationary price increases for part of a particular good (labor, overhead and a secondary raw material--new parts) and takes into account inflation and changes in market value for the remaining portion of the goods (the principal raw material--the core). This is inconsistent with the plain language of § 472 and the purpose of the LIFO method. A taxpayer must decide in toto for a type or class of goods whe- ther it will use either the LIFO method to currently deduct inflationary price increases or the LCM method to currently deduct decreases in the market value of production costs. A taxpayer is not permitted to use a hybrid of these two methods for a single type or class of goods.

In support of respondent’s position, respondent points,

inter alia, to section 472(a) and section 1.472-1(a), Income Tax

Regs. Section 472(a) provides in pertinent part: "A taxpayer may

use the [LIFO inventory] method * * * in inventorying goods

specified in an application to use such method". Section 1.472-

1(a), Income Tax Regs., elaborates on section 472(a), in

pertinent part, as follows:

Any taxpayer permitted or required to take inventories pursuant to the provisions of section 471, and pursuant to the provisions of §§ 1.471-1 to 1.471-9, inclusive, may elect with respect to those goods specified in his application and properly subject to inventory to compute his opening and closing inventories in accordance with the method provided by section 472, this section, and § 1.472-2. * * * -39-

Petitioner concedes in its opening brief that "Section 472

and the Regulations promulgated thereunder are worded in terms of

electing to value "goods" under the LIFO method". However,

according to petitioner:

Treasury Regulation Section 1.471-3(c) is clear that the "cost" of finished and partly finished goods consist [sic] of the "cost" of raw materials, labor and overhead. * * * Thus, * * * the finished and partly finished goods included in such an [LIFO] election necessarily consist of the cost attributable to raw materials, labor, and overhead.

Petitioner elaborates on the foregoing argument in its answering

brief, as follows:

Treasury Regulation Section 1.472-1 provides that "[a]ny taxpayer permitted or required to take inventories pursuant to the provisions of section 471, and pursuant to the provisions of §§ 1.471-1 to 1.471- 9, inclusive, may elect with respect to those goods specified in his application and properly subject to inventories to compute his opening and closing inventories in accordance with" the LIFO method. Treas. Reg. §1.472-1(a). The cost of raw materials, the cost of labor, and the cost of overhead are expressly identified as inventoriable costs in Treasury Regulation Section 1.471-3(c). Hence, such costs are included within the specified provisions identified in Treasury Regulation Section 1.472-1(a) for which the LIFO inventory method is expressly made available. Respondent may not, therefore, deny Petitioner's right to elect the LIFO method for labor and overhead costs or condition its right to make such an election on electing LIFO for the "good" produced by such labor and overhead.

We agree with respondent. We find petitioner's

interpretation of sections 1.471-3(c) and 1.472-1(a), Income Tax

Regs., on which it relies to be strained, and its reliance on -40-

those regulations to be misplaced.11 The latter regulation,

section 1.472-1(a), Income Tax Regs., merely provides that a

taxpayer who is allowed or required to use the inventory

accounting method as provided by section 471 and the regulations

thereunder may elect the LIFO inventory method under section 472,

but only "with respect to those goods specified in his

application and properly subject to inventory". The cross-

reference in section 1.472-1(a), Income Tax Regs., to all the

regulations promulgated under section 471, including section

1.471-3(c), Income Tax Regs., that were extant when section

1.472-1(a), Income Tax Regs., was promulgated is of no relevance,

let alone significance, in deciding whether section 472(a) and

the regulations thereunder mean what they say when they permit a

taxpayer to elect the LIFO inventory method in inventorying goods

specified in an application filed by such taxpayer.

The former regulation, section 1.471-3(c), Income Tax Regs.,

on which petitioner relies and to which section 1.472-1(a),

Income Tax Regs., inter alia, refers, merely defines the term

"cost", one of the two commonly used bases of inventory valuation

11 We also find petitioner’s reliance on Rev. Rul. 60-321, 1960-2 C.B. 166, to be misplaced. Petitioner argues that, because that ruling permitted a dealer in securities, which are intangibles, to account for such securities under the LIFO inventory method, Consolidated should be permitted to elect the LIFO inventory method for the inventoriable costs of its labor and overhead, which also are intangibles, even though they are not goods. Rev. Rul 60-321, supra, holds only that a taxpayer is permitted to elect the LIFO inventory method for the intangible goods, securities. -41-

that satisfy the requirements of section 471, to mean in the case

of inventories for goods in process and for finished goods--

(1) the cost of raw materials and supplies entering into or consumed in connection with the product, (2) expenditures for direct labor, and (3) indirect production costs incident to and necessary for the production of the particular article * * *

The foregoing definition of the term "cost" does not transform

the latter two items in that definition (viz, in the instant case

labor and overhead) into goods subject to inventory as to which a

taxpayer may elect the LIFO inventory method under section 472.

In other words, just because the costs of the labor and overhead

involved here are two of the three basic elements of cost that

were reflected in Consolidated’s inventories for goods in process

and for finished goods, see sec. 1.471-4(a), Income Tax Regs.,

does not convert labor and overhead into goods themselves as to

which Consolidated could have elected the LIFO inventory method

under section 472.

Nor does the fact that the cost of Consolidated’s new parts,

one of the two raw materials used by Consolidated in its

remanufacturing business, is a third basic element of cost that

also was reflected in Consolidated’s inventories for goods in

process and for finished goods, see id., mean that its labor and

overhead, when combined with its new parts, become goods as to

which Consolidated could have elected the LIFO inventory method

under section 472. As stated above, the goods produced by

Consolidated are remanufactured automobile parts or a type or -42-

class of such goods (e.g., remanufactured automobile engines).

Although Consolidated’s new parts, labor, and overhead enter into

the production, and thus are components, of those goods, another

raw material, indeed the principal raw material, that enters into

the production, and thus is a component, of the goods produced by

Consolidated is the customer cores. The labor and overhead

involved in this case are not goods. The new parts, labor, and

overhead involved in this case, when taken together but without

customer cores, do not constitute goods. However, the new parts,

labor, overhead, and customer cores involved in this case, when

taken together, do constitute goods and are included in and

comprise Consolidated's inventories for goods in process and for

finished goods.

Section 472(a) allows a taxpayer to elect the LIFO inventory

method in inventorying goods specified in the taxpayer's

application. That section does not state that a taxpayer may

elect the LIFO inventory method in inventorying other than a

good. Nor does that section state that a taxpayer may elect the

LIFO inventory method in inventorying a portion of a good. The

labor and overhead involved here are not a good, let alone the

entire good, of Consolidated subject to inventory, even though

they (1) enter into the production of Consolidated’s finished

goods (viz, remanufactured automobile parts) by transforming

Consolidated’s customer cores and new parts into such goods and

(2) are included, along with customer cores and new parts, in -43-

Consolidated’s inventories for goods in process and for finished

goods. Nor do the labor and overhead involved here become a

good, let alone the entire good, of Consolidated subject to

inventory when the new parts involved here are combined with

them. The goods of Consolidated subject to inventory as to which

it was permitted by section 472(a) and the regulations thereunder

to elect the LIFO inventory method are the remanufactured

automobile parts produced by Consolidated, a type or class of

those goods (e.g., remanufactured automobile engines), and, if

Consolidated had made the election permitted by section 1.472-

1(c), Income Tax Regs., which it did not, its raw material goods

(i.e., customer cores and/or new parts).

We conclude that section 472(a) requires a taxpayer who

wants to elect the LIFO inventory method (1) to make that

election with respect to a good or goods, which are subject to

inventory and specified in a Form 970 and which could include one

or more raw material goods used by a manufacturer or processor

that will become part of the merchandise intended for sale, see

sec. 1.472-1(c), Income Tax Regs., and (2) to make that election

with respect to such entire good or goods. That section does not

permit, and we do not construe it to allow, a taxpayer to make

such an election (1) with respect to other than such a good or

goods or (2) with respect to a portion thereof. If Congress had

intended to permit such an election under section 472, it would

have so provided in that section. It did not. -44-

Petitioner also relies on section 1.472-1(c), Income Tax

Regs., to support the validity of Consolidated’s LIFO method.

Petitioner asserts:

Respondent apparently believes that Treasury Regulation 1.472-1(c) supports her position in this matter. To the contrary. Treasury Regulation Section 1.472-1(c) contradicts her argument that the LIFO inventory method may only be elected with respect to goods. Under the raw material content method, a taxpayer's LIFO election is limited to the cost of raw materials, including the cost of the raw material content of work-in-progress and finished goods. Treas. Reg. § 1.472-1(c). The Regulation describes the manner in which a taxpayer may segregate the cost of one or more raw materials from work-in-progress and finished goods and value those costs using LIFO, while all other costs associated with work-in-progress and the finished good are valued under the FIFO convention. Thus, a taxpayer using the raw material content method elects to value the cost of raw materials (including the cost of raw materials incorporated into work-in-progress and finished goods) using the LIFO convention, not the raw material themselves. Rather than support her position in this matter, Treasury Regulation Section 1.472-1(c) provides further evidence of the validity of Petitioner's [sic] LIFO election. In addition, Respondent's attempt to characterize the raw material content method as the single "permissive variance to the inclusion of the total goods in LIFO" is not an accurate statement of the law. * * *

We disagree with the foregoing contentions of petitioner as

to what section 1.472-1(c), Income Tax Regs., which permits a

taxpayer to elect what we shall refer to as the raw material

content LIFO inventory method, provides and allows. We reject

petitioner’s position that that regulation "contradicts * * *

[respondent’s] argument that the LIFO inventory method may only

be elected with respect to goods." Section 1.472-1(c), Income

Tax Regs., which is virtually identical to the 1944 amendment to -45-

section 29.22(d)-1 of Regulations 111, provides in pertinent

(c) A manufacturer or processor who has adopted the LIFO inventory method as to a class of goods may elect to have such method apply to the raw materials only (including those included in goods in process and in finished goods) expressed in terms of appropriate units. If such method is adopted, the adjustments are confined to costs of the raw material in the inventory and the cost of the raw material in goods in process and in finished goods produced by such manufacturer or processor and reflected in the inventory. * * *

Section 1.472-1(j), Income Tax Regs., as did the 1944 amendment

to section 29.22(d)-1 of Regulations 111, states that the

election under section 1.472-1(c), Income Tax Regs., may "apply

to any one raw material, when two or more raw materials enter

into the composition of the finished product". We disagree with

petitioner’s assertions that, under section 1.472-1(c), Income

Tax Regs.,

a taxpayer’s LIFO election is limited to the cost of raw materials, including the cost of the raw material content of work-in-progress and finished goods. * * * [A] taxpayer using the raw material content [LIFO inventory] method elects to value the cost of raw materials (including the cost of raw materials incorporated into work-in-progress and finished goods) using the LIFO convention, not the raw materials themselves. * * *[12] [Emphasis added.]

12 Petitioner also contends that, because the examples in sec. 1.472-1(c), Income Tax Regs., illustrate the manner in which a raw material may be accounted for on the raw material content LIFO inventory method and labor and overhead on the FIFO inventory method,

It is not logical to conclude that when LIFO is elected for one raw material, together with labor and overhead, (continued...) -46-

Pursuant to section 1.472-1(c), Income Tax Regs., a manufacturer

or processor "may elect to have such [LIFO inventory] method

apply to the raw materials only (including those included in

goods in process and in finished goods)"; such an election is not

made with respect to the costs of such raw materials. Petitioner

takes the reference in section 1.472-1(c), Income Tax Regs., to

"costs of the raw material" out of context and misstates the

reason for that reference in that regulation. Once a manu-

facturer or processor has elected the raw material content LIFO

inventory method as to one or more raw materials (including those

included in goods in process and in finished goods), such a

taxpayer is required by section 472(b)(2) to inventory such raw

material(s) at cost. That is why section 1.472-1(c), Income Tax

Regs., states:

If such method [the raw material content LIFO inventory method] is adopted, the adjustments are confined to costs of the raw material in the inventory and the cost of the raw material in goods in process and in finished

(...continued) that a second raw material cannot be valued under FIFO * * *

We disagree. The examples in sec. 1.472-1(c), Income Tax Regs., merely illustrate how the adjustments should be made under the raw material content LIFO inventory method. Even if a taxpayer were to rely on those examples in calculating the adjustments under such taxpayer's LIFO inventory method, that taxpayer would not be able to use such a method unless it were permitted by or not inconsistent with sec. 472 and the regulations thereunder. -47-

goods produced by such manufacturer or processor and reflected in the inventory. * * *[13] [Emphasis added.]

We also disagree with petitioner's contention that section

1.472-1(c), Income Tax Regs., "provides * * * evidence of the

validity of Petitioner's [sic] LIFO election." As discussed

above and as made clear by that regulation, a manufacturer or

processor may elect to apply the LIFO inventory method to one or

more raw materials only, including those included in goods in

process and in finished goods. Consolidated could have elected,

but did not elect, to apply the raw material content LIFO

inventory method to its new parts and/or its customer cores.

Sec. 1.472-1(c), Income Tax Regs. It could not have elected to

apply that method to its new parts, labor, and overhead only or

to its labor and overhead only. Id. We conclude that section

1.472-1(c), Income Tax Regs., does not permit Consolidated's LIFO

method and does not provide "evidence of the validity of * * *

[Consolidated's] LIFO election."14

13 Under the raw material content LIFO inventory method, "The only adjustment to the closing inventory is the cost of the raw material [for which a taxpayer elects the raw material content LIFO inventory method]; the processing costs and overhead cost are not changed." Sec. 1.472-1(c), Income Tax Regs., Example (1) (last sentence). 14 Although petitioner concedes that it may not be used or cited as precedent, sec. 6110(j)(3), petitioner relies on Tech. Adv. Mem. 94-45-004 (Apr. 25, 1994) in an effort to show that respondent has permitted a taxpayer to account for one or more, but less than all, of its raw materials and all of its labor and overhead under the LIFO inventory method. It is not at all clear from Tech. Adv. Mem. 94-45-004 what, if any, of the labor and (continued...) -48-

To the contrary, we find section 1.472-1(c), Income Tax

Regs., to be consistent with respondent’s position regarding

Consolidated's LIFO method. The Secretary promulgated that

regulation under the authority granted by section 472(a) to

prescribe regulations "as necessary in order that the use of such

[LIFO inventory] method may clearly reflect income".15 As

discussed above, the raw material content LIFO inventory method

authorized by section 1.472-1(c), Income Tax Regs., permits a

manufacturer or processor who has adopted the LIFO inventory

method with respect to a class of goods to apply that method to

"the raw materials only (including those included in goods in

process and in finished goods)". Raw materials are goods.

(...continued) overhead in question ultimately were allowed to be on, or ultimately were disallowed from being on, the LIFO inventory method upon examination of the income tax returns of the taxpayer. To the extent that Tech. Adv. Mem. 94-45-004 may be read to suggest that a taxpayer may validly elect the LIFO inventory method with respect to all of its labor and overhead, but not all of its raw materials, that enter into the production of a good or type or class of goods, we reject any such suggestion as contrary to sec. 472 and the regulations thereunder. 15 The position of the Secretary in sec. 1.472-1(c), Income Tax Regs., is identical to the position taken by the Commissioner and approved by the Secretary under the original predecessor of sec. 472 (viz, sec. 22(d)(2) of the 1939 Code as amended), which was set forth in the 1944 amendment to sec. 29.22(d)-1 of Regulations 111. We have found nothing in sec. 472, its predecessor provisions, or their legislative history which establishes that sec. 1.472-1, Income Tax Regs., and its predecessor regulations, as they relate to the raw material content LIFO inventory method, were intended to be anything other than a proper interpretation of the statutory language under which those regulations were promulgated. -49-

Section 1.472-1(c), Income Tax Regs., is consistent with section

472(a) and section 1.472-1(a), Income Tax Regs., which require a

taxpayer who wants to elect the LIFO inventory method to make

that election with respect to a good or goods, which are subject

to inventory and specified in a Form 970, and with respect to

such entire good or goods. When a manufacturer or processor

elects the raw material content LIFO inventory method under

section 1.472-1(c), Income Tax Regs., the good or goods specified

in a Form 970 to which that method applies are one or more raw

materials, and not the goods produced or processed by such a

taxpayer, and that method must be applied to such entire raw

material goods. See sec. 1.472-1(c), (j), Income Tax Regs.

Respondent also points to section 472(b) in support of

respondent’s position that Consolidated's LIFO method is contrary

to the requirements of section 472 and the regulations

thereunder. We agree. Section 472(b) states: "In inventorying

goods specified in the application described in subsection (a),

the taxpayer shall * * * (2) Inventory them at cost". Section

472(b) thus requires a taxpayer who has elected the LIFO

inventory method under section 472(a) to inventory the good or

goods specified in a Form 970 at cost. That section does not

permit, and we do not construe it to allow, a taxpayer to

inventory at cost (1) other than such a good or goods or (2) a

portion of such a good or goods. -50-

As further support for respondent’s position that

Consolidated’s LIFO method contravenes the requirements of

section 472 and the regulations thereunder, respondent directs

our attention to section 1.472-8, Income Tax Regs., the

regulations under section 472 relating to the dollar-value LIFO

inventory method. According to respondent, Consolidated’s LIFO

method contravenes those regulations.16 We agree. Regardless of

the different types of pools that a taxpayer may use if such

taxpayer elects the dollar-value LIFO inventory method (e.g.,

natural business unit pools, multiple pools, or pools established

under the IPI computation method), that method must be used with

respect to a good or goods subject to inventory and specified in

a Form 970 and with respect to such entire good or goods. See

sec. 1.472-8(b), (e), Income Tax Regs.

16 Petitioner argues that respondent's contention that Consolidated’s LIFO method contravenes the dollar-value LIFO inventory method regulations under sec. 472 is a new matter in respect of which the burden of proof is on respondent under Rule 142(a). We disagree. The determinations in the 1990 notice and the 1991 notice are stated quite broadly, and we construe them to encompass respondent’s contentions relating to Consolidated’s dollar-value LIFO inventory method. Respondent determined in the 1990 notice: "Since you did not include the cost of yard cores in the LIFO calculation of inventory for taxable year 1990 as required in accordance with your LIFO election, taxable income is increased by the amount of your LIFO reserve". An identical determination for 1991 appears in the 1991 notice. Even if we were not to address respondent's argument under the regulations relating to the dollar-value LIFO inventory method because it is a new matter, our holding regarding Consolidated's LIFO method would not change. -51-

To illustrate, pursuant to the rules for establishing

natural business unit pools, a pool is to consist of all items

entering into the entire inventory investment for a natural

business unit of a business enterprise,17 unless the taxpayer

elects to use the multiple pooling method provided in section

1.472-8(b)(3), Income Tax Regs. If a business enterprise is

comprised of only one natural business unit, one pool is to be

used for "all of its inventories, including raw materials, goods

in process, and finished goods". Sec. 1.472-8(b)(1), Income Tax

Regs. If a business enterprise is composed of more than one

natural business unit, more than one pool is required. Id.

To illustrate further, a taxpayer may elect to establish

multiple pools for inventory items that are not within a natural

business unit as to which the taxpayer has adopted the natural

business unit method of pooling as provided in section 1.472-

8(b)(1), Income Tax Regs. Sec. 1.472-8(b)(3)(i)(a), Income Tax

Regs. In the event of such an election, each such pool is

ordinarily to consist of a group of inventory items that are

substantially similar, which is to be determined based on all the

17 Whether an enterprise consists of more than one natural business unit is a matter of fact to be determined from all the circumstances. Sec. 1.472-8(b)(2)(i), Income Tax Regs. In the case of a manufacturer, like Consolidated, a natural business unit "ordinarily consists of the entire productive activity of the enterprise within one product line or within two or more related product lines including * * * the obtaining of materials, the processing of materials, and the selling of manufactured * * * goods." Id. -52-

facts and circumstances. Id. Pursuant to the rules for

establishing multiple pools, unprocessed raw materials which are

substantially similar are to be pooled together, and goods in

process and finished goods in the inventory are to be placed in

pools classified by major types or classes of goods.18 Sec.

1.472-8(b)(3)(i)(b) and (c), Income Tax Regs.

In the face of various provisions in section 472 and the

regulations thereunder that respondent contends, and we agree,

are contrary to Consolidated’s LIFO method, petitioner argues

that taxpayers are afforded great flexibility with respect to the

dollar-value LIFO inventory method and computational procedures

under that method. Consequently, according to petitioner,

Consolidated should be afforded great flexibility with respect to

Consolidated's LIFO method. In support of that position,

petitioner cites section 1.472-1(a), (l) and section 1.472-

8(b)(3)(i)(d), Income Tax Regs.

Section 1.472-1(a), Income Tax Regs., provides in pertinent

18 The requirement in sec. 1.472-8(b)(3)(i)(b) and (c), Income Tax Regs., that a taxpayer establish pools by major types of materials or major classes of goods does not preclude the establishment of a miscellaneous pool. Because a taxpayer may elect the dollar-value LIFO inventory method with respect to all or any designated goods in such taxpayer’s inventory, there may be a number of such inventory items covered in the election. A miscellaneous pool is to consist only of items that are rela- tively insignificant in dollar value when compared to other inventory items in the particular trade or business and that are not properly includible as part of another pool. Sec. 1.472- 8(b)(3)(i)(d), Income Tax Regs. -53-

The LIFO inventory method is not dependent upon the character of the business in which the taxpayer is engaged or upon the identity or want of identity through commingling of any of the goods on hand, and may be adopted by the taxpayer as of the close of any taxable year.

The foregoing regulation does not permit a taxpayer flexibility

to elect a LIFO inventory method that is contrary to the

requirements of section 472 and the regulations thereunder.

Section 1.472-1(l), Income Tax Regs., provides:

If a taxpayer uses consistently the so-called "dollar- value" method of pricing inventories, or any other method of computation established to the satisfaction of the Commissioner as reasonably adaptable to the purpose and intent of section 472 and this section, and if such taxpayer elects under section 472 to use the LIFO inventory method authorized by such section, the taxpayer's opening and closing inventories shall be determined under section 472 by the use of the appropriate adaptation. * * *

Petitioner directs us to the reference in the foregoing

regulation to "any other method of computation". Consolidated

elected the dollar-value LIFO inventory method in the 1980 Form

970 and the 1982 Form 970. It did not elect "any other method of

computation" referred to in the foregoing regulation. Even if

Consolidated had used any such other method, it would have been

required to establish to the satisfaction of respondent that such

other method is "reasonably adaptable to the purpose and intent

of section 472 and" the regulations thereunder. Consolidated has

failed to make such a showing to respondent or to the Court.

Petitioner also argues that section 1.472-8(b)(3)(i)(d),

Income Tax Regs., supports its position that Consolidated should -54-

be afforded great flexibility regarding its LIFO method. That

regulation provides in pertinent part that "a taxpayer may elect

the dollar-value LIFO inventory method with respect to all or any

designated goods in his inventory". Contrary to petitioner's

argument, we find that the foregoing language in section 1.472-

8(b)(3)(i)(d), Income Tax Regs., supports respondent's position

and is consistent with section 472(a) which requires a taxpayer

who elects the LIFO inventory method to make that election with

respect to a good or goods subject to inventory and specified in

a Form 970.19

The issue relating to Consolidated’s LIFO method is one that

is answered by the requirements of section 472 and the

regulations thereunder. The Court has no flexibility to rewrite

section 472. Our flexibility to reject the legislative

regulations under section 472 that are implicated here is quite

limited; those regulations must be upheld unless they are

arbitrary, capricious, or manifestly contrary to section 472.

19 Petitioner also cites the following cases in support of its contention that this Court has shown a willingness to allow flexibility with respect to the dollar-value LIFO inventory method and computational matters relating thereto: Richardson Invs., Inc. v. Commissioner, 76 T.C. 736 (1981); Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708, 727 (1981); and Amity Leather Prods. Co. v. Commissioner, 82 T.C. 726, 734 (1984). In each of those cases, the taxpayer elected the LIFO inventory method as to a good or goods or a type or class of goods and as to such entire good or goods or type or class thereof. In none of those cases was the Court presented with the issue that we now are addressing. -55-

Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc.,

467 U.S. 837, 844 (1984).

Petitioner also contends that section 472 and its

predecessor provisions in the Internal Revenue laws have been

interpreted broadly and that the Court should interpret that

section broadly in this case and find that Consolidated's LIFO

method does not contravene it or the regulations thereunder. In

support of that contention, petitioner cites several cases,

including Hutzler Bros. Co. v. Commissioner, 8 T.C. 14, 29

(1947). We find all of those cases to be distinguishable and

petitioner's reliance on them to be misplaced. In the interest

of brevity, we shall discuss only the Hutzler Bros. Co. case.

Because of the number and diversity of the goods of the

taxpayer involved in Hutzler Bros. Co. v. Commissioner, supra,

the taxpayer, a department store retailer, devised a LIFO

inventory method that reduced the goods to their lowest common

denominator, viz, a dollar figure. That method, which is now

known as the dollar-value LIFO inventory method, was not

expressly permitted by regulation for the year before the Court

in the Hutzler Bros. Co. case. Hutzler Bros. Co. v.

Commissioner, supra at 24. The only method for that year that

was permitted by the regulations under section 22(d) of the 1939

Code as amended, a predecessor of section 472, was a method that

required the identification of specific goods in a taxpayer’s

inventory, a method known as the specific goods LIFO inventory -56-

method, see sec. 1.472-2, Income Tax Regs. The Court in Hutzler

Bros. Co. v. Commissioner, supra, reviewed the legislative

history of not only section 22(d) of the 1939 Code as amended,

which was applicable to the year at issue, but also section 22(d)

of the 1938 Act, 52 Stat. 459, and concluded that "the purpose of

the lawmakers was to have it [the LIFO inventory method] apply in

general terms to all those coming within its provisions." Id. at

29. The Court explained that, in contrast to the determination

under the LIFO inventory method of the merchandise to which a

cost is to be attributed in the case of a manufacturer, the

determination under the LIFO inventory method of the merchandise

to which a cost is to be attributed "becomes difficult in the

case of a retail merchant primarily because of the complications

of the retail method itself." Id. at 30. The Court added:

The * * * process engaged in by petitioner [a retail merchant] is to reduce the price level of the retail stock to that prevailing as of the opening inventory, and thereby to identify the merchandise remaining in inventory at the close of the year as that constituting inventory at the beginning of the year to the extent of the size of the opening inventory. That this is done by dealing with the merchandise stated in terms of dollars rather than of numbers or quantities is a requisite of the aspect of department store accounting which relies for its inventory volume on a statement in dollars alone. [Id.]

The Court rejected respondent's contention that stating inventory

in terms of "dollars instead of other measures of quantity has

the effect of distorting the inventory content", pointing out

that the "retail method has been used with respondent's complete -57-

approval for too long a time for the assumption to be permissible

that the contents of an inventory can not be satisfactorily

represented for all purposes by its expression in dollars only".

Id. The Court then examined the LIFO inventory method used by

Hutzler Brothers Company and held that that method was permitted

by section 22(d) of the 1939 Code as amended and clearly

reflected income even though it was not expressly permitted by

the regulations under that section. Id. at 28-31.

Although we find Hutzler Bros. Co. v. Commissioner, supra,

to be distinguishable from the instant case, the following

explanation by the Court in that case of the LIFO inventory

method is instructive and rejects petitioner's position here:

The process envisaged by Lifo involves not so much the ascertainment of cost as the ascertainment of what it is of which we are to discover the cost. The last in, first out formula assumes that the merchandise remaining in inventory is that which was first purchased. * * *

If we were dealing with a fabricator or manufacturer, the first step would be to determine which merchandise it is to which a cost is to be attributed, and the second, to determine that cost. * * * [Emphasis added.]

Hutzler Bros. Co. v. Commissioner, supra at 30. We see no reason

to elaborate further on the foregoing succinct explanation in the

Hutzler Bros. Co. case regarding what the "process envisaged by"

the LIFO inventory method is. -58-

We conclude that petitioner has not shown that respondent

abused respondent’s discretion in determining that Consolidated's

LIFO method is contrary to the requirements of section 472 and

the regulations thereunder and that therefore that method does

not clearly reflect income.

We shall next address the parties' dispute over whether

respondent abused respondent's discretion in terminating

Consolidated's election to use Consolidated's LIFO method because

that method does not clearly reflect income. Petitioner contends

that in the event that the Court were to find that Consolidated's

LIFO method does not clearly reflect income, respondent would not

be permitted to terminate Consolidated's election to use that

method provided that Consolidated agrees to account for its

customer cores under the LIFO inventory method and to make any

necessary adjustments resulting therefrom.20 Petitioner asserts:

20 In conceding that Consolidated would have to make "any necessary adjustments", we believe that petitioner is acknowledging that Consolidated would be required to produce the books and records needed to make such adjustments. However, petitioner did not produce at trial any of Consolidated's books and records that would be required to make "any necessary adjustments". Instead, without even indicating on brief whether or not Consolidated has the books and records to make "any necessary adjustments", petitioner takes the position that respondent must establish that Consolidated does not have such books and records because whether or not it does is a new matter on which respondent has the burden of proof. We disagree. It is petitioner who is claiming that Consolidated should be permitted to modify its LIFO election to include customer cores provided that, inter alia, Consolidated establishes that it can, and does, make "any necessary adjustments". Petitioner has failed to establish its ability to make such adjustments. -59-

It would be unreasonable, unduly punitive, and constitute an abuse of her discretion for Respondent to terminate * * * [Consolidated's] LIFO election because Petitioner has sought judicial review of her determination that it is essential to a clear reflection of income that its [customer] core inventory be included in the LIFO election.

In support of its position, petitioner cites, inter alia, Rev.

Proc. 79-23, 1979-1 C.B. 564, and section 1.472-3(c), Income Tax

Regs.21

We first turn to Rev. Proc. 79-23, supra, on which

petitioner relies. Petitioner contends that Rev. Proc. 79-23,

supra, "provides that a termination of a taxpayer's LIFO election

may be warranted only where one of four specified circumstances

exists". Petitioner maintains that the present case does not

involve any of those four situations.22 We note initially that

21 Petitioner also cites Tech. Adv. Mem. 79-47-001 (July 25, 1979) to show "that Respondent has previously recognized that a taxpayer may contest her determination regarding LIFO inventory matters without the threat of having its LIFO election terminated." Petitioner's reliance on Tech. Adv. Mem. 79-47-001 is misplaced. Tech. Adv. Mem. 79-47-001, which has no precedential value, sec. 6110(j)(3), involved an adjustment proposed by the District Director pursuant to sec. 1.472-4, Income Tax Regs., to "perfect the [taxpayer's] LIFO election", and not a termination of that election. To the extent that Tech. Adv. Mem. 79-47-001 may be read to suggest that respondent does not have the authority in this case to terminate Consolidated's election to use Consolidated's LIFO method, such a reading is wrong. See sec. 446(b); sec. 1.472-3(d), Income Tax Regs. 22 Petitioner further contends that the exclusion of customer cores from Consolidated's LIFO pools fits within one or both of the following situations described in sec. 3.02(b) and (d) of Rev. Proc. 79-23, 1979-1 C.B. 564, 565, as to which respondent has indicated termination of a LIFO election is not warranted: (continued...) -60-

Rev. Proc. 79-23, supra, does not provide the only circumstances

in which respondent will, in respondent's discretion, terminate a

taxpayer's LIFO election. In any event, one of the four

situations described in Rev. Proc. 79-23, supra, in which

respondent will, in respondent's discretion, terminate such an

election is found in section 3.01(b) of that revenue procedure,

viz, "Failure by the taxpayer to properly elect the LIFO method".

That situation exists in the instant case. We have held that,

contrary to the requirements of section 472 and the regulations

thereunder, Consolidated's LIFO election did not apply to an

entire good or goods subject to inventory and specified in a Form

970. Consequently, Consolidated failed "to properly elect the

22 (...continued) (b) Selection by the taxpayer of a fewer or greater number of inventory pools than those determined by an examining agent; * * * * * * * (d) The taxpayer improperly including (or excluding) a specific item in a particular inventory pool * * *

We do not believe that the situation presented here is described in sec. 3.02(b) or (d) of Rev. Proc. 79-23, supra. Respondent does not take the position that Consolidated selected too few or too many inventory pools, nor does respondent take the position that Consolidated improperly included or excluded a specific item in a particular inventory pool. Respondent is arguing, inter alia, that, regardless of the different types of pools that a taxpayer may use if such taxpayer elects the dollar-value LIFO inventory method, that method must be used with respect to a good or goods subject to inventory and specified in a Form 970 and with respect to such entire good or goods. -61-

LIFO method" when it filed the 1980 Form 970 and the 1982 Form

970.23

We now turn to section 1.472-3(c), Income Tax Regs., on

which petitioner relies. That regulation provides:

As a condition to the taxpayer's use of the LIFO inventory method, the Commissioner may require that the method be used with respect to goods other than those specified in the taxpayer's statement of election if, in the opinion of the Commissioner, the use of such method with respect to such other goods is essential to a clear reflection of income.

Petitioner contends that in the instant case the foregoing

regulation "does not authorize Respondent to terminate a

taxpayer's LIFO election". Petitioner's reliance on section

1.472-3(c), Income Tax Regs., is misplaced. That regulation

authorizes respondent to require a taxpayer who has elected the

LIFO inventory method with respect to an entire good or goods

subject to inventory and specified in a Form 970 to apply the

LIFO inventory method to any other such good or goods but not

specified in that form. In the present case, respondent is not

seeking to require Consolidated, which did not elect the raw

material content LIFO inventory method, to apply the LIFO

inventory method to a good or goods subject to inventory but not

specified in the 1980 Form 970 and the 1982 Form 970. Conse-

23 We reject the suggestion of petitioner that sec. 3.01(b) of Rev. Proc. 79-23, supra at 564, applies only to the procedural requirements for electing the LIFO inventory method. See Rev. Proc. 76-28, 1976-2 C.B. 645. -62-

quently, section 1.472-3(c), Income Tax Regs., is not apposite

here.

The pertinent authority governing disposition of the issue

regarding respondent's termination of Consolidated's LIFO

election is section 446(b) and section 1.472-3(d), Income Tax

Regs. Section 446(b) provides:

(b) Exceptions.--If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.

The foregoing section permits respondent to terminate a

taxpayer's method of accounting that does not clearly reflect

income (here, Consolidated's LIFO method) and to require the

taxpayer to use a method (here, the FIFO inventory method) that

does clearly reflect income.

Section 1.472-3(d), Income Tax Regs., provides:

(d) Whether or not the taxpayer's application for the adoption and use of the LIFO inventory method should be approved, and whether or not such method, once adopted may be continued, and the propriety of all computations incidental to the use of such method, will be determined by the Commissioner in connection with the examination of the taxpayer's income tax returns.

Under the foregoing regulation, it is within respondent's

discretion to determine whether or not a "taxpayer's application

for the adoption and use of the LIFO inventory method should be

approved * * * and * * * continued". -63-

abused respondent's discretion in terminating Consolidated's

election to use Consolidated's LIFO method.

Amounts at Which Customer Cores Should Be Reflected in Inventory

As permitted by section 1.471-2(c), Income Tax Regs.,

Consolidated chose to apply the LCM basis of valuation in

accounting for its customer cores under the FIFO inventory

method. In applying LCM in its returns for the years at issue,

Consolidated reflected the customer cores (1) in its finished

goods inventory at core supplier amounts and (2) in its unpro-

cessed cores raw material inventory and its goods in process

inventory at scrap value. Respondent determined that Conso-

lidated's FIFO-LCM method did not reflect the customer cores in

its inventories at the proper amounts. We must decide whether

respondent abused respondent's discretion in making that

determination. That inquiry requires us, inter alia, to

determine the cost and the market for Consolidated's customer

cores for purposes of section 471.

As we understand it, it is petitioner's position that

Consolidated's FIFO-LCM method conforms to GAAP and clearly

reflects income. Respondent disagrees. For financial reporting

purposes, Consolidated reflected its customer cores in all of its

inventories at core supplier amounts. However, for tax purposes,

Consolidated reflected customer cores in its finished goods

inventory at core supplier amounts; it reflected customer cores -64-

in its unprocessed cores raw material inventory and its goods in

process inventory at scrap value. On the record before us, we

find that petitioner has not met its burden of establishing that

Consolidated's FIFO-LCM method conforms to GAAP or that that

method otherwise satisfies the requirement in section 471 that it

conform "as nearly as may be to the best accounting practice in

the trade or business".

We shall now consider whether Consolidated's FIFO-LCM method

satisfies the requirement under section 471 that that method

clearly reflect income. In support of that position, petitioner

contends that Consolidated obtained customer cores in exchange,

and not purchase, transactions and that therefore the cost and

the market for those cores for purposes of section 471 are to be

determined on the basis of the respective fair market values of

those cores. According to petitioner, those values were either

the salvage yard cost for non-bin salvage yard cores or the scrap

value for bin salvage yard cores that did not pass inspection at

Bishop Engine's place of business.24

24 Petitioner asserts on brief:

[T]he price paid [the salvage yard cost] by core suppliers to purchase cores from salvage yards on an individual basis [non-bin salvage yard cores] should be determinative of the actual value of cores received by * * * Consolidated from its customers. In this regard, at trial Mr. Bishop, the President of one of the largest core suppliers in the country, testified that the cores received by remanufacturers from their customers are the cores [bin salvage yard cores which (continued...) -65-

Petitioner further asserts that even if the Court were to

find that the transactions by which Consolidated acquired

customer cores were purchases, and not exchanges, only the

respective fair market values of those cores are the cost and the

market for purposes of section 471 and that the alleged excesses

24 (...continued) did not pass inspection at Bishop Engine's place of business] that core suppliers do not ordinarily purchase from salvage yards, except at scrap value. Thus, for a substantial number of the cores received by * * * Consolidated from its customers, the fair market value of such cores is, as correctly reported on its 1990 and 1991 federal income tax returns, scrap value. * * * [Citations omitted.]

Assuming arguendo that fair market value were the proper criterion under sec. 471, petitioner's position regarding what the fair market values of its customer cores were appears to be inconsistent. On the one hand, petitioner contends that the salvage yard cost for non-bin salvage yard cores "should be determinative of the actual value of" Consolidated's customer cores. On the other hand, petitioner asserts that "Mr. Bishop * * * testified that the" customer cores of the type acquired by Consolidated are comparable to bin salvage yard cores which did not pass inspection at Bishop Engine's place of business and which were purchased by core suppliers from salvage yards at scrap value. Consequently, according to petitioner "for a substantial number of" Consolidated's customer cores, the fair market value was scrap value. In any event, even assuming arguendo that we were to agree with petitioner that either the salvage yard cost for non-bin salvage yard cores or the scrap value for bin salvage yard cores which did not pass inspection at Bishop Engine's place of business is the determinant of the cost and the market for customer cores for purposes of sec. 471, which we do not, petitioner has not established either what those amounts were or that, "for a substantial number" of customer cores, those amounts did not exceed scrap value. Moreover, petitioner concedes that at least with respect to other than "a substantial number" of Consolidated's customer cores, Consolidated erred when it included in its returns those cores in its unprocessed raw materials inventory and in its goods in process inventory at scrap value. -66-

over such cost and market that Consolidated credited to each

customer account receivable are deductible expenses under section

162.

In support of respondent's position that Consolidated's

FIFO-LCM method does not clearly reflect income, respondent

contends that Consolidated acquired customer cores in purchase,

and not exchange, transactions and that therefore the cost and

the market for those cores for purposes of section 471 are to be

determined by reference to the invoice prices that were shown on

the customer core sales invoices. According to respondent, those

invoice prices are the amounts (viz, the core credit amounts)

that Consolidated credited to each customer account receivable

and that were shown on those invoices under the column headed

"Cores--Price Each".25

Respondent further asserts that even if the Court were to

customer cores were exchanges, and not purchases, respondent's

25 On brief respondent uses the term "core amount" when refer-ring to the amount that Consolidated credited to each customer account receivable for each core that it acquired. In fact, the amount of such a credit was generally equal to the core amount, and we assume that respondent uses the term "core amount" for convenience. However, because of, inter alia, the condition of each customer core that a customer decided to deliver to Consol-idated, it was possible that Consolidated sometimes credited to a customer account receivable an amount that was less than the core amount. Unless we are quoting from the briefs of the parties, we shall refer to the amounts that Consolidated credited to each customer account receivable as the core credit amounts. -67-

position as to what are the cost and the market for Conso-

lidated's customer cores for purposes of section 471 would not

change.

Purchase vs. Exchange Transactions

In support of petitioner's position that Consolidated

acquired customer cores in exchange transactions, petitioner

asserts:

Petitioner's method of obtaining cores from its customers is, at its root, an exchange of a remanu- factured automobile part for a sum of money (the exchange amount) plus the customer's core. * * * Respondent's attempt to characterize the core deposit[26] as the "cost" to Petitioner of a core provided to it by a customer is apparently founded in Treasury Regulation 1.471-3(b) and assumes that the core deposit is the "invoice price" of the core. Respondent's position ignores both the absence of an "invoice" or "invoice price" relating to a customer core and the fundamental nature of the transaction between Petitioner and its customer.

Petitioner's customers do not issue invoices to Petitioner. On the sale of a remanufactured automobile part, Petitioner issues an invoice to its customer that reflects an exchange amount and a core deposit. * * * The core deposit is reflected on the invoice with the understanding that the customer can return his or her core and receive back from Petitioner the full amount of the core deposit shown. * * * The recording of the core deposit on Petitioner's invoice is, therefore, simply the posting of a customer deposit to secure the return of the customer's core. Further, the refunding of the core deposit and the issuance of a credit invoice by Petitioner to a customer simply documents

26 Petitioner uses the term "core deposit" on brief presumably because it contends that the core amount for a customer core represents a deposit made by Consolidated's customer to secure "the return of the customer's core", which was to be refunded at the time that customer decided to deliver a customer core to Consolidated. -68-

the refunding of that deposit. Finally, the credit invoice [customer core sales invoice] issued by Petitioner to its customers relates to the sale of the remanufactured automobile part to the customer, not the purchase of a core by Petitioner. The absence of an invoice or invoice price regarding customer cores is not surprising when the transaction between Petitioner and its customer is analyzed for what it is: an exchange in which the customer's core is received by Petitioner as partial payment for the remanufactured automobile part sold.

When a customer purchases one of Petitioner's remanufactured automobile parts, the customer must either provide to Petitioner a core, corresponding in type and style to the remanufactured automobile part purchased, or post a core deposit with the under- standing that the deposit will be refunded when the customer returns his or her core. * * * If a customer were to provide a core to Petitioner at the time of sale, the existence of the exchange would be indis- putable: the customer receives a remanufactured automobile part in exchange for cash (the exchange amount) and the customer's core. See Treas. Reg. § 1.1002-1(d)(exchange defined as a reciprocal transfer of property, as distinguished from a transfer of property for a money consideration only). The fact Petitioner's customers do not generally provide a core to it at the time of sale does not, as Respondent would have this Court hold, transform the transaction into two separate sales.

It is well established "that an integrated transaction may not be separated into components for the purposes of taxation by either the Internal Revenue Service or the taxpayer." Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652, 658 (5th Cir. 1968); see also Kanawha Gas & Utilities Co. v. Commissioner of Internal Revenue, 214 F.2d 685, 691 (5th Cir. 1954) * * *

In Burrell v. Commissioner, 400 F.2d 682 (10th Cir. 1968), affirming 26 T.C.M. (CCH) 748 (1967), a case factually indistinguishable from the one at bar, the exchange * * * analysis set forth above * * * [was] recognized by both the Tax Court and the Tenth Circuit Court of Appeals. [Fn. ref. omitted.] -69-

In support of respondent's position that Consolidated

acquired customer cores in purchase transactions, respondent

The parties have stipulated that when Consolidated sells a remanufactured automobile part to a customer, it receives a total sales amount. * * * The total sales amount, consisting of the exchange amount plus core amount, is taken into income as a cash/credit transaction. * * * A customer core may or may not subsequently be acquired by Consolidated at the core amount. If it is, this is a separate cash/credit transaction whereby Consolidated is out-of-pocket the core amount. * * * The [customer core sales] invoices * * * use the term "price each", not "refund" or "deposit" when referring to the value given up by Consolidated for cores provided to Consolidated by its customers. These stipulated facts are not indicative of an "exchange transaction" as advocated by petitioner. These facts also do not support the proposition that the customer cores are obtained by Consolidated at little or no out-of-pocket cost.

Petitioner acknowledges that Consolidated's customers do not generally provide a core to Consolidated at the time a remanufactured part is sold. In fact, an entire year may go by before a customer provides a core. Nevertheless, petitioner presents a scenario in support of the exchange argument in which the core is provided simultaneously. Petitioner has not established in the record that such a scenario is treated any differently than a normal core acquisition. It is instructive to consider the scenario wherein Consolidated knows, at the time that a remanufactured part is sold, that the customer cannot provide a core. The stipulated facts indicate the customer would still pay the core amount although there is no possible core return to be "secured".

Petitioner's argument that it acquires cores in an integrated transaction does not comport with the facts. Consolidated's customers are not required to provide a core. The remanufactured part is not sold to the customer contingent upon a core being provided. There -70-

is no evidence that any negotiation whatsoever is permitted regarding the price of the remanufactured part. The customer must pay the stated or list price of the remanufactured part, even if Consolidated knows that the customer will not provide a core.

We have found the following facts on the instant record:

At the time a customer purchased a remanufactured automobile part

from Consolidated, (1) that customer became obligated to pay

Consolidated the remanufactured automobile part sales price

which consisted of the exchange amount and the core amount and

which, along with the exchange amount and the core amount,

Consolidated reflected on the remanufactured automobile part

sales invoice that it generated for that sale and (2) Consoli-

dated offered to purchase from that customer a customer core

corresponding to that part for the customer core purchase offer

amount. There was no obligation on the part of that customer to

deliver a customer core to Consolidated as part of that sale.

The remanufactured automobile part sales price, the customer core

purchase offer amount, and the core credit amount were determined

on the basis of market-related factors, including supply and

demand. Consolidated accounted for each remanufactured

automobile part that it sold to a customer by making entries

increasing (1) "sales (exchange amount)" by the exchange amount

that was part of the remanufactured automobile part sales price

for each such part, (2) "sales (core amount)" by the core amount

that was part of that price for each such part, and (3) "customer

account receivable" by that price for each such part. If a -71-

customer, even though under no obligation to do so, decided to

accept Consolidated's offer to purchase and delivered a customer

core to Consolidated and if that core satisfied Consolidated's

requirements for acceptance of a customer core, Consolidated

(1) purchased that core for a price which generally was equal to

the core amount (i.e., the core credit amount) and which was

shown on the customer core sales invoice under the column headed

"Cores--Price Each" and (2) paid for it by crediting that

customer's customer account receivable in an amount equal to that

price (viz, the core credit amount). The customer core purchase

offer amount and the core credit amount for each customer core

were set at an amount that the marketplace in which Consolidated

The facts that we have found on the record in this case and

the issue under section 471 that is presented to us distinguish

this case from Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652

(5th Cir. 1968), and Burrell v. Commissioner, 400 F.2d 682 (10th

Cir. 1968), affg. T.C. Memo. 1967-160, the principal cases on

which petitioner relies to support its position that Consolidated

acquired customer cores in exchange, and not purchase,

transactions. Consequently, we find petitioner's reliance on

those cases to be misplaced.

The Court of Appeals for the Fifth Circuit began its opinion

in Redwing Carriers, Inc. v. Tomlinson, supra, by framing the

issue presented to it as follows: -72-

This case involves another attempt by a taxpayer to insulate himself from the incidence of taxation by means of paper armor. The question presented is whether a taxpayer may shape what is essentially an integrated purchase and trade-in transaction of new and used trucks into two separate transactions in order to recognize an immediate gain at capital gains rates and concomitantly to take a larger depreciation deduction from ordinary income. * * * [Redwing Carriers, Inc. v. Tomlinson, supra at 654.]

The Court of Appeals then recited certain facts relevant to its

resolving the foregoing issue, including the following, which it

characterized as "indicia of transactional unity". Id. at 655.

During 1958, 1959, and 1961, respectively, the taxpayer, a

profitable trucking concern and a prestigious account for General

Motors Corporation (G.M.C.) and White Motor Company (White),

transferred title to 27, 36, and 14 used trucks to G.M.C., and at

about the same time the taxpayer's wholly owned subsidiary

acquired 28, 36, and 14 new trucks from G.M.C. Id. During 1959,

transactions in like form were executed with White. Id. The

taxpayer was in a strong bargaining position vis-a-vis G.M.C. and

White. Consequently, it succeeded in having the form of each

transfer by it of used trucks and each acquisition by its

subsidiary of new trucks cast as a sale and a purchase,

respectively. It also succeeded in having the aggregate price

for such alleged sales set at an amount in excess of the

aggregate fair market value of the used trucks that it

transferred to G.M.C. and White and the aggregate price for such

alleged purchases set at an amount in excess of the aggregate -73-

fair market value of the new trucks that its subsidiary acquired

from those companies. Id. In negotiating the foregoing

transactions with G.M.C. and White, Charles E. Mendez (Mendez),

the president and chairman of the board of both the taxpayer and

its subsidiary, did not indicate to either G.M.C. or White which

corporation he was representing, and it made no difference to

G.M.C. or White whether they were dealing with the taxpayer or

with its subsidiary. Id. Both the taxpayer and its subsidiary

used the same address on the checks utilized in the transactions

in question even though they were located in different cities in

Florida and even though the taxpayer's subsidiary used a

different bank account for all of its business activities. Id.

G.M.C. and White delivered most of the trucks acquired in the

alleged purchases by the taxpayer's subsidiary directly to the

taxpayer even though they were ostensibly being sold to that

subsidiary for resale to the taxpayer. Id.

In addition to reciting the foregoing facts in Redwing

Carriers, Inc. v. Tomlinson, supra, the Court of Appeals for the

Fifth Circuit observed that "a definite contractual inter-

dependency between the sale of new trucks and the trade-in of old

trucks" existed, id., in that there "would have been no purchase

by * * * [the taxpayer's subsidiary] of new trucks or tractors

without concurrent and binding agreements to purchase * * * [the

taxpayer's] used equipment", id. (quoting the U.S. District

Court's opinion in Redwing Carriers, Inc. v. Tomlinson, 19 AFTR -74-

2d 1253, 67-1 USTC par. 9392 (M.D. Fla. 1967)). The Court of

Appeals further noted that, because the aggregate price that

G.M.C. paid for the used trucks was in excess of their aggregate

fair market value, G.M.C. could have yielded a profit from the

transactions in question only by viewing the alleged purchases of

used trucks and the alleged sales of new trucks as one

transaction. Id. According to the Court of Appeals, the

transactions in question were

sculptured * * * so as to achieve the best possible tax results for Redwing. Instead of obtaining customary discounts from the retail price of the new trucks, Mendez would insist that the manufacturers add the discount amount to the price of the used trucks being repurchased. The gain of the trade-in price over the depreciated basis of the used trucks would be recognized at capital gains rates, and the basis of the new trucks for depreciation purposes would be inflated. As a result, Redwing's depreciation deductions from ordinary income would also be inflated, resulting in considerable tax savings. [Redwing Carriers, Inc. v. Tomlinson, supra at 655-656.]

The Court of Appeals for the Fifth Circuit held in the

Redwing Carriers, Inc. case that the transfers of used trucks by

the taxpayer and the acquisitions of new trucks by its subsidiary

were, in substance, like-kind exchanges. In so holding, the

Court stated:

As is obvious from the above facts, these Mendez- dominated transactions were severable in form only. On substance, the sale was in bondage to the purchase and the purchase indissolubly dependent upon the sale. If Redwing had not carried out the agreement to buy the new trucks, the auto makers would have had no juristic obligation to purchase the used trucks. The buying and selling were synchronous parts meshed into the same transaction and not independent transactions. -75-

Taxation is transactional and not cuneiform. Our tax laws are not so supple that scraps of paper, regardless of their calligraphy, can transmute trade- ins into sales. Although [the taxpayer's] * * * transfers may have been paper sales, they were actual exchanges. A taxpayer may engineer his transactions to minimize taxes, but he cannot make a transaction appear to be what it is not. Documents record transactions, but they do not always become the sole criteria for transactional analysis. [Id. at 656, 659.]

Redwing Carriers, Inc. v. Tomlinson, supra, is distin-

guishable from the instant case for several reasons, including

the following. Unlike the case before us, the Redwing Carriers,

Inc., supra, case did not involve the inventory accounting issue

under section 471 that is presented here. In Redwing Carriers,

Inc. v. Tomlinson, supra, the respective prices at which the old

trucks were transferred by the taxpayer and the new trucks were

acquired by its subsidiary were set for tax purposes in excess of

the aggregate fair market value of those trucks and were

therefore not determined on the basis of market-related factors,

such as supply and demand, and G.M.C. could have yielded a profit

from the transactions in question only by viewing the alleged

purchases of used trucks and the alleged sales of new trucks as

one transaction. In contrast, we have found in the instant case

that the remanufactured automobile part sales price (i.e., the

price that Consolidated charged a customer who purchased a

remanufactured automobile part) as well as the customer core

purchase offer amount and the core credit amount (i.e., the price -76-

that Consolidated paid to acquire a customer core) were

determined on the basis of market-related factors, such as supply

and demand. We conclude that Redwing Carriers, Inc. v.

Tomlinson, 399 F.2d 652 (5th Cir. 1968), does not control our

resolution of the issue presented here.

Nor does Burrell v. Commissioner, 400 F.2d 682 (10th Cir.

1968), govern our resolution of the inventory accounting issue

under section 471 that is involved in the instant case. In

Burrell v. Commissioner, supra, the Court of Appeals for the

Tenth Circuit, to which an appeal in this case would generally

lie, recited the facts on which it relied as follows:

In 1962, William P. Burrell,* * * as a sole proprietor, was engaged in reboring automobile engine blocks, called "cores," using them to rebuild automobile engines which he sold to both retail and wholesale customers. In order to maintain an inventory of cores to be rebored, Burrell desired that each customer to whom he sold a rebuilt engine with a rebored core therein, deliver to him the old core in the automobile engine which the rebuilt engine replaced, or a like old core from an automobile engine of the same make.

The amount of the bill which Burrell rendered to customers who purchased from him rebuilt engines with rebored cores was for a single amount, which, in fact, was made up of two items. Such items were reflected separately on an invoice furnished to the customer. Item One on such invoice was for the rebuilt engine. Item Two was for the core from the old engine, or a substitute therefor, to be delivered to Burrell by the customer.

When a new core was returned, Item Two was cancelled, although the actual value of the old core did not equal the amount of the Item Two charge. Such -77-

charge was purposely made higher than the value of the old core to be returned, in order to induce customers to return old cores and to enable Burrell to maintain a needed inventory of old cores. Burrell did not strictly enforce the 45-day limit, but accepted old cores tendered to him for credit by customers a considerable time after the 45-day period had expired.

The effect of a transaction between Burrell and a customer was a charge against the customer in one amount, reflected on the bill delivered to him, made up of two items, one being Item One, the charge for the rebuilt engine with a rebored core sold to the customer, payable in cash, and which most customers paid on receipt of the bill; and the other, Item Two, to be paid by the return of a like core to Burrell within 45 days, or if not returned within 45 days, to be paid in full, in cash. The reason Burrell did not strictly enforce the 45-day time limit was that he preferred old cores to cash.

Burrell carried on his books an account referred to as "Customer Core Deposits." It reflected the amounts of Item Two charges which customers would have to pay in cash if they failed to discharge them by the return of an old core. * * *

On November 1, 1962, the Corporation [Engine Rebuilders, Inc.] was organized under the laws of Colorado. On that date, the Corporation, which was wholly owned by the Burrells, took over the wholesale business of Burrell. * * * The Corporation continued to use the same billing and invoice procedures; the same "Customer Core Deposits" account, and generally the same bookkeeping methods that the Burrells had followed.

Burrell v. Commissioner, supra at 683 (fn. ref. omitted). (We

shall refer to Burrell and the Corporation collectively as the

taxpayers.)

The issue in Burrell v. Commissioner, supra, was whether the

taxpayers were required to include the so-called item two charge

in income at the time they sold a rebuilt engine. Unlike the -78-

instant case, the Court of Appeals for the Tenth Circuit in the

Burrell case was not presented with the inventory accounting

question under section 471 of the proper amounts at which the

taxpayers were required to reflect the cores that they acquired

in their inventories, and that Court did not decide that issue.

The Court of Appeals in Burrell v. Commissioner, supra at 685,

held that the item two charges should have been included in

income at the time the rebuilt engines were sold by the

taxpayers. In dictum, that court suggested that

there might be some basis for the contention that the amount thereof [the item two charge] did not accrue until the expiration of 45 days from the date of the sale and unless the customer during such period failed to return the replacement core, and that the value of the core returned should be accrued on the date of its return within the 45-day period. [Id.]

However, the Court of Appeals did not apply the foregoing dictum

because "the taxpayers' books were so lacking in completeness,

that it would have been impossible to determine the amount the

taxpayers should have accrued on that basis." Id. Even assuming

arguendo that we were to find the above-quoted dictum to be a

correct statement of the tax law, we reject petitioner's

contention that that dictum controls our resolution of the

inventory accounting issue involving Consolidated's customer

cores that is presented here.

The facts involved in Burrell v. Commissioner, supra,

although they might appear to be facially similar to the facts

involved here, are different from the facts established by the -79-

record in the present case. For example, the Court of Appeals

for the Tenth Circuit stated that the item two charge "was

purposely made higher than the value of the old core to be

returned, in order to induce customers to return old cores and to

enable Burrell to maintain a needed inventory of old cores." Id.

at 683. It is not clear what the Court of Appeals meant by the

term "value". In any event, in the instant case, we have found

on the record presented to us that Consolidated determined the

price that it was willing to pay to acquire customer cores on the

basis of market-related factors, including supply and demand, and

that it did not pay more to acquire customer cores than the

marketplace in which it acquired those cores demanded. The Court

in Burrell v. Commissioner, supra at 683, also indicated that the

taxpayers' books reflected an account called "Customer Core

Deposits" which "reflected the amounts of Item Two charges which

customers would have to pay in cash if they failed to discharge

them by the return of an old core." In the present case, we have

found that at the time of each sale of a remanufactured auto-

mobile part the core amount, which was part of the remanufactured

automobile part sales price for each such sale, was reflected in

Consolidated's books as an entry increasing "sales (core amount)"

and as part of an entry (i.e., the remanufactured automobile part

sales price) increasing "customer account receivable"; the core

amount was not shown in those books as a deposit. -80-

Based on our examination of the entire record in this case,

we reject petitioner's position that Consolidated acquired

customer cores in exchange transactions in which Consolidated's

customers purchased remanufactured automobile parts from it in

exchange for the payment by them of the exchange amounts and

delivery by them of customer cores to Consolidated. On that

record, we find that the substance of the transactions by which

Consolidated acquired customer cores were purchases in which

Consolidated purchased customer cores for the prices that were

shown in the customer core sales invoices under the column headed

"Cores--Price Each".

We shall now address what the cost and the market are for

purposes of section 471 for the customer cores that Consolidated

acquired.27

The Cost for Consolidated's Customer Cores

For purposes of inventory accounting under section 471, the

cost of merchandise purchased is determined under section 1.471-

3, Income Tax Regs. That section provides in pertinent part:

Cost means:

27 Assuming arguendo that we were to have found that Consolidated’s acquisitions of customer cores were exchanges, and not purchases, our findings below as to the cost and the market for Consolidated's customer cores for purposes of sec. 471 would not change. -81-

(b) In the case of merchandise purchased since the beginning of the taxable year, the invoice price * * *

Although petitioner disputes that the transactions by which

Consolidated acquired customer cores constituted purchases,

petitioner agrees with respondent that if the Court were to find

that such transactions were purchases, the term "merchandise

purchased" in section 1.471-3(b), Income Tax Regs., includes raw

materials purchased by a manufacturer, such as the customer cores

purchased by Consolidated. However, petitioner contends that

that regulation does not apply in determining the cost of the

customer cores acquired by Consolidated because there was no

invoice issued by any of Consolidated's customers and no invoice

price for any of those cores. On the record before us, we reject

petitioner's contention. We have found that at or about the time

that a customer delivered a customer core to Consolidated,

Consolidated prepared a sales invoice28 (viz, the customer core

sales invoice) which identified the type and the number of

customer cores of each type that each of its customers delivered

to it. We find no significance for purposes of section 471 and

section 1.471-3(b), Income Tax Regs., in the fact that it was

Consolidated, and not its customers, that generated the customer

core sales invoices. We also have found that the price which

28 Indeed, petitioner stipulated that the customer core sales invoice prepared by Consolidated was a "sales invoice". Attached to each customer core sales invoice was, inter alia, a completed copy of a request for core credit. -82-

Consolidated paid for each customer core delivered to it by a

customer (viz, the core credit amount) was shown on each of the

customer core sales invoices under the column headed "Cores--

Price Each".

Petitioner further contends that section 1012 and the

regulations thereunder relating to the cost basis of property

require Consolidated to ascertain the respective fair market

values of the customer cores that it acquired in determining the

cost of those cores for purposes of section 471. According to

petitioner, the core credit amount for each customer core which

Consolidated acquired exceeded its fair market value, and the

aggregate amount of such alleged excesses is deductible under

section 162 as an amount expended to protect and promote

Consolidated's supply of raw materials. We disagree with

petitioner's position that section 1012 and the regulations

thereunder are determinative of the cost of Consolidated's

customer cores for purposes of section 471. Those provisions do

not control the determination of the proper amounts at which

property must be reflected in a taxpayer's inventories for

purposes of section 471. The regulations under section 1013

relating to the basis of property included in inventory make it

clear that the amounts at which property must be reflected in a

taxpayer's inventories are controlled by section 471 and the

regulations thereunder. Section 1.1013-1, Income Tax Regs.,

provides: -83-

The basis of property required to be included in inventory is the last inventory value of such property in the hands of the taxpayer. The requirements with respect to the valuation of an inventory are stated in subpart D (sections 471 and following), part II, subchapter E, chapter 1 of the Code, and the regulations thereunder.

We also reject petitioner's position that the aggregate

amount of the alleged excesses of the core credit amounts over

the alleged fair market values of Consolidated's customer cores

is deductible under section 162. In support of that position,

Even if one regards the refund of the core deposit as "payment" for the core, an artificially or unnecessarily high payment does not change the "cost" of property under the Code. Rather, when a taxpayer pays more than the fair market value for the purchase of an asset and the excess payment is for a purpose other than the acquisition of the property or the transaction is based upon peculiar circumstances which influence the purchaser to pay more than fair market value, the excess amount is excluded from the "cost" of the property. Jordan v. Commissioner, 60 T.C. 872, 879 (1973), aff'd 514 F.2d 1209 (8th Cir. 1975); Majestic Securities Corp. v. Commissioner, 120 F.2d 12, 14- 15 (8th Cir. 1941), affirming 42 B.T.A. 698 (1940); New Hampshire Fire Insurance Co. v. Commissioner, 2 T.C. 708, 724 (1943), aff'd, 146 F.2d 697 (1st Cir. 1945). Instead, under such circumstances, cost is determined with reference to the fair market value of the property received. Lemmen v. Commissioner, 77 T.C. 1326, 1348 (1981), acq. 1983-1 C.B. 1.

As illustrated above, Respondent cannot reasonably dispute that the core deposit for any particular remanufactured automobile part is greatly in excess of the fair market value of the core. In Burrell, the Tenth Circuit found that the core deposit was purposely set higher that [sic] the value of the core "in order to induce the customers to return the old cores and to enable Burrell to maintain a needed supply of cores." Burrell, 400 F.2d at 683. The same is true in the present case. -84-

We find the foregoing cases on which petitioner relies to be

distinguishable from the instant case and petitioner's reliance

on them to be misplaced. None of those cases involved the issue

of the proper amounts at which a taxpayer must reflect property

in such taxpayer's inventories. Moreover, unlike the cases (viz,

Majestic Sec. Corp. v. Commissioner, 120 F.2d 12 (8th Cir. 1941),

affg. 42 B.T.A. 698 (1940); Lemmen v. Commissioner, 77 T.C. 1326

(1981); and New Hampshire Fire Ins. Co. v. Commissioner, 2 T.C.

708 (1943), affd. 146 F.2d 697 (1st Cir. 1945)) on which

petitioner relies in which the respective purchasers involved

there paid more than fair market value for the assets that they

purchased, we have found on the record before us that the amounts

for which Consolidated acquired customer cores were based on

market-related factors, including supply and demand, and were set

at amounts that the marketplace in which Consolidated purchased

those cores demanded.

On the record before us, we find that for purposes of

section 471 the cost for each of the customer cores that

Consolidated acquired is the price (viz, the core credit amount

for each such core) which it paid for each such core and which is

shown under the column headed "Cores--Price Each" on the customer

cores sales invoice that was prepared at or about the time a

customer delivered such a core to Consolidated.

The Market for Consolidated's Customer Cores

Petitioner contends that, as a result of "extraordinary -85-

facts and circumstances", section 1.471-4(b), Income Tax Regs.,

and not section 1.471-4(a), Income Tax Regs., applies in

determining the market for Consolidated's customer cores for

purposes of section 471. In support of that contention,

petitioner asserts that, unlike the manner in which prices are

set under normal market conditions with numerous buyers and

sellers operating at arm's length to achieve for themselves the

best economic bargain possible, Consolidated intentionally set

the core amounts, and consequently the customer core purchase

offer amounts and the core credit amounts, at amounts greater

than the core supplier amounts that it was paying its core

suppliers to purchase core supplier cores which had core supplier

guarantees and were of higher quality than customer cores of the

same types.29 As we understand it, petitioner also contends that

section 1.471-4(b), Income Tax Regs., and not section 1.471-4(a),

Income Tax Regs., applies because Consolidated did not purchase

customer cores in an open market.

Respondent contends that the market for Consolidated's

customer cores for purposes of section 471 is determined under

section 1.471-4(a), Income Tax Regs. Respondent further asserts

29 We are not persuaded on the record before us that Bishop Engine and other core suppliers would not have increased their prices (i.e., the core supplier amounts) for core supplier cores in the event that Consolidated and/or other automobile parts remanufacturers had decided to fill more of their respective core inventory requirements from those core suppliers, rather than from those remanufacturers' customers. -86-

that, pursuant to that section, as interpreted by Thor Power Tool

Co. v. Commissioner, 439 U.S. 522 (1979), and Bamert v.

Commissioner, 8 B.T.A. 1099 (1927), the market for each of

Consolidated's customer cores is the current bid price (i.e., the

replacement cost) for a customer core of the same type that was

prevailing at the respective dates of Consolidated's inventory in

the marketplace in which Consolidated actually participated and

that that marketplace is the marketplace in which it obtained

customer cores from its customers. According to respondent, the

current bid price or replacement cost for a customer core that

was included in Consolidated's inventories at the end of each of

the years at issue is the core credit amount for a customer core

of the same type that was prevailing at the end of each of those

years.

Section 1.471-4(a) and (b), Income Tax Regs., provides in

(a) Under ordinary circumstances and for normal goods in an inventory, "market" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayer, and is applicable in the cases--

(1) Of goods purchased and on hand, and

(2) Of basic elements of cost (materials * * *) in goods in process of manufacture and in finished goods on hand; * * *

(b) Where no open market exists or where quotations are nominal, due to inactive market conditions, the taxpayer must use such evidence of a fair market price at the date or dates nearest the -87-

inventory as may be available, such as specific purchases or sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid for cancellation of contracts for purchase commitments. * * *

The Supreme Court of the United States has held that the

term "current bid price" used in section 1.471-4(a), Income Tax

Regs., is synonymous with the "replacement cost, that is, the

price the taxpayer would have to pay on the open market to

purchase or reproduce the inventory items." Thor Power Tool Co.

v. Commissioner, supra at 534. The current bid price is to be

determined based on prevailing prices in the market in which the

taxpayer actually participates. D. Loveman & Son Export Corp. v.

Commissioner, 34 T.C. 776, 799 (1960), affd. 296 F.2d 732 (6th

Cir. 1961); Bamert v. Commissioner, supra at 1100.

Based on our examination of the entire record before us, we

find that Consolidated acquired its customer cores under

ordinary, and not extraordinary, circumstances. In acquiring

customer cores, Consolidated participated in the marketplace in

which it purchased those cores from its customers, and not in the

marketplace in which it purchased core supplier cores from core

suppliers. We further find that petitioner has failed to

persuade us either that the marketplace in which Consolidated

acquired customer cores from its customers is not an open market

in which Consolidated participated within the meaning of section

1.471-4(b), Income Tax Regs., or that Consolidated did not

acquire its customer cores in an open market. On the instant -88-

record, we find that section 1.471-4(a), Income Tax Regs., and

not section 1.471-4(b), Income Tax Regs., applies in determining

the market for Consolidated's customer cores for purposes of

section 471. We further find that the market under section

1.471-4(a), Income Tax Regs., is the replacement cost and that

the replacement cost for each of the customer cores of

Consolidated that were included in its inventories at the end of

each of the years at issue is the core credit amount for a

customer core of the same type that was prevailing at the end of

each of those years.

we find that petitioner has not shown that respondent abused

respondent's discretion in determining that Consolidated's FIFO-

LCM method does not clearly reflect income because that method

did not reflect the proper amounts for customer cores.

To reflect the foregoing and the concession of petitioner

for 1990,

Decision will be entered

for respondent.