No deduction or gross profit offset is allowed for discounts offered on future fuel purchases by customers under a customer loyalty program.
The Tax Court held that a taxpayer was not entitled to deduct the estimated future cost of fuel discounts earned by its customers until those discounts were redeemed.
Facts: Giant Eagle, a Pennsylvania corporation, operates supermarkets, pharmacies, gas stations, and convenience stores. As part of a customer loyalty program, customers who made qualifying purchases at its supermarkets could earn “fuelperks!” credits that could be redeemed for a discount of 10 cents per gallon on up to 30 gallons of a future gasoline purchase at the taxpayer’s gas stations. The credits could not be redeemed in cash and would expire three months after the last day of the month in which they were earned. Giant Eagle, an accrual-basis taxpayer, claimed deductions totaling $6.16 million and $1.13 million for tax years 2006 and 2007, respectively, for the estimated cost of redeeming unexpired, unredeemed credits at the end of each year. The IRS disallowed the deductions and assessed tax deficiencies of $3.36 million and $313,490, respectively.
Issues: Sec. 162(a) allows a taxpayer to deduct all ordinary and necessary business expenses paid or incurred in carrying on a trade or business. Under Sec. 461(a), a deduction must be taken in the proper tax year, based on the taxpayer’s method of accounting. Accrual-basis taxpayers may deduct an expense in the year it is incurred, regardless of when it is paid. Under the all-events test of Regs. Sec. 1.461-1(a)(2)(i), the deduction is allowed when (1) all events have occurred that establish the fact of the liability; (2) the amount of the liability can be determined with reasonable accuracy; and (3) economic performance has occurred with respect to the liability.
While Giant Eagle contended that it had met all the requirements of the all-events test, the IRS argued that it had not met the first requirement of establishing the fact of the liability.
Holding: The Tax Court held that Giant Eagle was not entitled to a deduction or gross revenue offset for the unredeemed fuel credits. The court determined that the liability and corresponding deduction for outstanding credits became fixed upon their redemption, not when the customer earned them. The credits were redeemable only as a discount on the future purchase of gasoline, a condition precedent to their redemption. Thus, the deduction did not satisfy the first requirement of the all-events test.
The Tax Court relied on the Supreme Court’s ruling in General Dynamics Corp., 481 U.S. 239 (1987). In General Dynamics, the taxpayer deducted the estimated cost of future claims by employees under its self-insured medical plan. The Supreme Court held that the employer’s liability for these future claims was not fixed until an employee filed a properly documented insurance claim. Even if an employee was clearly entitled to a reimbursement, for a variety of reasons, that employee might not file a claim. Accordingly, filing the claim was a condition precedent to the employer’s liability and resulting deduction.
Regs. Sec. 1.451-4(a)(1) provides an exception to the all-events test for taxpayers that issue trading stamps or premium coupons redeemable by the taxpayer in merchandise, cash, or other property. This exception allows a reduction in sales revenue from selling the trading stamps or premium coupons for the cost of redeeming the coupons. Giant Eagle argued that the exception applied in its case. The Tax Court, however, noted that the provision’s purpose is to match sales revenue with the expenses incurred to create it. Since the redemption of Giant Eagle’s credits was conditioned on an additional purchase of gasoline, the court held that the credits were not redeemable in merchandise, cash, or other property within the meaning of the regulation. Rather, they were discounts associated with the future purchase of gasoline. Thus, the court held that Giant Eagle was not entitled to reduce its sales revenues by the estimated future costs of redeeming the credits.
By Karen M. Cooley, CPA, MBA, instructor of
accounting, and Darlene Pulliam, CPA, Ph.D.,
Regents Professor and McCray Professor of Business, both of the
College of Business, West Texas A&M University, Canyon, Texas.