A couple of days ago I received a series of perspectives on the impact of the stimulus plan, the President’s budget agenda and other pieces of legislation coming soon to a theater near you. Now I realize reading articles such as An Analysis of the Tax Provisions in the American Reinvestment and Recovery Act of 2009 may not sound exciting to you but there is nothing like a little tiny accounting rule change to make the business community go haywire (think bigger than Sarbanes-Oxley).
And given the fact that we just released a white paper on cost reduction challenges in the oil and gas industry, this article from Deloitte, Key Tax Issues: President Obama’s Plans and Effects on the Oil and Gas Industry, rang an alarm bell over the repeal of last-in/first-out (LIFO) accounting rules. The article starts out outlining some benefits for small businesses that ordinarily, I’d welcome with open arms, specifically, potential tax cuts, making permanent the R&D tax credit, capital gains taxation changes and the expansion of the net operating loss (NOL) carry back. But what I have a problem with is the proposal for how to pay for those changes such as: ¦to codify the economic substance doctrine, repeal last-in/first-out (LIFO) accounting rules, tax income from carried interests as ordinary income, eliminate a variety of oil-and-gas company tax preferences, and implement a cap-and-trade program.
For now, we’ll focus on the repeal of LIFO. In short, the repeal of LIFO, a widely used practice of measuring one’s inventory to come up with the company’s book income and tax liability has been suggested previously. LIFO has been in use since the 1930’s by large and small companies alike. It essentially provides a means to measure the financial picture of a company taking into consideration inflation. According to the National Association of Manufacturing, LIFO takes into account the greater costs of replacing inventory, thereby giving both a more conservative measure of the financial condition of the business and the economics to which tax should apply. Absent LIFO, phantom profits would be taxed. This write-up provides a good overview of LIFO.
According to the National Association of Manufacturers, if LIFO were to be repealed, the tax bills for thousands of manufacturers would increase and would be higher in the future. Sectors which could be severely impacted by any repeal include: industrial equipment, metal fabrication and transportation equipment where LIFO accounting methods are used by 40% to 50+% of companies within those industry verticals.
Why should you care?
LIFO might not make much of a difference right now in markets where metals prices are languishing. But any inflation will have the very real (and negative) effect of increasing a company’s tax burden, lowering its global competitiveness, increasing cash flow problems and decreasing working capital. Base metals prices have notched up a bit this past week. It is only a matter of time when production cuts and upward ticks in demand will cause prices to once again rise (and we haven’t even discussed the inflationary impacts of loose monetary policy that has begun in the UK). By 2010-2011 inflation could become a grave concern to everyone.
Metals price volatility has been in high gear since Q4 2003. With the unprecedented drops in metals prices in Q4 2008, is now really the time to repeal LIFO?