According to Rev. Rul. 2000-4, businesses may deduct the cost of obtaining ISO 9000 certification in the year in which the expenses were incurred. In the past, the Service had taken the position that those costs had to be capitalized, based on an IRs interpretation of INDOPCO, Inc., 503 US 79 (1992).
Becoming an Industry Standard
ISO 9000 is a nationally recognized quality assurance program that is rapidly becoming standard in industry. Certification (often required by manufacturing customers) requires a lengthy, cosily and exhaustive review of all the processes and procedures in a business's operations.
All things being equal, an ISO 9000-certified firm is likely to win business over a noncertified firm. Certification offers a buyer some level of assurance that the products are going to meet high-quality standards.
In INDOPCO, the Supreme Court held that a business could not deduct an expenditure if it resulted in a benefit to the company that lasted beyond the year in which the money was spent. The Service has taken the position that INDOPCO applies to all ISO 9000 certification costs, which in the past would have been considered ordinary and necessary business expenses.
Manufacturers whose ISO 9000 deductions faced challenges from IRS auditors successfully argued that at least some of the training costs associated with certification were period costs and should be deductible. In addition, because ISO certification is valid for only three years before renewal, manufacturers were often successful in arguing that they should be allowed to amortize ISO 9000 expenses over those three years.
Given the court's ruling and the fact that ISO 9000 clearly has benefits that last well over a year, manufacturers were relieved to obtain those concessions. Even so, the difference between getting an up-front deduction or amortizing it over three years is significant.
For example, if 50% of $1 million spent on ISO certification can be deducted as training costs, the other $500,000 must be spread out. If a corporation's effective tax rate is 39%, spreading the deduction over three years reduces the first-year tax benefit from $195,000 to $65,000. First-year tax losses could be significant--perhaps totaling $130,000 on an expense of $1 million--and it is not unusual for manufacturers to spend that much or more as they prepare for an ISO 9000 auditors' review.
Rev. Rul. 2000-4 will consider ISO 9000 costs as period expenses. The better news may be that the revenue ruling implies that the Service could relax its position on other management consulting fees as well.
The ISO 9000 three-year certification renewal is a best-case scenario, because manufacturers could argue that the expenditure's benefits did not outlast the certification. In other situations (such as switching over from batch to just-in-time (JIT) manufacturing), there is an intangible benefit with an indefinite useful life. In these situations, the IRS has attempted to make companies capitalize consulting fees, so that businesses would get no deduction at all, because this type of intangible asset has no determinable useful life.
Danaher Deductions Cited
The IRS took that position in a technical advice memorandum (TAM), in which Danaher Corp. had incurred substantial expense in reengineering its manufacturing process.
That memorandum (which has not been revoked) asserted that the consulting fees, training costs, moving expenses and plant design changes associated with conversion to JIT manufacturing were not deductible and had to be capitalized.
Danaher won a settlement that allowed it to amortize its costs, but the industry remained concerned that the Service would use INDOPCO and the TAM to disallow deductions on consulting fees of any kind in other cases.
Rev. Rul 2000-4 is a big step toward the IRS changing its position on consulting fees. If it is allowing deductions for ISO 9000 expenses, it may also be more accommodating to taxpayers who incur consulting fees for a JIT or supply-chain reorganization.
Regardless of what position the Service finally takes, it is unlikely that businesses that negotiated ISO 9000-related settlements before the ruling was issued will see any sort of redress.
FROM THOMAS P. OCHSENSCHLAGER, CPA, VIENNA,VA