Common use of Unique item and classification Clause in Contracts

Unique item and classification. In December 2001, C enters into a contract with B to design and manufacture a new type of industrial equipment. C reasonably expects the normal production period for this type of equipment to be eight months. Because the new type of industrial equipment requires a substantial amount of research, design, and engineering to produce, C determines that the equipment is a unique item and its con- tract with B is a long-term contract. After delivering the equipment to B in September 2002, C contracts with B to produce five addi- tional units of that industrial equipment with certain different specifications. These additional units, which also are expected to take eight months to produce, will be deliv- ered to B in 2003. C determines that the re- search, design, engineering, retooling, and similar customizing costs necessary to produce the five additional units of equip- ment does not exceed 10 percent of the first unit’s share of estimated total allocable con- tract costs. Consequently, the additional units of equipment satisfy the safe harbor in paragraph (b)(2)(ii) of this section and are not unique items. Although C’s contract with B to produce the five additional units is not completed within the contracting year, the contract is not a long-term contract since the additional units of equipment are not unique items and do not normally re- quire more than 12 months to produce. C must classify its second contract with B as a non-long term contract, notwithstanding that it classified the previous contract with B for a similar item as a long-term contract, because the determination of whether a con- tract is a long-term contract is made on a Internal Revenue Service, Treasury § 1.460–3 contract-by-contract basis. A change in clas- sification is not a change in method of ac- counting because the change in classifica- tion results from a change in underlying facts. Example 2. 12-month rule—related party. C manufactures cranes. C purchases one of the crane’s components from R, a related party under § 1.460–1(b)(4). Less than 50 percent of R’s gross receipts attributable to the sale of this component comes from sales to unre- lated parties; thus, the exception for compo- nents and subassemblies under § 1.460– 1(g)(1)(ii) is not satisfied. Consequently, C must consider the activities of R as R incurs costs and performs the activities rather than as C incurs a liability to R. The normal time period between the time that both C and R incur five percent of the costs allocable to the crane and the time that R completes the component is five months. C normally re- quires an additional eight months to com- plete production of the crane after receiving the integral component from R. C’s crane is an item of a type that normally requires more than 12 months to complete under paragraph (c) of this section because the pro- duction period from the time that both C and R incur five percent of the costs allocable to the crane until the time that production of the crane is complete is normally 13 months. Example 3. 12-month rule—duration of con- tract. The facts are the same as in Example 2, except that C enters into a sales contract with B on December 31, 2001 (the last day of C’s taxable year), and delivers a completed crane to B on February 1, 2002. C’s contract with B is a long-term contract under para- graph (a)(2) of this section because the con- tract is not completed in the contracting year, 2001, and the crane is an item that nor- mally requires more than 12 calendar months to complete (regardless of the duration of the contract).

Unique item and classification. In December 2001, C enters into a contract with B to design and manufacture a new type of industrial equipment. C reasonably expects the normal production period for this type of equipment to be eight months. Because the new type of industrial equipment requires a substantial amount of research, design, and engineering to produce, C determines that the equipment is a unique item and its con- tract with B is a long-term contract. After delivering the equipment to B in September 2002, C contracts with B to produce five addi- tional units of that industrial equipment with certain different specifications. These additional units, which also are expected to take eight months to produce, will be deliv- ered to B in 2003. C determines that the re- search, design, engineering, retooling, and similar customizing costs necessary to produce the five additional units of equip- ment does not exceed 10 percent of the first unit’s share of estimated total allocable con- tract costs. Consequently, the additional units of equipment satisfy the safe harbor in paragraph (b)(2)(ii) of this section and are not unique items. Although C’s contract with B to produce the five additional units is not completed within the contracting year, the contract is not a long-term contract since the additional units of equipment are not unique items and do not normally re- quire more than 12 months to produce. C must classify its second contract with B as a non-long term contract, notwithstanding that it classified the previous contract with B for a similar item as a long-term contract, because the determination of whether a con- tract is a long-term contract is made on a Internal Revenue Service, Treasury § 1.460–3 contract-by-contract basis. A change in clas- sification is not a change in method of ac- counting because the change in classifica- tion results from a change in underlying facts. Example 2. 12-month rule—related party. C manufactures cranes. C purchases one of the crane’s components from R, a related party under § 1.460–1(b)(4). Less than 50 percent of R’s gross receipts attributable to the sale of this component comes from sales to unre- lated parties; thus, the exception for compo- nents and subassemblies under § 1.460– 1(g)(1)(ii) is not satisfied. Consequently, C must consider the activities of R as R incurs costs and performs the activities rather than as C incurs a liability to R. The normal time period between the time that both C and R incur five percent of the costs allocable to the crane and the time that R completes the component is five months. C normally re- quires an additional eight months to com- plete production of the crane after receiving the integral component from R. C’s crane is an item of a type that normally requires more than 12 months to complete under paragraph (c) of this section because the pro- duction period from the time that both C and R incur five percent of the costs allocable to the crane until the time that production of the crane is complete is normally 13 months. Example 3. 12-month rule—duration of con- tract. The facts are the same as in Example 2, except that C enters into a sales contract with B on December 31, 2001 (the last day of C’s taxable year), and delivers a completed crane to B on February 1, 2002. C’s contract with B is a long-term contract under para- graph (a)(2) of this section because the con- tract is not completed in the contracting year, 2001, and the crane is an item that nor- mally requires more than 12 calendar months to complete (regardless of the duration of the contract).

Unique item and classification. In December 2001, C enters into a contract with B to design and manufacture a new type of industrial equipment. C reasonably expects the normal production period for this type of equipment to be eight months. Because the new type of industrial equipment requires a substantial amount of research, design, and engineering to produce, C determines that the equipment is a unique item and its con- tract with B is a long-term contract. After delivering the equipment to B in September 2002, C contracts with B to produce five addi- tional units of that industrial equipment with certain different specifications. These additional units, which also are expected to take eight months to produce, will be deliv- ered to B in 2003. C determines that the re- search, design, engineering, retooling, and similar customizing costs necessary to produce the five additional units of equip- ment does not exceed 10 percent of the first unit’s share of estimated total allocable con- tract costs. Consequently, the additional units of equipment satisfy the safe harbor in paragraph (b)(2)(ii) of this section and are not unique items. Although C’s contract with B to produce the five additional units is not completed within the contracting year, the contract is not a long-term contract since the additional units of equipment are not unique items and do not normally re- quire more than 12 months to produce. C must classify its second contract with B as a non-long term contract, notwithstanding that it classified the previous contract with B for a similar item as a long-term contract, because the determination of whether a con- tract is a long-term contract is made on a Internal Revenue Service, Treasury § 1.460–3 contract-by-contract basis. A change in clas- sification is not a change in method of ac- counting because the change in classifica- tion results from a change in underlying facts. Example 2. 12-month rule—related party. C manufactures cranes. C purchases one of the crane’s components from R, a related party under § 1.460–1(b)(4). Less than 50 percent of R’s gross receipts attributable to the sale of this component comes from sales to unre- lated parties; thus, the exception for compo- nents and subassemblies under § 1.460– 1(g)(1)(ii) is not satisfied. Consequently, C must consider the activities of R as R incurs costs and performs the activities rather than as C incurs a liability to R. The normal time period between the time that both C and R incur five percent of the costs allocable to the crane and the time that R completes the component is five months. C normally re- quires an additional eight months to com- plete production of the crane after receiving the integral component from R. C’s crane is an item of a type that normally requires more than 12 months to complete under paragraph (c) of this section because the pro- duction period from the time that both C and R incur five percent of the costs allocable to the crane until the time that production of the crane is complete is normally 13 months. Example 3. 12-month rule—duration of con- tract. The facts are the same as in Example 2, except that C enters into a sales contract with B on December 31, 2001 (the last day of C’s taxable year), and delivers a completed crane to B on February 1, 2002. C’s contract with B is a long-term contract under para- graph (a)(2) of this section because the con- tract is not completed in the contracting year, 2001, and the crane is an item that nor- mally requires more than 12 calendar months to complete (regardless of the duration of the contract).