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Taxing Dilemma

Feel free to cite this column liberally if your company ever gets called for an official IRS audit.

by Paul Scicchitano

I'd like to preface this month's column with a brief flashback to my days at Monsignor Bonner High School in suburban Philadelphia. It was there that an algebra teacher, who I will refer to only as Father Havener, helped me realize my true potential for number crunching.

A balding man who never strayed very far from his chrome chalk holder, Father Havener imparted the following words of wisdom that I carry with me to this day: "Mr. Scicchitano,"  he said in a plangent voice, "some people in this world are not cut out for mathematics. You, Mr. Scicchitano, are one of those people."

This, of course, hasn't discouraged me one bit from discussing the tax consequences associated with ISO 9000, QS-9000 and ISO 14001 registration. In fact, feel free to cite this column liberally if your company ever gets called for an official Internal Revenue Service audit, especially one that could result in a stiff fine and/or jail time. Tell them Father Havener's prize student coached you.

In recent years, U.S. companies have been wrestling with the question of how to account for the costs associated with attaining their registration certificates -- $187,000 on average, in the case of ISO 9000 alone, when you consider the costs of training, consulting and auditing, as well as the internal work hours expended during the 15 months it typically takes to complete the process.

The issue is whether this money should be expensed in the tax year incurred, or treated as a capital expense and amortized over the life of the registration certificate. Most companies probably prefer to avoid capitalizing the costs associated with registration and reduce their taxable income during the years in which the money is spent. But this may not be consistent with IRS precedent.

The debate essentially involves two sections in the tax code: sections 263(a) and 162. Section 263(a) states that no deductions shall be allowed for any permanent improvements made to increase the value of any property or estate, or for any amount expended in restoring property, or in making good the exhaustion thereof for which an allowance is, or has been made. Section 162 holds that companies may deduct all ordinary and necessary expenses paid or incurred as current expenditures in carrying on any trade or business during the taxable year.

As of this writing, the IRS does not have a coordinated position on registration. But you can expect to see one in the future, as more companies hoist registration flags. Even some IRS agents have been seeking clarification with respect to the treatment of such costs. An unofficial IRS white paper frames the debate and provides a discussion of relevant case law. It stops short, however, of being an agencywide policy. It holds that most registration expenses should be amortized over the life of a certificate, rather than deducted as costs are incurred.

    The paper states: "The ability to compete for business in markets that would otherwise be unavailable absent the ISO 9000 certification confers upon the taxpayer a business advantage that is intended to last beyond the taxable year. In this respect, payments incurred in connection with obtaining access to such markets are analogous to the capital expenditures incurred in connection with obtaining a seat on a stock exchange, admission to the bar or acquisition of hospital staff privileges.

"As with these other payments, the certification costs do not guarantee future income, but do provide the right to compete. As set forth above, judicial and administrative authorities clearly establish that acquisition of this right is sufficient to require capitalization of related costs."

The document also finds that subsequent costs incurred to maintain registration, such as an annual or semiannual surveillance visit, need not be capitalized, but that the comprehensive nature of triennial audits suggests they should be treated the same as an initial registration audit.

It would not be unreasonable to conclude that the ISO 9000 governing authorities have determined that the original external audit has a useful life of approximately three years, at which time the external review portion of the certification process must be repeated,"  the document goes on to say.

This should clear up some of the confusion surrounding ISO 9000 registration costs. But, should a copy of this article find its way to Father Havener or an attorney representing the Archdiocese of Philadelphia, please be advised that I may have confused the good padre with another bald clergyman sporting a chrome chalk holder.

 

About the author

Paul Scicchitano is managing editor of Quality Systems Update and QSU's Environmental Management Report, monthly newsletters devoted to ISO 9000, QS-9000 and ISO 14000 by The McGraw-Hill Companies, 11150 Main St., Suite 403, Fairfax, VA 22030. Telephone (703) 591-9008,   fax (703) 591-0971 or e-mail isoeditor@aol.com.

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