There is a
grocery store chain that my wife uses on a regular basis. They have a
gasoline-discount program, whereby amounts spent on purchasing groceries go
toward price discounts on the purchase of gasoline. As the gas stations are
adjacent to the grocery store, it is a convenient perk.
I admit I
used the discount all the time. I purchased a luxury car this year, however,
and my mechanic has advised me not to use their gasoline. It sounds a bit over
the top, but until I learn otherwise I am purchasing gasoline elsewhere. My wife
however continues as a regular customer.
Giant Eagle
is a grocery store chain headquartered out of Pittsburgh. They have locations
In Pennsylvania, Ohio, West Virginia and Maryland. They have a similar fuel perk
program, except that their gasoline station is called “GetGo” and their fuel
points are called “fuelperks!”
Their
fuelperks! operate a bit differently, though. The perks expire after three months,
and they reduce the price of the fuel to the extent possible. I suppose it is
possible that they could reduce the price to zero. My fuel points reduce the
price of a gallon by 10-cent increments, up to a ceiling. I am not going to get
to zero.
Giant Eagle
found itself in Tax Court over its 2006 and 2007 tax returns. The IRS was
questioning a deduction on its consolidated tax return: the accrued liability
for those fuelperks! at year-end. The liabilities were formidable, amounting to
$6.1 million and $1.1 million for 2006 and 2007, respectively. Multiply that by
a corporate tax rate of 34% and there are real dollars at stake.
What are
they arguing over?
To answer
that, let’s step back for a moment and talk about methods of accounting. There are
two broad overall methods: the cash method and the accrual method. The cash
method is easy to understand: one has income upon receiving money and has deductions
upon spending money. There are tweaks for uncashed checks, credit cards and so
forth, but the concept is intuitive.
The accrual
method is not based on receiving or disbursing cash at all. Rather, one has
income when monies are due from sale of product or for performance of services.
That is, one has income when one has a “receivable” from a customer or client.
Conversely one has a deduction when one owes someone for the provision of
product or services. That is, one has a “payable” to a vendor, government agency
or employee.
If one has
inventories, one has to use the accrual method for tax purposes. Take a grocery
store – which is nothing but inventory – and Giant Eagle is filing an accrual-basis
tax return. There is no choice on that one.
There are
additional and restrictive tax rules that are placed on “payables” before one
is allowed to deduct them on a tax return. These are the “all events” rules,
are found in IRC Section 461(h), and have three parts:
·
Liability
must be fixed as of year end
·
Liability
must be determined with reasonable accuracy
·
Economic
performance must occur
Why all this?
Congress was
concerned that accrual taxpayers could “make up” deductions willy-nilly absent
more stringent rules. For example, a grocery store could argue that its coolers
were continuously wearing out, so a deduction for a “reserve” to replace the coolers
would be appropriate. Take the concept, multiply it by endless fact patterns
and – unfortunately – Congress was probably right.
All parties
would agree that Giant Eagle has a liability at year-end for those fuel points.
Rest assured that the financials statement auditors are not have any qualms about
showing the liability. The question becomes: does that liability on the
financial statements rise to the level of a deduction on the tax return?
You ever
wonder what people are talking about when they refer to a company’s financial
statements and tax return and say that there are “two sets of books?” Here is
but a small example of how that happens, and it happens because Congress made
it happen. There are almost endless examples throughout the tax Code.
The IRS is
adamant that Giant Eagle has not met the first requirement: the “liability must
be fixed.”
To a non-tax
person, that must sound like lunacy. Giant Eagle has tens of thousands of
customers throughout multiple states, racking up tons of fuel discount points for
the purchase of gasoline at – how convenient – gasoline stations right next to
the store. What does the IRS think that people are going to do with those
points? Put them on eBay? If that isn’t a liability then the pope is not Catholic.
But consider
this…
The points
expire after three months. There is no guarantee that they are going to be
used.
OK, you say,
but that does not mean that there isn’t a liability. It just means that we are
discussing how much the liability is. The existence of the liability is given.
COMMENT: Say, you have potential as a tax person, you know that?
That is not
what the IRS was arguing. Instead they were arguing that the liability was not “fixed,”
meaning that all the facts to establish the liability were not in.
How could
all the facts not be in? The auditors are going to put a liability on the
year-end audited financial statements. What more do you want?
The IRS
reminds you that it refuses to be bound by financial statement generally-accepted-accounting-principles
accounting. Its mission is to raise and collect money, not necessarily to
measure things the way the SEC would require in a set of audited financial
statements in order for you not to go to jail. In fact, if you were to release
financial statements using IRS-approved accounting you would probably have
serious issues with the SEC.
OK, IRS,
what “fact” is missing?
The customer
has to return. To the gasoline station. And buy gasoline. And enough gasoline
to zero-out the fuel points. Until then all the facts are not in.
Another way
of saying it is that there is a condition precedent to the redemption of the
fuel points: the purchase of gasoline. Test (1) of Sec 469(h) does not allow for
any conditions subsequent to the liability in order to claim the tax deduction,
and unfortunately Giant Eagle has a condition subsequent. No deduction for you!
Mind you the
deduction is not lost forever. It is delayed until the following year, because
(surely) by the following year all the facts are in to establish the liability.
The effect is to put a one-year delay on the liability: in 2008 Giant Eagle
would deduct the 12/31/2007 liability; in 2009 it would deduct the 12/31/2008
liability, and so on.
And the government
gets its money a year early. It is a payday-lender mentality, but there you
are.
BTW test (1)
is not even the difficult part of Section 469(h). That honor is reserved for
test (3): the economic performance test. Some day we will talk about it, but
not today. That one does get bizarre.
