Tax Issues for Idle and Excess Capacity Facilities
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Tax Issues for Idle and Excess Capacity Facilities 

 4/20/2010 


Section 1 from the Plante & Moran 14-part publication, "Issues for Distressed Manufacturing Companies"

DEPRECIATION 
Generally, when facilities are idled, an impairment loss might be recognized for book purposes if the carrying amount of a long-lived asset is not recoverable from its undiscounted
cash flows. If this condition is met, such an impairment loss would be measured as the difference between the carrying amount and fair value of the asset. For tax purposes, assets generally cannot be written down until disposed of but may continue to be depreciated even if they are not currently in use. This may result in taxable income being higher than book income. Fixed asset records should be closely monitored to ensure that tax depreciation is calculated accurately.

FIXED ASSET WRITE-OFFS
Fixed assets generally cannot be written off for tax purposes until physically disposed of. However, the potential exists to write off some assets if they are formally abandoned or permanently withdrawn from service (usually by physically segregating the abandoned assets from the productive assets). These abandoned assets may even be kept on hand to use for spare parts, as long as the equipment itself is not on “standby” in case of productive equipment failures.

CAPITAL ASSET TRANSFERS
When facilities are idled or closed, assets are commonly transferred to other facilities. The tax implications of transferring assets between facilities should be considered, particularly if the facilities transferring or receiving capital assets are held by separate legal entities. The form of the transfer may involve a sale or intercompany lease at fair market value. From a tax perspective, it is important to characterize the transfers and to record the transfers consistently with that characterization. This is true even if filing consolidated tax returns, since any deferred intercompany gains may have current or future tax consequences or if the transfers are between disregarded entities since certain states do not follow the disregarded federal status and may separately tax the transactions. The form of the transaction could also result in other state and local income, sales tax, or transfer tax implications. It is important to substantiate and document asset transfers so the separate legal entities maintain properly stated books in case of a bankruptcy or other legal claims are made against the entities.

PROPERTY TAXES
Some states or municipalities have provisions allowing for reduced personal property tax assessments for idle or scrap property (neither Illinois nor Ohio have a personal property tax but Michigan does allow for an idle or scrap property reduction). For real property within any state, there could potentially be valuation reductions due to functional or economic obsolescence. Functional obsolescence is the inability of the property to perform the function for which it was originally designed or intended while economic obsolescence occurs when the property owner can no longer earn a fair rate of return on the ownership or operation of the property. A depressed economy may cause a property to be used at less than normal capacity (i.e., economic obsolescence). State and local rules as well as the current fair market value, use, and utilization of all personal and real property should be evaluated to determine if property tax savings opportunities exist.

SECTION 263A CAPITALIZATION
When a facility is idled, GAAP may require some or all costs allocable to an idle facility to be immediately expensed and not capitalized into the value of the inventory. Tax rules may require costs such as insurance, taxes, rent, and other similar costs to continue to be capitalized. However, depreciation and amortization expense related to a temporarily idled facility can be immediately expensed under §263A as long as the idling is not ordinary (i.e., closing a facility on a weekend is ordinary while a two-week shutdown for retooling is not ordinary). The overall adjustment related to this issue may lead to a significant increase in capitalized §263A costs. See Treas. Reg. §1.263A-1(e)(3)(iii)(E).

PRACTICAL CAPACITY INVENTORY ADJUSTMENTS 
If a facility is not idled, but is simply operating at less than normal or maximum capacity, GAAP may require fixed and variable facility costs that are associated with unused capacity to be immediately expensed and not capitalized into the carrying cost of inventory on the balance sheet. This method of accounting is specifically barred by tax rules and may result in a significant increase in capitalized §263A costs for tax purposes. See Treas. Reg. 1. §263A-2(a)(4). 

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At Plante & Moran, we understand the tremendous challenges, as well as the unique concerns, of distressed companies. We can help you evaluate the tax-related complexities associated with your situation so that you can have confidence that the steps you are taking today are the right ones.

We focus on helping distressed and underperforming companies:

  • Uncover opportunities for tax efficiency
  •  Identify tax refund opportunities
  •  Preserve and manage tax attributes
  •  Walk through the tax considerations associated with all phases of bankruptcy administration and liquidation
  •  Provide structuring guidance to potentially derive future tax benefits

In addition, our dedicated team of turnaround and restructuring advisors can help you look at the big picture, including cost estimating and cost reduction strategies, employee productivity, quality issues, inventory control, health care, logistics, information technology, and more. Services include:

  •  Bankruptcy
  •  Cash flow modeling
  •  Debt restructuring
  •  Operational restructuring
  •  Services to committees
  •  Services to lenders
  •  Viability assessments

For more information about how Plante & Moran can help your company, please visit plantemoran.com or call 877.622.2257.