Affiliated Foods, Inc., A Corporation v. Commissioner

128 T.C. No. 7
UNITED STATES TAX COURT
AFFILIATED FOODS, INC., A CORPORATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12846-04. Filed March 29, 2007.
P, a wholesale food purchasing cooperative, holds
one or more food shows a year at which member stores
and vendors selling to P meet. The vendors offer
special show discounts to member stores placing orders
with P for the vendors’ products at the food shows.
The special discount sometimes takes the form of a cash
payment from the vendor to the member store based on
the quantity of the vendor’s products ordered. Vendors
not bringing currency to the shows obtain cash for
those payments from promotional allowance accounts
established by the vendors with P or from checks given
to P and cashed by P. R treats such P-delivered
currency as, first, being received by P as a vendor
rebate, second, being returned by P to the vendor, and,
third, being paid by the vendor to the member store. R
considers the first step to result in a reduction in
P’s cost of goods sold and the third step to be the
payment by P of a defective (nondeductible) patronage
dividend. According to R, the defect is that the
payment is not out of P’s net earnings. The net result
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of R’s adjustments is an increase in P’s gross income
for each of the years in question in the amount of P-
delivered currency paid by vendors to member stores.
1. Held: P is not collaterally estopped from
challenging R’s adjustments by our report in Affiliated
Foods, Inc. v. Commissioner, T.C. Memo. 1996-505, affd.
in part, revd. in part and remanded 154 F.3d 527 (5th
Cir. 1998).
2. Held, further, the payments that R charges P
with making to member stores are properly characterized
as trade discounts. They were not paid with reference
to P’s net earnings but merely passed along the price
adjustments that P was entitled to on account of the
orders placed by the member stores at the food shows.
They reduce P’s gross sales and are not defective
patronage dividends.
William A. Hoy, for petitioner.
George E. Gaspar and Mark E. O’Leary, for respondent.
HALPERN, Judge: By notice of deficiency dated April 22,
2004, respondent determined deficiencies in petitioner’s Federal
income tax of $143,978, $166,493, and $11,101 for petitioner’s
taxable (fiscal) years ended September 30, 1991, October 2, 1992,
and October 1, 1993, respectively (the audit years). Petitioner
is a corporation operating on a cooperative basis (a purchasing
cooperative), whose shareholder-patrons operate retail grocery
stores. The issues for decision concern the proper treatment of
certain payments made to petitioner’s shareholder-patrons at food
shows petitioner conducted during the audit years.
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Respondent increased petitioner’s gross income for each of
the audit years on account of those payments and denied
petitioner any offsetting deductions on the ground that the
payments are nondeductible patronage dividends. In part,
respondent defends against petitioner’s assignments of error by
claiming that petitioner is precluded from challenging
respondent’s adjustments on the basis of the outcome in
Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505,
affd. in part, revd. in part and remanded 154 F.3d 527 (5th Cir.
1998); on remand T.C. Memo. 1999-136. Petitioner denies that it
is precluded from challenging the adjustments and claims that it
did not receive the payments, but, if it did, the payments either
did not increase its gross income because of offsetting
adjustments or, if they did increase its gross income, it was
entitled to offsetting deductions.
Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the audit years. The
references to subchapter T are to that subchapter (sections 1381
through 1388) of chapter 1 of subtitle A of the Internal Revenue
Code. Subchapter T deals with cooperatives and their patrons.
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FINDINGS OF FACT
Some facts are stipulated and are so found. The stipulation
of facts, with accompanying exhibits, is incorporated herein by
this reference.
Petitioner
Petitioner is a wholesale food purchasing cooperative that
resells a variety of products to retail grocery stores in Texas,
New Mexico, Oklahoma, Kansas, Colorado, and Arizona. At the time
the petition was filed, petitioner maintained its principal place
of business in Amarillo, Texas. Petitioner was incorporated in
1946 under the cooperative laws of the State of Texas to increase
the bargaining power of member stores in their dealings with
vendors.1 As of the time of the trial, petitioner had more than
239 shareholder-patrons, who operated approximately 715 member
stores. Petitioner does not own any interest in any member
store.
Petitioner computes its taxable income using an accrual
method of accounting and pursuant to the provisions of part I
1
The parties have stipulated that the term “member stores”
refers to retail grocery stores that individually or as a group
of related and associated retail grocery stores purchase food and
other consumer products from or through petitioner and that are
members of, or shareholders in, petitioner’s cooperative system.
They have further stipulated that the term “vendor” refers to
manufacturers or other producers of food and other products sold
to petitioner and member stores. We shall adopt those locutions
for purposes of this report.
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(sections 1381 through 1383) of subchapter T, which addresses the
tax treatment of cooperatives.
At the end of its fiscal year, petitioner returns the
profits from its wholesale grocery purchasing business to its
shareholder-patrons as patronage dividends.
Member Stores
Member stores determine independently of petitioner the
types, brands, and quantities of the commodities that they
purchase for resale to customers.
Promotional Allowance Accounts
From time to time, petitioner receives from some vendors and
vendor representatives (without distinction, vendors)2 funds to
be spent in promoting the sale of products offered by those
vendors. Petitioner deposits the funds in its own bank account
and, on its books, treats the deposits as liabilities owed to the
contributing vendors. Petitioner identifies the balance on hand
for each contributing vendor in a set of accounts that it has
designated the “promotional allowance accounts” (promotional
allowance accounts).
2
The parties have stipulated that the term “vendor
representative” refers to an individual or entity who solicits
and concludes sales of food and food products to petitioner and
member stores on behalf of vendors, including all independent
distributors, brokers, sales representatives, and agents of
vendors. We shall adopt that locution for purposes of this
report.
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Discounts and Allowances
Petitioner negotiates with individual vendors to obtain
discounts and allowances (without distinction, discounts) from
the list prices advertised by the vendors. Thus, for example,
for a limited time, a vendor of canned goods may offer $1 off on
each case of its 16-oz. cans of peaches ordered.
Except with respect to certain special price discounts
offered by vendors only at the food shows and described in the
next paragraph, vendor discounts on merchandise purchased by
petitioner reduce the price paid by (invoiced to) petitioner and
are referred to by petitioner as “off-invoice” (off-invoice)
discounts. Petitioner passes on to member stores off-invoice
discounts it obtains from vendors unless the associated
administrative costs exceed the amount of the discount.
Hereafter, we shall use the term “usual discount” to describe any
vendor discount other than the special price discounts offered
only at the food shows.
Food Shows-–General
Beginning in 1984 and extending at least through the audit
years, petitioner held one or more food shows a year at which
vendors and member stores met. One purpose of those shows was to
encourage member stores to place orders with petitioner for the
products that vendors promoted at the shows. The food shows held
during the audit years were held in Amarillo, Texas.
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Several weeks before each food show, petitioner sent
invitations to member stores and vendors. Attendance at the
shows by members, and participation in the shows by vendors, was
voluntary. A vendor wishing to participate in a food show
entered into an agreement with petitioner under which the vendor
agreed to pay a participation fee, rent and decorate a booth at
the show, and offer to member stores discounts on the products
that the vendor offered at the show. Those discounts, although
negotiable, were subject to petitioner’s approval and had to be
greater than the usual discounts. The special show discounts,
although limited to orders placed at the food shows, were, like
the usual discounts, based on the quantity of merchandise
ordered.
Also, in preparation for each food show, each participating
vendor provided petitioner with a “deal data sheet”, which, among
other things, showed the products the vendor was promoting and
the per-unit show discount (referred to by petitioner as “show
money” (show money)) offered for each product. Petitioner had
the right to reject individual product items. Vendors had
discretion to make show money available to member stores in one
of two ways: (1) a credit against the purchase price of the
product to be reflected on the invoice to be issued to the member
store by petitioner on fulfillment of the order after the food
show (i.e., an off-invoice discount), or (2) an immediate payment
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at the food show, in currency or by check, from the vendor to the
member store. In the case of an off-invoice discount, petitioner
stood as an intermediary between the vendor and the member store,
reducing the price it charged the member store to reflect the
off-invoice discount and receiving an equal reduction from the
vendor in the price it charged petitioner. Petitioner made no
explicit price reduction if the vendor agreed to pay show money
directly to the member at the food show.
Vendors exercised their discretion with respect to show
money by indicating their choices on the deal data sheets they
submitted. Information from deal data sheets was transferred by
petitioner to individual sheets for each vendor. Those sheets
were then reproduced and bound into books (show books) for
distribution to members attending the food show.
Each sheet in the show book had attached to it a perforated
strip (tear strip) that the member store could detach and use to
order from petitioner an item (or items) described on the
associated sheet. The member store delivered the tear strip to
the appropriate vendor, who, if an immediate payment of show
money was called for, made that payment and then delivered the
tear strip to petitioner for fulfillment of the order.
Petitioner entered the necessary information from the tear strip
into its billing and accounting records and, in most cases, then
discarded the tear strips. Petitioner ordered additional
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merchandise from the vendor, if necessary, and filled the order
on the date requested by the member store. Petitioner invoiced
the member store for the shipment, reflecting on the invoice
credit for the appropriate amount of show money if, and only if,
that amount had not already been paid by the vendor to the member
store.
A member store had discretion not to receive show money in
currency or by check from a vendor who had elected to offer show
money that way. A member store had no discretion, however, to
demand a payment from a vendor if the vendor had elected the off-
invoice method of offering show money.
Petitioner’s Profit on Sales to Member Stores
Petitioner profits on sales to member stores by marking up
the prices it charges member stores from the prices it pays
vendors. Except with respect to off-invoice discounts resulting
from show money offered at the food shows, petitioner applies its
customary markup to the price it charges a member store; i.e.,
the markup is applied to the vendor’s list price less the usual
discount obtained by petitioner. With respect to show money,
petitioner applies any off-invoice discount only after adding its
own markup. Thus, petitioner calculates that its margin (the
difference between the cost and selling price) and its markup on
food show orders are the same if a member store receives show
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money in currency or check or if the member store elects an off-
invoice credit.3
3
The following table is based on a table prepared by
Tammie Coffee, petitioner’s chief financial officer, to
illustrate the point in the text.
Consolidated Foods, Inc.
Comparison of gross profit on AFI’s ledger of off-invoice/at-show
payment:
Item #27024
Off invoice At show
Sale to AFI customer:
List price $76.20 $76.20
Less: usual discount 1.20 1.20
Subtotal: Price before markup 75.00 75.00
Add Markup: 7.5% 5.25 5.25
Subtotal 80.25 80.25
Less: Off-invoice show money discount .75 n/a
Total amount billed to member store 79.50 80.25
AFI purchase price from vendor:
List cost 76.20 76.20
Less:
Usual discount 1.20 1.20
Off-invoice show money discount .75 n/a
Total cost of goods sold 74.25 75.00
Gross profit on AFI general
ledger (margin):
1
Amount billed to member store 79.50 80.25
Less: cost of goods sold 74.25 75.00
Total margin 5.25 5.25
1
We note that, if it is assumed that the member store
receives a payment of $0.75 at the food show, it would have to
subtract that receipt ($0.75) from the amount it pays petitioner
($80.25) to determine its cost for the goods it purchased
($79.50).
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Food Shows; Currency
The currency used by vendors to pay show money had three
possible sources: (1) the vendor’s promotional allowance account,
if the vendor gave petitioner written instructions to charge a
specific amount against the account and to deliver currency in
that amount to the vendor at the food show, (2) a vendor’s check,
given by the vendor to petitioner for the specific purpose of
providing currency to the vendor at the food show, and (3)
currency brought to the food show by the vendor and taken from an
account of the vendor unknown to petitioner. In the first two
cases, petitioner obtained the necessary currency from the
Amarillo National Bank (the bank).
Petitioner obtained currency from the bank in denominations
sufficient to meet the individual vendors’ requests for currency
in specific denominations. Petitioner placed the currency in
locked bank bags identified with numbers unique to each vendor.
Immediately before a food show began, vendors retrieved their
bags from petitioner at a central location after, first,
verifying that the bag’s contents were as expected and, second,
signing a receipt.
At the conclusion of the food show, vendors who had received
bank bags from petitioner returned to petitioner those bags and
any currency they wanted to deliver to petitioner. Petitioner
issued written receipts for the bank bags and currency returned.
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Respondent’s Adjustments
Respondent attached to the notice of deficiency an
explanation of his adjustments to petitioner’s tax liabilities
for the audit years. The explanation states that respondent has
determined that “the food show distributions” to petitioner’s
shareholders are both income to petitioner and nondeductible
patronage dividends paid by it to its members. Therefore, the
explanation continues, petitioner’s taxable income is increased
by $421,973, $489,685, and $144,122, for 1991, 1992, and 1993,
respectively.
OPINION
I. Introduction
During the audit years, petitioner, a wholesale food
purchasing cooperative, conducted one or more food shows a year
at which member stores met with vendors. Among other things, the
food shows were designed to encourage member stores to order from
petitioner the vendors’ products offered at the shows. Pursuant
to an agreement with petitioner, each vendor attending a show was
required to offer member stores special show discounts on the
vendor’s products offered at the show. Petitioner referred to
those special show discounts as “show money”. Vendors could make
show money available to member stores in one of two ways. First,
a vendor could offer a member store a discount on an order placed
with petitioner at the show, petitioner having agreed to honor
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the discount (referred to by petitioner as an “off-invoice”
discount) when it invoiced the member store upon fulfillment of
the order after the show. Petitioner would receive an identical
discount from the vendor. Second, instead, the vendor could
offer to pay the member an amount equal to the off-invoice
discount immediately upon its executing an order to be placed
with petitioner. In that case, no invoice either from petitioner
to the member store or from the vendor to petitioner would
reflect the payment.
We are concerned here only with show money made available to
member stores in the second way; i.e., by an immediate payment by
a vendor to a member store. Moreover, we are concerned with
those payments only if they were made in currency (i.e., not by
check), and then only if the currency was delivered by petitioner
to the vendor at the start of the food show. We are not,
therefore, concerned with payments out of currency brought to a
food show by a vendor. The currency delivered by petitioner to a
vendor at the start of a food show (which we shall refer to as
petitioner-delivered currency) had one or perhaps both of two
sources: (1) a charge against the vendor’s promotional allowance
account, at the direction of the vendor, for the specific purpose
of providing the vendor with currency at the food show, and, (2)
checks received from the vendor and cashed by petitioner for the
same purpose. We shall use the terms “promotional-allowance
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currency” and “vendor-check currency” to refer to petitioner-
delivered currency attributable to the former and the latter of
those sources, respectively.
While, in the notice of deficiency, respondent explained
that his adjustments to petitioner’s Federal income tax for the
audit years were based on his determination that petitioner’s
“food show distributions” to its shareholders are income to
petitioner (and nondeductible patronage dividends paid to its
members), respondent did not explain how he computed those
adjustments. The parties have stipulated respondent’s method of
computation:
Respondent increased Petitioner’s taxable income
in each of the years in issue by an amount equal to the
difference between: (a) the sum of (i) the cash amounts
withdrawn from the Promotional Allowance Accounts and
(ii) the checks delivered to Petitioner by Vendors
* * * in anticipation of the Food Shows, over (b) the
cash returned to the Petitioner at the conclusion of
the Food Shows by the same Vendors * * * .[4]
We shall first address respondent’s claim that petitioner is
precluded from challenging respondent’s adjustments. Since we
believe that petitioner is not so precluded, we shall then
address the parties’ other claims.
4
The parties’ stipulation repeats the explanation as
follows: “Respondent’s adjustment to Petitioner’s income for the
years in issue is, therefore, the difference between the checks
and withdrawals from the Promotional Allowance Accounts provided
by Vendors * * * to Petitioner reduced by the cash returned by
the Vendors * * * at the conclusion of the Food Shows.”
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II. Issue Preclusion
A. Introduction
Respondent asserts that the Court in Affiliated Foods, Inc.
v. Commissioner, T.C. Memo. 1996-505, found that payments by
vendors to member stores of petitioner-delivered currency during
petitioner’s 1989 and 1990 tax years were both gross income to
petitioner and nondeductible payments of patronage dividends by
petitioner to its shareholders. Relying on the doctrine of issue
preclusion (or collateral estoppel), respondent argues that
petitioner is precluded from relitigating those issues. Since,
during the audit years, vendors also made payments of petitioner-
delivered currency to member stores, respondent argues that those
payments are items of gross income to petitioner for those years
and nondeductible payments of patronage dividends.
B. The Doctrine of Issue Preclusion
In Monahan v. Commissioner, 109 T.C. 235, 240 (1997), we
said:
The doctrine of issue preclusion, or collateral
estoppel, provides that, once an issue of fact or law
is “actually and necessarily determined by a court of
competent jurisdiction, that determination is
conclusive in subsequent suits based on a different
cause of action involving a party to the prior
litigation.” Montana v. United States, 440 U.S. 147,
153 (1979) (citing Parklane Hosiery Co. v. Shore, 439
U.S. 322, 326 n.5 (1979)). Issue preclusion is a
judicially created equitable doctrine whose purposes
are to protect parties from unnecessary and redundant
litigation, to conserve judicial resources, and to
foster certainty in and reliance on judicial action.
See, e.g., id. at 153-154; United States v. ITT
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Rayonier, Inc., 627 F.2d 996, 1000 (9th Cir. 1980).
This Court in Peck v. Commissioner, 90 T.C. 162,
166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990), set
forth the following five conditions that must be
satisfied prior to application of issue preclusion in
the context of a factual dispute * * * :
“(1) The issue in the second suit must be
identical in all respects with the one decided in the
first suit.
(2) There must be a final judgment rendered by a
court of competent jurisdiction.
(3) Collateral estoppel may be invoked against
parties and their privies to the prior judgment.
(4) The parties must actually have litigated the
issues and the resolution of these issues must have
been essential to the prior decision.
(5) The controlling facts and applicable legal
rules must remain unchanged from those in the prior
litigation. * * * ”
C. Discussion
1. Petitioner’s Argument
Petitioner concedes that the first three conditions are
satisfied. Petitioner argues that the fourth condition is not
satisfied since, by assigning error to respondent’s failure to
allow it offsetting deductions or adjustments to gross income
from sales--if we should decide in the first place that
petitioner received anything on account of the vendors’ payments
to members of petitioner-delivered currency--petitioner has
raised issues that were neither litigated nor resolved in the
prior litigation. Petitioner argues that the fifth condition is
not satisfied since the controlling facts in this case are not
the same as in the prior case.
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2. Points Not at Issue in the Prior Litigation
“Collateral estoppel applies only to an issue that was
actually litigated and determined in a prior action, not to an
issue that might have been litigated.” Anderson, Clayton & Co.
v. United States, 562 F.2d 972, 992 (5th Cir. 1977); see also
Commissioner v. Sunnen, 333 U.S. 591, 597-598 (1948). As put by
the Supreme Court in Commissioner v. Sunnen, supra at 598:
“Since the cause of action involved in the second proceeding is
not swallowed by the judgment in the prior suit, the parties are
free to litigate points which were not at issue in the first
proceeding, even though such points might have tendered and
decided at that time.” Moreover, it is well settled that each
taxable year is the origin of a new liability and of a separate
cause of action. Id.; see also Estate of Hunt v. United States,
309 F.2d 146, 148 (5th Cir. 1962). In Cloud v. Commissioner,
T.C. Memo. 1976-27, we held that the taxpayers were not
collaterally estopped from challenging the Commissioner’s
disallowance of their deductions of certain expenses under a
theory different from the losing theory they had advanced in
litigation concerning the same types of expenses for prior years.
Petitioner’s assignments of error to respondent’s failure to
allow it offsetting deductions or adjustments to gross income
from sales do raise issues that were neither litigated nor
resolved in the prior litigation. Although petitioner did raise
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the issue of an offsetting deduction in Affiliated Foods, Inc. v.
Commissioner, supra, and was sustained on that issue with respect
to petitioner-delivered currency given to one vendor, petitioner
failed on brief to argue the issue with respect to vendors
generally and, on account of that failure, was deemed to have
conceded the issue. Id. n.11. The issue of offsetting
deductions was not fully litigated in the prior litigation, and
petitioner is not precluded from raising it here. See Coors v.
Commissioner, 60 T.C. 368, 392 (1973) (Commissioner not barred
from litigating capitalization issue that, in prior litigation
between parties, he had abandoned, where no findings had been
made by Court with regard to issue, and it was not necessary to
result reached), affd. 519 F.2d 1280 (10th Cir. 1975). Nor is
petitioner precluded from arguing for an offsetting adjustment to
gross income from sales, because that issue was not raised in the
prior litigation. See Monahan v. Commissioner, supra at 240.
3. Difference in Controlling Facts
The fact that petitioner is free to argue for offsetting
deductions or adjustments does not mean that it is free to argue
that it has no gross income (or no gross receipts) on account of
vendor payments to member stores of petitioner-delivered currency
if that issue was settled in the prior litigation. See Jaggard
v. Commissioner, 76 T.C. 222, 224 (1981) (issue-by-issue
determination of whether collateral estoppel applies).
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Nevertheless, petitioner claims that it is free to so argue since
the facts controlling the issue here are different from those in
Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505. In
that case, we found facts that, in much the same terms we use
today, describe food shows petitioner put on during its 1989 and
1990 taxable years (1989 and 1990, respectively). We described
show money (although we did not use that term) much as we
describe it today, although we included no specific description
of off-invoice discounts. We described the order forms (deal
data sheets) submitted by vendors and said “there was no
negotiating” after the order forms were submitted. We described
the procedures for supplying petitioner-delivered currency much
as we describe them today. We also said:
In both instances [i.e., in the case of both
promotional-allowance currency and vendor-check
currency], petitioner required the vendors to sign for
the cash received, and, most importantly, it also
required any unused cash to be returned to it at the
end of the food show. This was not a check-cashing
service. Unlike a check-cashing service, petitioner
ensured that the check proceeds were either paid to its
shareholders or returned to it. [Emphasis added.]
We ended our discussion of petitioner-delivered currency by
concluding:
Petitioner was not a nontaxable intermediary with
respect to the food show cash disbursements arising
from the promotional accounts. * * * Similarly, as
for the food show cash disbursements arising from the
check-cashing transactions, petitioner exercised
dominion and control over these funds, as evidenced by
the return of any “unused” cash. Thus, these amounts
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must also be included in petitioner’s income. * * *
[Emphasis added.]
Petitioner argues that the important facts we relied on in
Affiliated Foods, Inc. v. Commissioner, supra, to support our
conclusion that it exercised dominion and control over the
petitioner-delivered currency are not present in this case.
Petitioner claims that, unlike what we found for 1989 and 1990,
during the audit years, (1) it did not require vendors to return
to it any remaining petitioner-delivered currency not paid to
member stores, and (2) although it had the final say, it did
negotiate with vendors the amounts of show money the vendor would
give. It also claims that, with respect to its 1993 food shows,
vendors gave it no checks. While we are not certain about
petitioner’s third claim, we have made findings consistent with
its first two claims. With respect to its first claim, we have
found: “At the conclusion of the food show, vendors who had
received bank bags from petitioner returned to petitioner those
bags and any currency they wanted to deliver to petitioner.” See
supra p. 11 (emphasis added). Our finding is almost a verbatim
recitation of a stipulated fact. From that stipulation, we draw
the inference that vendors had discretion to, but were not
required to, return to petitioner at the end of a food show any
undistributed petitioner-delivered currency, and we so find.
Whatever limited power vendors had to negotiate food show
money and, more importantly, their right to retain any
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undistributed petitioner-delivered currency distinguish the facts
before us from the facts we relied on in Affiliated Foods, Inc.
v. Commissioner, supra. In the prior litigation, we found “most”
important the requirement that undistributed petitioner-delivered
currency be returned; that requirement evidenced to us
petitioner’s exercise of dominion and control over petitioner-
delivered currency.5 The return requirement ensured that
petitioner-delivered currency would either be paid to member
stores or returned to petitioner. In the present litigation, we
cannot be equally confident that petitioner-delivered currency
not returned to petitioner was paid to member stores, since
5
In Affiliated Foods, Inc. v. Commissioner, T.C. Memo.
1996-505, affd. in part, revd. in part and remanded 154 F.3d 527
(5th Cir. 1998), we found that amounts received from vendors and
credited to the vendors’ promotional allowance accounts were
items of gross income to petitioner when received. We were
reversed on that point by the Court of Appeals for the Fifth
Circuit. Affiliated Foods, Inc. v. Commissioner, 154 F.3d 527
(5th Cir. 1998). Respondent has made no adjustments for amounts
similarly received during the audit years, and we assume that, at
least for purposes of this case, respondent accepts the Court of
Appeals’ conclusion that vendors retained control of funds
credited to the promotional allowance accounts and receipt of
those funds did not give rise to gross income to petitioner.
Id. at 533. We assume further that an amount equal to any
petitioner-delivered currency that a vendor chose to return to
petitioner following a food show during the audit years was
either returned to the vendor or credited to its promotional
allowance account (and, therefore, petitioner retained no control
over any currency returned to it). We make those assumptions
because, for the audit years, respondent has increased
petitioner’s income by only the excess of the petitioner-
delivered currency over the amount of cash returned by vendors to
petitioner at the conclusion of the food show.
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vendors were under no obligation to return to petitioner any
petitioner-delivered currency not paid to member stores or to
account to petitioner for their disposition of petitioner-
delivered currency. Petitioner’s dominion and control over
petitioner-delivered currency was different in the audit years
than it was in the years subject to the prior litigation.
Denying a party the right to litigate an issue is a matter that
requires circumspection. Monahan v. Commissioner, 109 T.C.
242. On balance, we think that the interests of justice are
better served by allowing petitioner to litigate the control
issue afresh, in the light of the difference in facts from the
prior litigation. See, e.g., Alexander v. Commissioner, 224 F.2d
788, 793 (5th Cir. 1955) (interests of justice not served by
holding barring taxpayer from showing change in facts concerning
partnership agreement subject to prior proceeding), affg. in
part, revg. in part and remanding 22 T.C. 318 (1954).
Affiliated Foods, Inc. v. Commissioner, supra, does not preclude
petitioner from litigating the inclusion in gross income of
petitioner-delivered currency.
D. Conclusion
Respondent’s affirmative defense of issue preclusion fails.
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III. Discussion
A. Arguments of the Parties
Respondent argues that, for each of the audit years,
petitioner has an item of gross income on account of petitioner-
delivered currency because petitioner “asserted control over
those funds and used the vendor representatives as conduits to
make ‘disguised patronage dividends’ to its member stores at the
food shows.” Respondent lists the following as among the
important operative facts:6
Petitioner negotiated for the food show rebates
and thereby provided for the direct payment of monies
from vendors to members that would otherwise have
accrued to Affiliated as earnings, i.e., rebates from
vendors to Affiliated for product purchased by
Affiliated.
A member received food show rebates based on the
amount of product purchased at the show. The greater
the product purchases meant more food show rebates.
Members committed to make purchases at the food
show and subsequently bought the product through
Affiliated.
In this manner, a member received rebates based on
the amount of product purchased through Affiliated, and
Affiliated was able to provide a patronage dividend
without complying with the statutory requirements.
While petitioner disagrees that it paid any patronage
dividends or asserted control over the petitioner-delivered
currency (petitioner argues that it was only delivering to
6
Paragraph numbers and citations of respondent’s proposed
findings of fact are omitted.
- 24 -
vendors their own money, either reducing the balance of a
vendor’s promotional allowance account or delivering the proceeds
of a vendor’s check), its description of the facts does not
differ markedly from respondent’s:
The payments in question were simply price rebates; no
different than the price discounts and rebates afforded
Member Stores on a day-to-day basis throughout the
year. The day-to-day rebates and price discounts also
represented value passing from Petitioner, who granted
them, to the Member Stores, who purchased the goods to
which the rebates and discounts attached. * * *
If we should find that petitioner exercised sufficient
control over the petitioner-delivered currency to cause us to
conclude that petitioner had a receipt in an equal amount,
petitioner argues that either the receipt did not increase its
gross income because of an offsetting adjustment (either an
increase in petitioner’s cost of goods sold or a reduction in the
amount of its receipts from sales to member stores) or, if the
receipt did increase its gross income, it had an offsetting
deduction.
B. Discussion
1. Control
Petitioner organized the food shows and required vendors
wishing to participate to offer special deals (show money) on
their products offered and ordered at the show. In the case of
an off-invoice discount, petitioner accorded the member store the
discount and, in turn, was accorded an equal discount by the
- 25 -
vendor. A vendor could choose, however, to make an immediate
payment of show money to a member store, either in currency or by
check. If the vendor chose currency, the currency either had
come from petitioner (i.e., petitioner-delivered currency) or was
provided by the vendor itself (vendor-provided currency). If
payment was of petitioner-delivered currency, respondent’s
argument is that the vendor was not using its own money to pay
show money: The vendor was using petitioner’s money to pay show
money. As respondent sees it, simultaneously with the vendor’s
making a payment of petitioner-delivered currency to a member
store, the vendor rebated an equal amount to petitioner, which
petitioner returned to the vendor under an earlier direction that
the vendor pay the amount to the member store on petitioner’s
behalf.
Respondent justifies such indirection on the ground that
petitioner asserted sufficient control over the circumstances
surrounding the vendors’ receipts of petitioner-delivered
currency that the vendors should be viewed as nothing more than
petitioner’s agents engaged to pay to the member stores rebates
from moneys (rebates) first received by petitioner. Respondent
does not pin down the nature of that control, however, and the
fact that respondent does not similarly treat the vendors as
petitioner’s agents in the case of vendor-provided currency or
checks (hereafter, without distinction, vendor-provided currency)
- 26 -
paid to member stores leaves us less than clear as to the
substance of respondent’s argument concerning control.
As set forth supra in section III.A., respondent claims as a
fact: “Petitioner negotiated for the food show rebates and
thereby provided for the direct payment of moneys from vendors to
members that would otherwise have accrued to Affiliated as
earnings, i.e., rebated from vendors to Affiliated for product
purchased for sale by Affiliated.” While it is true that
petitioner negotiated with respect to show money and had the
right to final approval and, therefore, exercised some control
over show money, petitioner’s authority and rights were the same
irrespective of whether the vendor chose to use petitioner-
delivered or vendor-provided currency to pay show money to member
stores. Yet respondent’s adjustments increasing petitioner’s
income on account of rebates petitioner is deemed to have
received is made only with regard to petitioner-delivered
currency (and without regard to vendor-provided currency). If
negotiation and approval with respect to show money signify
control, then we do not see why those factors do not equally
signify control with respect to vendor-delivered currency. The
singular distinction between petitioner-delivered and vendor-
provided currency is that the former came to vendors from
petitioner’s hands. As explained in the next two paragraphs, we
do not see that distinction as justifying different treatment.
- 27 -
With respect to each vendor receiving petitioner-delivered
currency, the delivery was of either, or both of, promotional-
allowance currency or vendor-check currency. A vendor retained
control of its promotional allowance account,7 and only upon its
specific instruction was petitioner authorized to charge the
account and deliver a specified amount of currency to the vendor
at the food show. Petitioner had no discretion in the matter.
Petitioner likewise lacked discretion with respect to the
proceeds of a vendor’s check that it delivered to the vendor at
the food show. In N. Am. Oil Consol. v. Burnet, 286 U.S. 417,
424 (1932), the Supreme Court announced what has been termed the
“claim-of-right” doctrine:
If a taxpayer receives earnings under a claim of right
and without restriction as to its disposition, he has
received income which he is required to return, even
though it may still be claimed that he is not entitled
to retain the money, and even though he may still be
adjudged liable to restore its equivalent. * * *
The doctrine does not apply to amounts a taxpayer receives as a
mere conduit or agent for transmittal to another. E.g.,
Apothaker v. Commissioner, T.C. Memo. 1985-445. Indeed, in a
case predating subchapter T and upholding the payer corporation’s
exclusion from gross income of patronage based refunds, the Court
of Appeals for the Fifth Circuit grounded its analysis in part on
the following proposition: “‘[I]n order for receipts to
7
See supra note 5.
- 28 -
constitute taxable income to a taxpayer there must be (1) the
presence of a claim * * * [of] right to such receipts, and (2)
the absence of a definite, unconditional obligation to pay the
same to another.’” United States v. Miss. Chem. Co., 326 F.2d
569, 573 (5th Cir. 1964) (quoting Farmers Coop. Co. v.
Birmingham, 86 F. Supp. 201, 214 (N.D. Iowa 1949) (citing
Commissioner v. Wilcox, 327 U.S. 404 (1946))).
Petitioner-delivered currency came into petitioner’s hands
on the understanding that petitioner would in short order deliver
the currency to the vendors whose promotional allowance accounts
had been debited, or whose checks had been cashed, to provide the
currency. Petitioner lacked meaningful control over petitioner-
delivered currency, and neither its receipt of checks from
vendors, its withdrawal of currency from the bank, nor its
delivery of that currency to vendors can, alone or together,
serve as the basis for charging petitioner with having received
rebates from vendors. With respect to this narrow aspect of the
show money operation, petitioner merely served as a conduit,
providing the vendors with liquidity from their own funds. We do
not see that petitioner effectively exercised any more control
over petitioner-delivered currency than it did over vendor-
provided currency.
We end our discussion of control inconclusively because, so
far as we understand respondent’s control argument, it is
- 29 -
unpersuasive: We do not see a sufficient difference between
petitioner’s control over petitioner-delivered and vendor-
provided currency that they should be treated differently, yet
that is what respondent has done. Nevertheless, we are mindful
that in affirming our prior treatment of show money in Affiliated
Foods, Inc. v. Commissioner, 154 F.3d at 533, the Court of
Appeals remarked that, by negotiating the terms of show money
payments, petitioner provided for the direct payment of moneys
from vendors to member stores that otherwise would have accrued
to petitioner as earnings. Even were we to ignore respondent’s
failure to treat petitioner-delivered and vendor-provided
currency equivalently, however, and to credit petitioner with
control over petitioner-delivered currency, we believe that
petitioner prevails for the reasons stated below.
2. Rebates
Both petitioner and the member stores are merchants. A
merchant computes its gross income from sales during a year by
subtracting from its revenue from sales the cost of the goods
sold. See sec. 1.61-3(a), Income Tax Regs. A purchase price
adjustment or a price rebate that a taxpayer receives with
respect to goods that it has purchased for resale is not, itself,
an item of gross income but, instead, is treated as a reduction
in the cost of the goods sold. See, e.g., Dixie Dairies Corp. v.
Commissioner, 74 T.C. 476, 492 (1980).
- 30 -
In his reply brief, respondent describes how petitioner
should have accounted for the rebates that respondent deems
petitioner received on account of the vendors’ currency payments
to member stores. Without distinguishing between petitioner-
delivered and vendor-provided currency, respondent states:
“Affiliated should have reduced its cost of goods sold to reflect
these currency rebates and thereby increased its income. This is
what happened, for example, with those rebates that took the form
for a reduction in the invoice price (i.e., ‘off invoice’).”
That, however, is not what happened with respect to off-invoice
discounts. Petitioner’s chief financial officer, Tammie Coffee,
gave uncontradicted and convincing testimony that, in the case of
show money paid by way of an off-invoice discount, the discount
reduced both the cost of the goods sold and petitioner’s receipt
from the sale of the goods (its gross receipt). The net effect,
of course, is that any off-invoice discount had no effect on
petitioner’s gross income.8 Nor did any payment of show money
from vendor-provided currency have any effect on gross income,
since petitioner ignored it in determining both the cost of the
8
Because petitioner had a fixed right to reimbursement at
the time it accorded an off-invoice discount to a member store,
there should be no difference between the time it accrued the
receipt from the sale and the time it reduced its cost for the
goods sold. See Rev. Rul. 84-41, 1984-1 C.B. 130 (citing Wolfors
v. Commissioner, 69 T.C. 975, 983-985 (1978)).
- 31 -
goods sold and the gross receipt from the sale, and respondent
has not challenged that treatment.
While he has misunderstood how petitioner accounted for the
off-invoice discounts, we assume that respondent would agree
that, as between petitioner and the vendors, any off-invoice
discounts or deemed rebates were trade discounts, which reduced
the cost to petitioner of merchandise purchased from the vendors.
See sec. 1.471-3(b), Income Tax Regs. (cost of merchandise
purchased during taxable year is invoice price less “trade” and
certain other discounts); Rev. Rul. 84-41, 1984-1 C.B. 130, 130
(“Trade discounts represent adjustments to the purchase price
granted by a vendor.”). Putting aside for the moment
petitioner’s status as a cooperative corporation, it is difficult
to see why the rebates that respondent deems petitioner received
from vendors and passed on without alteration to member stores on
sales made to those stores should not also be deemed to reduce
petitioner’s receipts from those sales. We have found that the
special show discounts were based on the quantity of merchandise
member stores ordered from petitioner at the food shows. The
discounts were an inducement to greater sales. If petitioner is
deemed to have paid any show money, its purpose was to increase
sales (and profits9) by reducing prices. Those deemed payments,
9
Petitioner ignored special show discounts in applying its
markup to food show sales. See supra note 3.
- 32 -
therefore, should be considered as reducing its receipts from
sales.
We cannot improve on the Commissioner’s explanation in Rev.
Rul. 2005-28, 2005-1 C.B. 997, as to why any deemed payments
should be considered as reducing petitioner’s receipts from
sales. In that revenue ruling, the Commissioner holds that
Medicaid rebates incurred by a pharmaceutical manufacturer are
purchase price adjustments that are subtracted from gross
receipts in determining gross income. The Commissioner states:
In Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707
(1956), * * * the Tax Court addressed whether
allowances, discounts, or rebates paid by a milk
producer to certain purchasers of its milk, in willful
violation of state law, are adjustments to the purchase
price of the milk resulting in a reduced sales price,
or ordinary and necessary business expenses under § 162
(in which case no deduction would be allowed under the
rules of § 162(c)). The court reasoned that for income
derived from the sale of property, in determining gain,
the amount realized must be based on the actual price
or consideration for which the property was sold and
not on some greater price for which it possibly should
have been, but was not, sold. The court focused on the
facts and circumstances of the transaction, what the
parties intended, and the purpose or consideration for
which the allowance was made. The court found that the
allowances were part of the sales transaction and
concluded that gross income must be computed with
respect to the agreed net prices for which the milk was
actually sold. Thus, under Pittsburgh Milk, where a
payment is made from a seller to a purchaser, and the
purpose and intent of the parties is to reach an agreed
upon net selling price, the payment is properly viewed
as an adjustment to the purchase price that reduces
gross sales. [Id., 2005-1 C.B. at 997; emphasis
added.]
- 33 -
We must, therefore, consider whether petitioner’s status as
a cooperative requires a different result.
3. Cooperative Status
a. Introduction
Section 1382 addresses the taxable income of cooperatives,
such as petitioner, to which section 1381 applies (individually,
a subchapter T cooperative). Section 1382(a) addresses the gross
income of subchapter T cooperatives. In pertinent part, it
provides:
SEC. 1382(a). Gross Income.–-Except as provided
in subsection (b), the gross income of any organization
to which this part applies shall be determined without
any adjustment (as a reduction in gross receipts, an
increase in cost of goods sold, or otherwise) by reason
of any allocation or distribution to a patron out of
the net earnings of such organization * * * .
Subsection (b)(1) of section 1382 provides an exception that, in
effect, allows a deduction from gross income for the payment of
“patronage dividends”. That term, in pertinent part, is defined
in section 1388(a) to mean amounts paid by a subchapter T
cooperative:
(1) on the basis of quantity or value of business
done with or for such patron,
(2) under an obligation of such organization to
pay such amount, which obligation existed before the
organization received the amount so paid, and
(3) which is determined by reference to the net
earnings of the organization from business done with or
for its patrons.
- 34 -
b. Respondent’s Argument: Defective Patronage
Dividends
As we understand respondent’s argument, it is that the trade
discounts that respondent deems petitioner to have received from
the vendors and to have passed on without alteration to member
stores on sales made to those stores do not reduce petitioner’s
gross receipts from those sales because those passed-on rebates
were defective patronage dividends.
According to respondent, the passed-on rebates resembled
patronage dividends in two respects. First, they were patronage
based. Indeed, respondent proposes that we find that the deemed
rebates “were based on the amount of product purchased, or
business done, by [petitioner’s shareholder-patrons]”. Second,
they were prearranged, at least in the sense that they were part
of the negotiated sale price of merchandise ordered by member
stores at the trade shows and were consistent with petitioner’s
policy of passing on to member stores discounts obtained from
vendors. Respondent argues, however: “[P]etitoner cannot show
that the dividends were calculated by reference to the net
earnings of the cooperative from business done with or for its
patrons.” Therefore, respondent concludes: “The amounts in
question do not qualify for the patronage dividend deductions.”
Respondent adds: “Once it has been determined that the amounts
at issue were disguised [we would say “defective”] patronage
dividends the analysis should stop.”
- 35 -
But if the analysis stops there, then respondent may well
lose. If the passed-on rebates are defective patronage dividends
because petitioner cannot show that they were calculated with
reference to its patronage-based net earnings, then, perhaps,
they were not calculated with reference to those earnings. If
not, then it would appear that section 1382(a) imposes no
restriction on petitioner’s reducing its gross receipts from
sales to member stores to reflect what respondent must concede
are price adjustments (i.e., trade discounts).10 Nor has
respondent advanced an argument separate from his defective
patronage dividend argument that any provision of subchapter T
prevents a subchapter T cooperative from subtracting trade
10
Moreover, in Pittsburgh Milk Co. v. Commissioner, 26
T.C. 707 (1956), and cases following that decision, the Tax Court
has held that when, as added consideration for a sale, a seller
rebates part of a customer’s purchase price or pays that customer
cash from a separate account, the amount of the rebate is not a
business expense, potentially deductible under sec. 162, but,
rather, a reduction of selling price. Regardless of whether the
rebate is legal (viz, whether sec. 162(c) would disallow
deduction of such an illegal rebate by that seller/taxpayer), the
seller is treated as if it never received more than the net
selling price (i.e., the stated selling price, less the rebate);
the amount of the rebate is excluded from the seller’s gross
income. See generally Max Sobel Wholesale Liquors v.
Commissioner, 630 F.2d 670, 671-672 (9th Cir. 1980), affg. 69
T.C. 477 (1977). In Max Sobel, 630 F.2d at 672, the Court of
Appeals for the Ninth Circuit further observed: “The Pittsburgh
Milk doctrine has the obvious merit of reflecting economic
reality.” The Commissioner has acquiesced to the Tax Court’s
holdings in Max Sobel and Pittsburgh Milk. See 1982-2 C.B. 2, 4;
see also Rev. Rul. 82-149, 1982-2 C.B. 56.
- 36 -
discounts accorded patrons from the purchase price it charges
those patrons in determining gross receipts.
We shall consider further the nature of patronage dividends.
c. Patronage Dividends Considered Price Adjusments
We have said: “Patronage dividends are considered rebates
on purchases or deferred payments on sales, allocated or
distributed pursuant to a preexisting obligation of the
cooperative, and, as such, do not constitute taxable income to
the cooperative.” Buckeye Countrymark, Inc. v. Commissioner, 103
T.C. 547, 558 (1994).
The notion that a cooperative should not be taxed on
patronage-based payments because those payments amount to nothing
more than price adjustments is a longstanding rationale
underlying the Federal income tax treatment of patronage
dividends. Subchapter T was added to the Internal Revenue Code
by the Revenue Act of 1962 (the 1962 Act), Pub. L. 87-834,
section 17, 76 Stat. 1045. Before the 1962 Act, non-tax-exempt
cooperatives were taxed as corporations. See Ravenscroft, “The
Proposed Limitation on the Patronage Dividend Deduction”, 12 Tax
L. Rev. 151, 152 (1957). However, under administrative
practices, judicially affirmed, they could exclude from gross
income the amounts allocated to patrons as patronage dividends.
E.g., Farmers Coop. Co. v. Birmingham, 86 F. Supp. 201, 219
(N.D. Iowa 1949) (collecting administrative rulings). Primarily,
- 37 -
two distinct theories were advanced as the reason for the
exclusion of patronage dividends from the taxable income of
cooperatives. Certified Grocers, Inc. v. United States, 18 AFTR
2d 5012, 66-2 USTC par. 9493 (M.D. Fla. 1966). In that case, the
District Court described those theories as follows:
Under the so-called agency theory, the cooperative
should never be taxed because it is conceived of as an
agent, bailee, or trustee for the patrons, serving
merely as a conduit for their income which it does not
own. On the other hand, the so-called price adjustment
theory excludes patronage dividends from income because
it treats the dividends as minor adjustments in the
costs of goods, analogous to discounts and rebates
given by a seller at the time of sale or upon prompt
payment. [Id. at 5,013, 66-2 USTC par. 9493, at
86,547.]
See also discussion and cases collected in Ravenscroft, supra at
154-168; Reynolds, “What Then To Do With a Non-Cooperative
Cooperative?” 56 Tax Law. 825, 831-832 (2003).
The price adjustment theory appears to have been the more
widely accepted theory. Certified Grocers, Inc. v. United
States, supra; Ravenscroft, supra at 157, 160; Reynolds, supra at
831. Indeed, the U.S. Court of Appeals for the Fifth Circuit has
said:
The exclusion of patronage dividends for federal
income tax purposes has not been placed upon the ground
that cooperatives are special creatures of statute
under the tax laws, but rather upon the theory that
patronage dividends are in reality rebates on purchases
or deferred payments on sales allocated or distributed
pursuant to a pre-existing obligation of the
cooperative, and thus do not constitute taxable income
to the cooperative. * * *
- 38 -
United States v. Miss. Chem. Co., 326 F.2d at 573 (citing Midland
Coop. Wholesale Oil Association v. Commissioner, 44 B.T.A. 824
(1941), for the stated proposition).
The legislative history of the 1962 Act indicates that, in
providing a statutory deduction for patronage dividends, the tax-
writing committees of Congress had in mind the price adjustment
theory. S. Rept. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B.
707, 822 (“patronage dividends represent price adjustments”); H.
Rept. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 405, 485-486
(similar).
d. The Price Adjustment Theory Has Its Limits
An examination of the limited caselaw on the subject and
scholarly and other authoritative writings convinces us that,
although the Federal income tax treatment of patronage dividends
may rest substantially on the price adjustment theory, a price
adjustment made by a cooperative may reduce its gross income even
if the adjustment does not qualify as a patronage dividend.
It has long been understood that the distinguishing
characteristic of a cooperative enterprise is the obligation of
the enterprise to distribute what may be called its “excess
receipts” (or “net margins”) on a patronage basis. See Packel,
Law of Cooperatives 248–249 (3d ed. 1956). While there is some
question as to whether, with regard to a cooperative enterprise,
the concept of profit is appropriate (since the enterprise is run
- 39 -
for the benefit of those who do business with it and not for the
purpose of making a profit for the organizers), the idea is that,
periodically, any surplus, or amount in excess of the break-even
point from doing business with patrons, will be returned to the
patrons on the basis of their dealings with the cooperative
(i.e., on a patronage basis). See id. Indeed, today, for
Federal income tax purposes, patronage dividends are determined
by reference to the “net earnings” of the organization from
business done with or for its patrons. Sec. 1388(a)(3); sec.
1.1388-1(a)(1), Income Tax Regs. The regulations describe “net
earnings” as including “the excess of amounts retained (or
assessed) by the organization to cover expenses or other items
over the amount of such expenses or other items.” Sec. 1.1388-
1(a)(1), Income Tax Regs.
Notwithstanding the question of the appropriateness of the
term “profit” with respect to a cooperative enterprise, both
early administrative interpretations and judicial decisions
conceived of a patronage dividend not as a simple price
adjustment or immediate rebate but as a distribution of corporate
profits or income. In O.D. 64, 1 C.B. 208 (1919), the
Commissioner ruled concerning an incorporated fruit grower’s
association that conducted its business at a profit. It ruled
that the nonexempt corporation would not have to pay any income
tax on its patronage dividends. It authorized the corporation
- 40 -
to: “deduct from gross income amounts periodically returned to
members as a refund of profits on business transacted with them,
and proportioned to the amount of such business.” Id. (emphasis
added). In United Coops., Inc. v. Commissioner, 4 T.C. 93, 107-
108 (1944), we held that an agricultural cooperative was entitled
to exclude from gross income as a patronage dividend the excess
of its net income available for distribution to its patrons (and
to which they had a right) over the amount of that income that
the cooperative had discretion to pay as dividends on its common
stock. We said:
These dividends, if paid, would be paid out of net
income. If dividends were not paid, then the net
income of petitioner available for distribution to its
patrons would be accordingly greater. The choice of
whether so much of its net income as equaled 8 percent
of the par value of its common stock should be
distributed to its stockholders as a dividend or to its
patrons as rebates was in the corporation. * * * [Id.
at 108; emphasis added.]
It hardly seems disputable that, whether by administrative or
judicial decision, or by act of Congress, the allowance of a
deduction for patronage dividends was intended not to confirm
that a trade discount is a proper adjustment to the price
reported on a particular sale of a good or service to a patron
(whether a shareholder or not) but was intended to allow a
deduction for a patronage-based return made from the excess
proceeds from many sales, to many patrons (i.e., from net
earnings), over the course of time.
- 41 -
That patronage dividends are somehow different from
transaction-specific price reductions was recognized well before
Congress codified the definition of a patronage dividend in 1962.
The difference was recognized by courts overseeing legislative
price regulation in fields in which cooperatives operated. In
1950, the U.S. Court of Appeals for the Third Circuit held that a
purchasing cooperative cannot use its cooperative status as a
shield against State Fair Trade Laws prohibiting price reductions
at the time of sale. Sunbeam Corp. v. Civil Serv. Employees’
Coop. Association, 187 F.2d 768 (3d Cir. 1951). Also in 1950,
the California District Court of Appeals held that the provisions
of the California Corporations Code that permit a cooperative
corporation to distribute its earnings to its shareholder-patrons
are paramount to the provisions of the California Alcoholic
Beverage Control Act that prohibit sales of liquor at less than
posted prices and secret rebates. Certified Grocers v. State Bd.
of Equalization, 223 P.2d 291 (Cal. Dist. Ct. App. 1950).
A categorical difference between patronage dividends and
transaction-specific price reductions had been recognized by
commentators. See, e.g., Packel, supra at 217 (“It is important
to distinguish a price reduction, given at the time of the
transaction, from a true patronage dividend.”); Bunn, Consumers’
Co-Operatives and Price Fixing Laws, 40 Mich. L. Rev. 165, 173
(1941) (“The truth is that a patronage dividend is not a price
- 42 -
reduction on any given sale.”). One commentator has explained
the distinction as being based on the impracticability, if not
the impossibility, of relating patronage dividends to gain or
loss upon any particular transaction with any particular patron.
Adcock, “Patronage Dividends: Income Distribution or Price
Adjustment”, 13 Law & Contemp. Probs. 505 (1948). As explained
by Professor Bunn (who, in Sunbeam Corp. v. Civil Service
Employees’ Cooperative Assn., supra, was credited for his
“scholarly discussion” that “greatly helped” the court):
[A patronage dividend] cannot be allowed or promised
when a sale is made, for it is made from earnings only,
and no one can be sure there will be any earnings. Our
business may sell at an eighty per cent mark-up and
still go broke if overhead exceeds that spread. And we
will not know our overhead per unit until we know our
total volume. Neither will we know our bad debts, or
other losses. We may make shrewd guesses, and quite
close estimates of earnings if we know our business
well, but we cannot be sure, and therefore we can never
promise. * * *
Bunn, supra at 173. Professor Bunn concludes:
True patronage dividends are divisions of net earnings.
Net earnings are not made on any single sale. They
result from the total operations of some accounting
period, and become known only after the results for
that period are in. A distribution of them, on
whatever basis, is not a price reduction nor a rebate
* * * .
Id. (fn. ref. omitted).
- 43 -
e. Conclusion
We do not believe that Congress intended to subsume within
the definition of the term “patronage dividend” transaction-
specific price reductions such as are encompassed by the term
“trade discount”. While the term “rebate” may sometimes be used
in explaining the allowance of the deduction for patronage
dividends, see, e.g., Buckeye Countrymark, Inc. v. Commissioner,
103 T.C. 558, we agree with the commentators that there is a
categorical difference between a rebate in the nature of a trade
discount and a patronage dividend. A patronage dividend is paid
under an obligation to distribute some or all of net earnings of
the enterprise on the basis of patronage.11 Respondent puts his
finger right on the difference when he argues that petitioner
cannot show that the passed-on rebates he deems petitioner to
have made “were calculated by reference to the net earnings of
the cooperative from business done with or for its patrons.”
They were not; they were calculated exclusively with reference to
the rebates accorded to petitioner by the vendors on account of
orders taken by petitioner from member stores at the food shows.
If we were to agree with respondent that, for lack of a net
11
In theory, of course, a cooperative could set its prices
so as to minimize its profit and reduce the amount available for
patronage dividends. That has been referred to as the “pricing
out” problem, which may exist more in theory than in practice.
See Patterson, The Tax Exemption of Cooperatives 89-90 (2d rev.
ed. 1961). In any event, it does not concern us here.
- 44 -
earnings connection, the passed-on rebates fail as price
adjustments because they are defective patronage dividends, then
what of other transaction-specific rebates, refunds, or price
adjustments? Are we to conclude that, if a purchasing
cooperative has a buy-two-get-one-free sale, offers a loss-leader
or a volume discount, or, indeed, sells any good or service for
less than some hypothetical normal price, it has paid a defective
patronage dividend unless, in some way, it can show that the
price reduction is a distribution of net earnings? Indeed, must
any merchant offering a rebate, refund, or other price reduction
consider whether it is operating on a cooperative basis,
distributing defective patronage dividends? We think not.
We conclude that a transaction-specific price reduction,
such as is encompassed by the term “trade discount”, is not
generally determined with respect to the net earnings of the
payer, and, for that reason, it is not a patronage dividend
(defective or not).
4. Other Factors
Respondent argues that petitioner “has virtually no records
of the currency incentives used at the food shows. It destroyed
most of the relevant records. * * * This fact combined with the
use of cash invites suspicion.” While it is true that petitioner
discarded most all of the tear strips after the relevant
information was entered into its billing and accounting records,
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petitioner had sufficient information to compute its margin on
each sale. There also is a stipulation as to the net amount of
petitioner-delivered currency retained by the vendors. There is
no evidence confirming the actual payments of petitioner-
delivered currency by vendors to member stores, but the deemed
fact of those payments underlies respondent’s adjustments. While
cash payments to member stores might invite abuse by the member
stores, there is no evidence of any such abuse here, and, to the
extent that payments were actually made by the vendors to member
stores, we assume that the vendors had adequate motivation to
keep adequate records of those payments. In short, whatever
shortcomings exist in petitioner’s records, respondent has failed
to convince us that those shortcomings justify denying petitioner
a reduction in the amount of its gross receipts from sales to
member stores on account of deemed rebates that respondent would
charge against petitioner’s costs of goods sold and would treat
as having been passed on as price reductions to the member
stores.
5. Conclusion
The deemed rebates that respondent charges petitioner with
making are (if they are to be charged to petitioner) properly
characterized as trade discounts. They were not paid with
reference to petitioner’s net earnings but merely passed along
price adjustments that petitioner was entitled to on account of
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the orders placed by the member stores at the food shows. They
reduce petitioner’s gross receipts and are not defective
patronage dividends.12
C. Conclusion
For the audit years, petitioner had no items of gross income
on account of petitioner-delivered currency paid by vendors to
member stores as show money.
IV. Conclusion
In the light of the foregoing,
Decision will be entered
for petitioner.
12
Our conclusion is, of course, based on the assumption
that the petitioner-delivered currency paid to member stores
flowed through petitioner, as passed-on rebates, in the manner
described supra in sec. III.B.1 of this report. We do not decide
that manufacturers’ rebates paid directly to retail customers are
necessarily deemed to pass through the retailer. Such a rebate
was addressed by the Commissioner in Rev. Rul. 76-96, 1976-1 C.B.
23, suspended in part by Rev. Rul. 2005-28, 2005-1 C.B. 997,
which describes an automobile manufacturer’s rebate paid directly
to qualifying retail customers and gives no indication that the
rebate was considered to have flowed through the retailer.