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Fortnightly Magazine - October 2010

incurred.

Under the general rules, when property is manufactured, constructed, or produced for the applicant by another person under a binding written contract, economic performance occurs, and the cost of such property is treated as incurred when the property finally is delivered or provided to the applicant. The exception is that, for periods before the property is provided to the applicant, costs incurred by another person, such as a contractor, are treated as costs of the property that are incurred by the applicant for purposes of the 5-percent safe harbor when those costs are incurred by the contractor.

Costs are deemed paid or incurred by the person providing property to the applicant ( e.g., a contractor) as that person pays or incurs costs in connection with providing property to the applicant. Property is provided to the applicant when title to the property passes to the applicant or when the property is delivered to, or accepted by, the applicant, depending on the applicant’s method of accounting. In addition, property that the applicant reasonably expects to be provided within 3.5 months after the date of payment will be considered to be provided on the earlier payment date.

In the case of property manufactured, constructed, or produced for the applicant by another person ( e.g., the contractor) under a binding written contract entered into before the manufacture, construction, or production of the property, the FAQ explains how the applicant determines what costs have been paid or incurred on its behalf by the contractor. If the contractor uses the accrual method of accounting, the applicant may rely on a statement by the contractor as to the amount incurred by the contractor with respect to the property to be manufactured, constructed, or produced for the applicant under the binding written contract. The contractor may use any reasonable, consistent method to allocate the costs incurred by the contractor among the units of property to be manufactured, constructed, or produced by the contractor. Only costs incurred by the contractor after the binding written contract is entered reasonably may be allocated to the property manufactured, constructed, or produced under that contract. The economic performance rules apply to determine when costs have been incurred by the contractor.

The exception that allows the applicant to take into account costs that are incurred by its contractor doesn’t apply to costs incurred by a subcontractor. Thus, if components are manufactured for the contractor by a subcontractor, the cost of those components is incurred only when the components are provided to the contractor and not as the subcontractor pays or incurs the costs of manufacturing the components. However, property that the contractor reasonably expects to receive from a subcontractor within 3.5 months of the date of the contractor’s payment to the subcontractor is considered to be provided by the payment date.

The FAQ addresses the effect of assignments of binding contracts between related entities. For example, a developer may enter into a binding written contract for multiple units of property to be manufactured for the developer by another person under a binding written contract (