Rev. Rul. 68-620

Advice has been requested regarding the treatment, for Federal income tax purposes, of gas that is commonly referred to as `line pack.'

A taxpayer is in the interstate gas transmission business. Its facilities consist mainly of a pipeline extending from one area of the country to another. The taxpayer acquires its gas primarily from suppliers in producing areas and transports it to markets for sale to distributors who resell the gas to others.

In order to maintain pressure and effect uninterrupted flow or transportation of natural gas to purchasers through pipelines, it is necessary to maintain a certain volume of gas in the line at all times. This volume of gas is commonly referred to as `line pack.' It has been the practice of the taxpayer to treat `line pack' as an item of expense and not to include it in inventory at the end of the year.

Section 1.471-1 of the Income Tax Regulations provides, in part, that in order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase or sale of merchandise is an income producing factor. It further provides that each such inventory must include all merchandise to which the taxpayer has ownership, although such merchandise is in transit or for other reasons has not been reduced to physical possession.

Although the gas referred to in this case as `line pack' plays an important part in determining the efficiency of the system, it is also an integral part of the taxpayer's inventory of merchandise (gas) which is intended to be sold to customers.

Accordingly, the `line pack' gas is merchandise in transit and must be included in the inventories of the taxpayer.

Since section 1.446-1(e)(2)(i) of the regulations provides, in part, that a change in the treatment of a material item is a change in method of accounting, a change from the expensing to the inventorying of `line pack' is a change in the taxpayer's method of accounting within the meaning of sections 446 and 481 of the Internal Revenue Code of 1954.

In order to change its method of accounting the taxpayer must under section 1.446-1(e)(3) of the regulations obtain the prior consent of the Commissioner of Internal Revenue by filing an application for such change on Form 3115, Application for Change in Accounting Method, with the Commissioner of Internal Revenue, Washington, D.C. 20224, within 90 days after the beginning of the taxable year in which the change is to be made.