City Line Candy & Tobacco Corp. v. Commissioner

141 T.C. No. 13UNITED STATES TAX COURT
CITY LINE CANDY & TOBACCO CORP., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 31303-08. Filed November 19, 2013.
P, a corporation, is a reseller and licensed wholesale dealer of
cigarettes in New York. New York law provides that all cigarettes
possessed for sale must bear a stamp issued by the New York tax
commissioner. N.Y. Tax Law sec. 471(1) (McKinney 2006 & Supp.
2013). Pursuant to this law, P, a licensed cigarette stamping agent for
New York, purchases cigarette packs for sale, purchases and affixes
cigarette tax stamps to those cigarette packs, and sells the stamped
cigarette packs to subjobbers and retailers in New York City and
throughout New York State. Under New York law, P is required to
include, and did include, the cost of the cigarette tax stamps in the
sale price of the cigarettes.
P uses the accrual method of accounting and a fiscal year
ending Oct. 31. For all relevant years P computed its gross receipts
from cigarette sales for financial statement purposes by totaling the
gross sale prices of the cigarettes sold during each year. However, for
income tax reporting purposes P adjusted its gross receipts from
-2-
cigarette sales by subtracting the approximate cost of cigarette tax
stamps purchased during the fiscal year and reporting as its gross
receipts the resulting net amount. P argued that its average annual
gross receipts (determined for income tax reporting purposes) for the
three-taxable-year period ending with the taxable year preceding each
of the years in issue did not exceed $10 million. P contends that it
therefore qualifies for the small reseller exception under I.R.C. sec.
263A(b)(2)(B) for each of the years in issue and consequently is not
required to comply with the uniform capitalization (UNICAP) rules of
I.R.C. sec. 263A with respect to the cigarettes it acquired for resale.
Held: R correctly determined P’s gross receipts for each of the
years in issue on the basis of the entire sale price of the cigarettes it
sold, including that part of the sale price attributable to the cost of the
cigarette tax stamps.
Held, further, P is subject to the UNICAP rules of I.R.C. sec.
263A because P failed to prove that its average annual gross receipts
for the three-taxable-year period ending with the taxable year
preceding each of the years in issue, correctly calculated to include
the entire sale price of the cigarettes it sold, did not exceed $10
million for any of the years in issue.
Held, further, the cigarette tax stamp costs are indirect costs
that must be capitalized under the UNICAP rules.
Held, further, the cigarette tax stamp costs are handling costs
that R properly allocated, in part, to P’s ending inventory using the
simplified resale method.
Felipe E. Orner, for petitioner.
Mimi M. Wong, for respondent.
-3-
MARVEL, Judge: In a notice of deficiency respondent determined
deficiencies in petitioner’s Federal income tax of $96,908 and $9,901 for the
taxable years ending (TYE) October 31, 2004 and 2006, respectively.1 After
concessions,2 the issues for decision are: (1) whether petitioner qualifies for the
small reseller exception to the uniform capitalization (UNICAP) rules of section
263A;3 if not, (2) whether the New York cigarette stamp tax petitioner incurred is
1
Respondent determined an overpayment of $861 for TYE October 31,
2005.
2
With the exception of costs related to the cigarette tax stamps, the parties
stipulated the allocation of petitioner’s costs as follows:
Handling & General & Indirect costs--
TYE storage Purchasing admin. nonallocable
10/31/04 $35,068 $44,856 $128,014 $292,034
10/31/05 28,135 36,334 116,818 254,331
10/31/06 28,019 40,064 121,354 289,856
The parties also stipulated adjustments for insurance expenses and for petitioner’s
“cost of goods sold--purchases” as follows:
Cost of goods sold--
TYE Insurance expenses purchases
10/31/04 $33,164 $6,362,650
10/31/05 24,557 5,852,508
3
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years in issue, and all Rule references are to
(continued...)
-4-
an indirect cost that it must capitalize under the UNICAP rules; and, if so, (3)
whether respondent properly allocated a portion of that cost to petitioner’s ending
inventory using the simplified resale method.
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulated facts and facts drawn
from stipulated exhibits are incorporated herein by this reference. When petitioner
filed its petition, its principal place of business was in New York.
I. Background
New York law imposes a tax on all cigarettes possessed for sale. N.Y. Tax
Law sec. 471(1) (McKinney 2006 & Supp. 2013). That tax is collected through
the sale of cigarette tax stamps issued by the New York tax commissioner under a
provision that requires that all cigarettes possessed for sale must bear such a
stamp. Id. For the relevant tax years, New York State and New York City each
imposed a cigarette stamp tax of $1.50 per pack, or $15 per carton.
As part of its cigarette tax collection efforts the New York State Department
of Taxation and Finance licenses cigarette stamping agents (stamping agents). A
stamping agent purchases unstamped cigarettes from tobacco manufacturers and
3
(...continued)
the Tax Court Rules of Practice and Procedure. Monetary amounts have been
rounded to the nearest dollar.
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purchases cigarette tax stamps4 from either New York State or New York City.
The stamping agent affixes the appropriate cigarette tax stamp to each cigarette
package in its possession as evidence that the cigarette stamp tax has been paid
and then sells the stamped cigarette packages to licensed retailers, subjobbers, or
vending machine operators for sale to consumers. The stamping agent must
include the cost of the cigarette tax stamp in the sale price of the cigarettes. Id.sec. 471(3).
Petitioner is a corporation engaged in the wholesale trading of tobacco.
Petitioner purchases tobacco products from various manufacturers and resells
them to subjobbers and retailers in New York State, both in and out of New York
City. Petitioner also is a licensed cigarette stamping agent for New York.
Petitioner purchased cigarette tax stamps, and thereby paid cigarette stamp taxes,
totaling $5,823,394, $4,842,912, and $5,005,152 for TYE October 31, 2004
(2004), October 31, 2005 (2005), and October 31, 2006 (2006), respectively.
II. Petitioner’s Accounting Methods and Financial Statements
For all relevant years petitioner used the accrual method of accounting for
income and expenses and the first-in, first-out method of accounting for inventory.
4
During the years in issue cigarette tax stamps were sold in rolls of 30,000.
Petitioner purchased a roll of tax stamps from New York State as needed,
approximately every three to four days.
-6-
Petitioner did not introduce its financial statements for each of the relevant years
into evidence. However, the profit and loss statement for 2004 that is in the record
confirms that for financial statement purposes petitioner calculated its gross
receipts from cigarette sales by totaling the gross sale prices of cigarettes sold
without any reduction for the cost of the cigarette tax stamps that was included in
the sale prices.
III. Petitioner’s Tax Reporting and the Notice of Deficiency
Petitioner timely filed its Forms 1120, U.S. Corporation Income Tax Return,
for 2004-06. Petitioner reported gross receipts of $6,919,789, $6,214,867, and
$6,420,823, for 2004, 2005, and 2006, respectively. Petitioner calculated its gross
receipts for income tax purposes by subtracting from its gross receipts from
cigarette sales the approximate total cost of the cigarette tax stamps it purchased
during each year.
Following an examination of petitioner’s income tax returns for 2004-06
respondent mailed to petitioner the notice of deficiency for 2004 and 2006. In the
notice of deficiency respondent determined that petitioner had underreported its
gross receipts for each taxable year in an amount approximately equal to the cost
-7-
of the cigarette tax stamps purchased during that taxable year.5 Consequently,
respondent determined that petitioner had additional gross receipts of $5,823,394,
$4,842,912, and $5,005,152 for 2004, 2005, and 2006, respectively.
As a result of the adjustments to petitioner’s gross receipts, respondent also
determined that petitioner’s average annual gross receipts for the three-taxable-
year period ending with the taxable year preceding each of 2004-06 exceeded $10
million and therefore it was subject to the UNICAP rules of section 263A.6 Under
the UNICAP rules, petitioner was required to include a portion of certain direct
and indirect costs in inventory costs. Respondent classified the cigarette tax stamp
costs as general and administrative costs and determined that petitioner’s indirect
5
The parties stipulated that petitioner “purchased cigarette stamps and paid
to New York state cigarette stamp taxes” of $5,823,394, $4,842,912, and
$5,005,152 for 2004, 2005, and 2006, respectively. Under N.Y. Tax Law sec.
472(1) (McKinney 2006 & Supp. 2013), stamping agents may retain a specified
percentage of collected cigarette stamp taxes as compensation for their duties.
Neither party addressed whether petitioner included such commissions in
calculating its gross receipts or in calculating the cost of cigarette tax stamps it
incurred.
6
Sec. 263A(b)(2)(B) provides that certain taxpayers are excepted from
complying with the UNICAP rules “if the average annual gross receipts of the
taxpayer (or any predecessor) for the 3-taxable year period ending with the taxable
year preceding such taxable year do not exceed $10,000,000.”
-8-
costs for handling and storage, purchasing, general and administrative, and
indirect costs--nonallocable expenses were as follows:7
Handling & General & Indirect costs--
TYE storage Purchasing admin. nonallocable
10/31/2004 $80,251 $96,951 $5,959,471 $186,986
10/31/2005 65,038 81,090 4,962,092 151,246
10/31/2006 79,740 100,970 5,143,209 205,756
Using the simplified resale method without historic absorption (simplified resale
method), respondent determined that petitioner had additional section 263A
capitalizable costs for 2004, 2005, and 2006 of $6,282, $3,963, and $6,268,
respectively. Respondent calculated the additional section 263A capitalizable
costs as the product of the combined absorption ratio and petitioner’s purported
section 471 costs8 at the end of the year.9
7
In the notice of deficiency respondent determined that the cigarette tax
stamp costs were general and administrative costs and referenced sec. 1.263A-
1(e)(4)(i)(A), Income Tax Regs., which defines service costs as “indirect costs
(e.g., general and administrative costs) that can be identified specifically with a
service department or function or that directly benefit or are incurred by reason of
a service department or function.”
8
Respondent calculated petitioner’s sec. 471 costs as $246,304, $186,921,
and $239,823 for 2004, 2005, and 2006, respectively. Respondent appears to have
calculated petitioner’s sec. 471 costs as the sum of: (1) storage and handling
costs; (2) purchasing costs; and (3) the product of petitioner’s general and
administrative costs and the storage and handling cost absorption ratio for the
relevant year. However, in calculating the storage and handling cost absorption
(continued...)
-9-
In the notice of deficiency respondent further determined that petitioner
8
(...continued)
ratio for each year, respondent used a value in the numerator that differed from
petitioner’s total storage and handling costs for the year. Respondent likewise
used a value in the numerator of the purchasing cost absorption ratio that differed
from petitioner’s total purchasing costs for the year.
Respondent has not adequately explained, either in the notice of deficiency
or in his posttrial briefing, how he came up with the numbers used in the
calculations attached to the notice of deficiency. It appears to the Court that
respondent made mistakes in adjusting petitioner’s inventory in the notice of
deficiency, and he appears to have conceded as much. However, on brief
respondent appears to be equivocating on his position regarding mistakes in the
calculations attached to the notice of deficiency. We expect respondent in his
Rule 155 computation to explain each of the values used and to identify clearly
how he made the computation of any deficiencies resulting from this Opinion.
9
After filing a petition with this Court petitioner filed an appeal with the
Internal Revenue Service Appeals Office. Appeals Officer Marco Minervini (AO
Minervini) prepared a number of spreadsheets purporting to calculate petitioner’s
inventory costs under the UNICAP rules. AO Minervini allocated petitioner’s
handling and storage, purchasing, and general and administrative costs using the
values stipulated, see supra note 2, rather than using the values in the notice of
deficiency. In the first spreadsheet AO Minervini determined that 100% of the
cigarette tax stamp costs were indirect costs not allocable to handling and storage,
purchasing, or general and administrative costs, and calculated that petitioner had
additional sec. 263A capitalizable costs for 2004, 2005, and 2006 of $1,376,
$1,809, and $2,228, respectively. In the second spreadsheet AO Minervini
allocated 50% of the cigarette tax stamp costs to handling costs and 50% to
indirect costs not allocable to handling and storage, purchasing, or general and
administrative costs and calculated that petitioner had additional sec. 263A
capitalizable costs for 2004, 2005, and 2006 of $53,423, $71,836, and $85,796,
respectively. In both spreadsheets AO Minervini used a value for petitioner’s sec.
471 costs for the year that was equal to its ending inventory for that year as
reported on its return.
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must increase its inventory costs for 2004, 2005, and 2006 by $252,586, $190,884,
and $246,091, respectively. Respondent arrived at these additional amounts by
adding the additional section 263A costs for each year and petitioner’s purported
section 471 costs for each year. Respondent then added the amount of the increase
to petitioner’s ending inventory to calculate its adjusted ending inventory for each
of the taxable years in issue.10
OPINION
I. Burden of Proof
Ordinarily, the Commissioner’s determinations in a notice of deficiency are
presumed correct and the taxpayer bears the burden of proving that they are
incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). However,
the burden of proof will shift to the Commissioner if the taxpayer proves that the
determinations are arbitrary, capricious, or unreasonable. Paccar, Inc. v.
Commissioner, 85 T.C. 754, 787 (1985), aff’d, 849 F.2d 393 (9th Cir. 1988).
Concessions by the Commissioner at or during the course of trial ordinarily are
insufficient to shift the burden of proof to the Commissioner. Gobins v.
10
In his spreadsheets AO Minervini determined that petitioner must increase
its inventory costs for 2004, 2005, and 2006 by the amounts of additional sec.
263A capitalizable costs, described supra note 9. In calculating petitioner’s
adjusted ending inventory AO Minervini added the additional sec. 263A
capitalizable costs to its ending inventory value for each year.
- 11 -
Commissioner, 18 T.C. 1159, 1168-1169 (1952), aff’d per curiam, 217 F.2d 952(9th Cir. 1954); see also Engles Coin Shop, Inc. v. Commissioner, T.C. Memo.
1983-561.
Petitioner appears to argue that the determinations in the notice of
deficiency are arbitrary, capricious, or unreasonable and therefore the burden of
proof is on respondent. Petitioner relies on the fact that during these proceedings
respondent stipulated an allocation of handling and storage, purchasing, and
general and administrative costs different from the allocation in the notice of
deficiency.11
The mere fact that respondent stipulated an alternative cost allocation is
insufficient to shift the burden of proof to him. While it appears that in the notice
of deficiency respondent may have made some mistakes in calculating the required
adjustments under section 263A, those mistakes are not sufficient to support a
finding that his determinations regarding petitioner’s gross receipts and its
11
Petitioner also contends that the determinations in the notice of deficiency
are arbitrary, capricious, or unreasonable because respondent used an incorrect
methodology in calculating its inventory costs under sec. 263A. However, the
parties stipulated that in the notice of deficiency respondent applied the simplified
resale method without historic absorption, a method expressly permitted under sec.
263A.
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obligation to adhere to the rules of section 263A were arbitrary, capricious, or
unreasonable.
We conclude that petitioner bears the burden of proving that respondent’s
determinations are incorrect. See Rule 142(a).12
II. Application of Section 263A
A. Introduction to Section 263A
Congress enacted section 263A as part of the Tax Reform Act of 1986, Pub.
L. No. 99-514, sec. 803(a), 100 Stat. at 2350. In enacting section 263A, Congress
intended that a single, comprehensive set of rules should govern capitalization of
the costs of producing, acquiring, and holding property for resale to more
accurately reflect income and create a more neutral tax system. See Suzy’s Zoo v.
Commissioner, 273 F.3d 875, 879 (9th Cir. 2001), aff’g 114 T.C. 1 (2000); S.
Rept. No. 99-313, at 140 (1986), 1986-3 C.B. (Vol. 3) 1, 140. Whether an
12
Under sec. 7491(a) the burden of proof shifts to the Commissioner if the
taxpayer produced credible evidence to support the deduction or position, the
taxpayer complied with the substantiation requirements, and the taxpayer
cooperated with the Secretary with regard to all reasonable requests for
information. Petitioner does not contend that sec. 7491(a) applies, and it has not
introduced evidence to prove it satisfied the requirements of sec. 7491(a).
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expenditure is deductible13 or must be capitalized is a question of fact. INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 86 (1992).
Under section 263A a taxpayer must capitalize certain direct and indirect
costs allocable to real or personal property that the taxpayer has acquired for
resale. See also sec. 1.263A-3(a)(1), Income Tax Regs. If the resale property is
inventory in the taxpayer’s hands, the taxpayer must include the direct and indirect
costs in inventory costs. Sec. 263A(a)(1)(A). Direct costs include “the acquisition
costs of property acquired for resale.” Sec. 1.263A-1(e)(2)(ii), Income Tax Regs.
Indirect costs include all costs, other than direct costs, properly allocable to
property acquired for resale. Sec. 1.263A-1(e)(3)(i), Income Tax Regs.
B. The Small Reseller Exception
Under section 263A(b)(2)(B) a taxpayer is excepted from complying with
the UNICAP rules of section 263A with respect to certain property acquired for
resale “if the average annual gross receipts of the taxpayer (or any predecessor) for
the three-taxable-year period ending with the taxable year preceding such taxable
13
Sec. 162(a) authorizes a taxpayer to deduct ordinary and necessary
business expenses paid or incurred during the taxable year in carrying on the
taxpayer’s trade or business. Advertising and other selling expenses are
deductible under sec. 162(a). See sec. 1.162-1(a), Income Tax Regs. However, no
deduction is available for items used by the taxpayer in computing the cost of
inventory property. See id.- 14 -
year do not exceed $10,000,000” (small reseller exception).14 A reseller is a
taxpayer who acquires for resale (1) property the taxpayer includes in inventory if
on hand at the end of the year, and (2) property the taxpayer holds primarily for
sale to customers in the ordinary course of business. See sec. 1.263A-3(a)(1),
Income Tax Regs.
1. Parties’ Arguments
Petitioner contends that it qualifies for the small reseller exception because
its average annual gross receipts for each of the years in issue did not exceed $10
million.15 According to petitioner, respondent erred by including in its gross
14
Two types of resellers must satisfy additional requirements to qualify for
the small reseller exception. If the reseller produces property, the reseller qualifies
for the exception only if the reseller meets the gross receipts test, see sec.
263A(b)(2)(B), and the reseller’s production activities are de minimis, see sec.
1.263A-3(a)(2)(ii) and (iii), Income Tax Regs. If the reseller is treated as
producing property because property is produced under contract for the reseller,
the reseller qualifies for the exception only if the reseller meets the gross receipts
test, see sec. 263A(b)(2)(B), and “if the contract is entered into incident to the
resale activities of the small reseller and the property is sold to its customers”, see
sec. 1.263A-3(a)(3), Income Tax Regs.; see also Suzy’s Zoo v. Commissioner, 273
F.3d 875, 880-881 (9th Cir. 2001), aff’g 114 T.C. 1 (2000).
15
Petitioner also contends that it qualifies for the small reseller exception
because it is a small reseller with de minimis production activity. An analysis of
whether a reseller has de minimis production activity is relevant only if the reseller
satisfies the gross receipts test of sec. 263A(b)(2)(B). If the reseller produces
property, the reseller is excepted from complying with the UNICAP rules only if
the reseller satisfies the gross receipts test and the de minimis production activity
(continued...)
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receipts proceeds attributable to collection of the New York cigarette stamp tax.
Petitioner contends that New York law imposes the cigarette stamp tax on
consumers, not stamping agents or wholesalers; therefore, gross receipts do not
include proceeds attributable to collection of the cigarette stamp tax. Petitioner
further contends that if in calculating its gross receipts for Federal income tax
purposes it properly subtracted the cost of the cigarette tax stamps it purchased,
then respondent’s determinations that petitioner underreported its gross receipts
and that petitioner is subject to the UNICAP rules of section 263A are erroneous
because petitioner’s average annual gross receipts did not exceed the $10 million
threshold for the relevant years.
Respondent contends that petitioner does not qualify for the small reseller
exception. Respondent explains that because New York law requires petitioner to
add the cost of the cigarette tax stamps to the cigarette sale price, it must include
in gross receipts the entire gross sale price, including that part of its gross sale
price approximately equal to the cost of cigarette tax stamps it incurred during
each taxable year. Respondent asserts that after petitioner’s gross receipts are
15
(...continued)
requirement. Sec. 1.263A-3(a)(2)(ii) and (iii), Income Tax Regs.; see also Suzy’s
Zoo v. Commissioner, 273 F.3d at 880-881. Because we find that petitioner’s
average annual gross receipts for the relevant periods exceeded $10 million, we
need not decide whether its production activity was de minimis.
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reconstructed, its average annual gross receipts for the relevant testing periods for
each year in issue exceed $10 million.
Accordingly, we first must decide whether for purposes of determining
qualification for the small reseller exception, petitioner’s gross receipts should
include the cost of the cigarette tax stamps it purchased during each taxable year.
2. Calculation of Petitioner’s Gross Receipts Under Section
263A(b)(2)(B)
For purposes of the small reseller exception, section 1.263A-3(b)(2)(i),
Income Tax Regs., defines gross receipts as “the total amount, as determined
under the taxpayer’s method of accounting, derived from all of the taxpayer’s
trades or businesses (e.g., revenues derived from the sale of inventory before
reduction for cost of goods sold).”16 Section 1.263A-3(b)(2)(ii), Income Tax
Regs., however, excludes certain items from the definition of gross receipts for
purposes of the small reseller exception:
(ii) Amounts excluded. * * * gross receipts do not include
amounts representing--
(A) Returns or allowances;
16
This calculation is consistent with the calculation of gross income in sec.
1.61-3(a), Income Tax Regs. (gross income derived from a business is “the total
sales, less the cost of goods sold”).
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(B) Interest, dividends, rents, royalties, or
annuities, not derived in the ordinary course of a trade or
business;
(C) Receipts from the sale or exchange of capital
assets, as defined in section 1221;
(D) Repayments of loans or similar instruments * * *;
(E) Receipts from a sale or exchange not in the
ordinary course of business * * *, and
(F) Receipts from any activity other than a trade or
business or an activity engaged in for profit.
By reason of the above, calculating petitioner’s gross receipts for purposes
of the small reseller exception requires a two-step inquiry: (1) whether, under its
accrual method of accounting, petitioner’s gross receipts for each taxable year in
issue included the entire sale price of the cigarettes it sold, including the amount
attributable to cigarette tax stamps it purchased during the year; and, if we answer
the first inquiry in the affirmative, (2) whether section 1.263A-3(b)(2)(ii), Income
Tax Regs., excludes from gross receipts the approximate cost of cigarette tax
stamps purchased during each year.
a. Petitioner’s Method of Accounting
Petitioner used the accrual method of accounting for the years in issue.
Under the accrual method of accounting, a taxpayer must recognize income for the
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year in which the taxpayer accrues the income. See, e.g., sec. 451(a). A taxpayer
accrues income when the all-events test has been met, meaning that the taxpayer’s
right to the income is fixed and the taxpayer can determine the amount of the
income with reasonable accuracy. Sec. 1.451-1(a), Income Tax Regs.
The only financial statement that petitioner introduced was its 2004 “Profit
and Loss” statement, which shows total sales of $12,767,183. We infer from the
profit and loss statement that petitioner determined its total sales under its accrual
method of accounting for financial accounting purposes by totaling its gross
receipts from cigarette sales during the taxable year without any reduction for the
cost of cigarette tax stamps purchased during that year. Petitioner then deducted
cost of goods sold, including the cost of the cigarette tax stamps, from its gross
receipts to arrive at gross profit before expenses.17
In contrast, petitioner calculated its gross receipts for income tax reporting
purposes by subtracting from its gross receipts from cigarette sales the
approximate cost of cigarette tax stamps purchased during the fiscal year and
reporting as its gross receipts the resulting net amount. Mr. Kun Sang Ruy, one of
17
Petitioner did not introduce into evidence financial statements for any
other taxable years. In the absence of any proof to the contrary, we infer from the
profit and loss statement in the record that petitioner calculated its gross receipts
for the other years in issue in a manner similar to that used on the profit and loss
statement for 2004.
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petitioner’s shareholders, testified that the amount reported as gross receipts on its
tax returns reflected a “net” amount.
For tax and financial accounting purposes a taxpayer must first calculate
total sales revenue determined in accordance with its method of accounting. For
financial accounting purposes petitioner did just that. For income tax reporting
purposes, however, petitioner reduced its total gross receipts from cigarette sales
by the cost of the cigarette tax stamps it purchased during the taxable year to
arrive at a gross receipts figure that was substantially lower than the figure used
for financial accounting purposes.
Petitioner’s profit and loss statement for 2004 confirms that under its
accrual method of accounting it included all of the gross receipts generated by its
sale of cigarettes during the taxable year, including gross receipts attributable to
the cigarette tax stamps affixed to the cigarette packs before sale, in calculating its
gross receipts from cigarette sales. This approach is consistent with New York
law, which requires a stamping agent to include the cost of the cigarette tax stamp
in the sale price of the cigarettes. See N.Y. Tax Law sec. 471(3). Petitioner’s
efforts to show that it qualified as a small reseller by reducing its gross receipts for
each taxable year in an amount approximately equal to the cost of cigarette tax
stamps it purchased during the year were inconsistent with its accrual method of
- 20 -
accounting and with applicable New York law. Consequently, we find that the
small reseller exception does not apply because gross receipts for each taxable
year in issue should not be reduced by an amount representing the cost of cigarette
tax stamps purchased during that year.
b. Whether the Cost of Cigarette Tax Stamps Is a Tax
Properly Excluded From Gross Receipts
Although petitioner’s arguments are not entirely clear, we interpret them to
be that for purposes of determining eligibility for the small reseller exception, the
cost of the cigarette tax stamps should be subtracted in calculating gross receipts
because either: (1) section 1.263A-3(b)(2), Income Tax Regs., permits or requires
the subtraction; or (2) sales tax or other similar State and local taxes are subtracted
in computing gross receipts if, under applicable State or local law, the tax legally
is imposed on the purchaser of the good or service and the taxpayer merely
collects and remits the tax to the taxing authority. We address each of these
arguments below.
i. Effect of Section 1.263A-3(b)(2) and (3), Income
Tax Regs.
In specifying how gross receipts are calculated for purposes of the small
reseller exception, section 1.263A-3(b)(2), Income Tax Regs., excludes several
enumerated items but makes no reference to taxes. Because taxes are not
- 21 -
specifically listed as an exclusion under section 1.263A-3(b)(2)(ii), Income Tax
Regs., the regulation provides no support for petitioner’s argument that the
regulation requires the cost of the cigarette tax stamps it purchased during the
relevant years to be excluded from the calculation of gross receipts for purposes of
the small reseller exception.
Petitioner points out that section 263A(b)(2)(C) requires gross receipts to be
calculated for purposes of the small reseller exception using rules similar to those
of paragraphs (2) and (3) of section 448(c). Respondent disagrees because section
263A(b)(2)(C) provides that the section 448(c) rules apply for aggregation
purposes only.
Section 1.263A-3(b)(3), Income Tax Regs., discusses the aggregation of
gross receipts for purposes of the small reseller exception. The aggregation
concept embodied therein, under which multiple persons treated as a single
employer under section 52(a) or (b) or section 414(m) are treated as one taxpayer
for purposes of the small reseller exception, simply does not apply because there is
only one taxpayer involved in this case. Consequently, we reject petitioner’s
argument that the aggregation rules of section 1.263A-3(b)(2) and (3), Income Tax
Regs., support its calculation of its gross receipts.
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ii. The Character of the New York Cigarette Tax
In its opening brief petitioner addresses the issue of whether the cigarette
stamp tax is imposed on the stamping agents, wholesalers, and resellers or on the
consumers. Petitioner contends that the tax is imposed on the consumers and
therefore is not includable in the calculation of its gross receipts for purposes of
the small reseller exception. In his reply brief respondent contends that the tax is
imposed on resellers like petitioner.
The parties appear to agree that if the cigarette stamp tax is imposed on
consumers, rather than on resellers, then a reseller may exclude from gross receipts
the sales proceeds attributable to collection of the tax. However, neither petitioner
nor respondent offered any legal authority for such a contention, and we are
unable to find any support for it.18 In any event, New York caselaw acknowledges
18
Two sections of the Code address the taxability of imposed versus
collected taxes, although neither party cites either section to support his or its
contention. Sec. 164(a) provides that State, local, and foreign taxes are deductible
by the person on whom the taxes are imposed. See sec. 1.164-1(a), Income Tax
Regs. However, sec. 164(a) addresses only the deductibility of taxes, not whether
taxes should be included in gross receipts. Consequently, sec. 164(a) is
inapplicable with respect to the issue of whether petitioner must include in gross
receipts proceeds attributable to the cigarette tax stamps.
Sec. 448(c) provides that a taxpayer may use the cash method of accounting
if the taxpayer has average annual gross receipts of less than $5 million. See sec.
1.448-1T(f)(2)(iv), Temporary Income Tax Regs., 52 Fed. Reg. 22772 (June 16,
(continued...)
- 23 -
that while the consumer bears the ultimate liability for the cigarette stamp tax, the
tax is imposed, at least to some degree, on the reseller. Schwartz v. Tax Appeals
Tribunal of N.Y., 643 N.Y.S.2d 761 (App. Div. 1996); Mandel Tobacco Co. v.
State Tax Comm’n, 397 N.Y.S.2d 23 (App. Div. 1977). We reject petitioner’s
second argument, and we hold that respondent properly determined petitioner’s
18
(...continued)
1987). Sec. 1.448-1T(f)(2)(iv), Temporary Income Tax Regs., supra, adjusts the
calculation of gross receipts for purposes of sec. 448 specifically with respect to
amounts attributable to the collection of taxes as follows:
[G]ross receipts do not include amounts received by the taxpayer with
respect to sales tax or other similar state and local taxes if, under the
applicable state or local law, the tax is legally imposed on the
purchaser of the good or service, and the taxpayer merely collects and
remits the tax to the taxing authority. If, in contrast, the tax is
imposed on the taxpayer under the applicable law, then gross receipts
shall include the amounts received that are allocable to the payment
of such tax.
Sec. 1.263A-3(b)(2), Income Tax Regs., provides an explicit definition of
gross receipts for purposes of the small reseller exception, whereas sec. 448(c) and
the regulations promulgated thereunder address the calculation of gross receipts
for purposes of determining whether a taxpayer may use the cash method of
accounting. Petitioner uses the accrual method of accounting and is not here
contending that it should be permitted to use the cash method of accounting. In
addition, the definitions of gross receipts in sec. 1.263A-3(b)(2), Income Tax
Regs., and sec. 1.448-1T(f)(2)(iv), Temporary Income Tax Regs., supra, are
inconsistent and cannot be read together. For example, while sec. 1.448-
1T(f)(2)(iv), Temporary Income Tax Regs., supra, provides that a taxpayer must
include in gross receipts incidental income not derived in the ordinary course of
business, sec. 1.263A-3(b)(2)(ii)(B), Income Tax Regs., excludes such amounts
from the gross receipts calculation.
- 24 -
gross receipts for purposes of the small reseller exception using the rules set forth
in section 1.263A-3(b)(2)(ii)(B), Income Tax Regs.
3. Application of the Small Reseller Exception
The testing period for 2004 includes TYE October 31, 2001, 2002, and
2003. The testing period for 2005 includes TYE October 31, 2002, 2003, and
2004. Petitioner did not introduce any credible evidence to prove the correct
amounts of its gross receipts for TYE October 31, 2001 and 2002.
For each of the taxable years in issue petitioner bears the burden of proving
that its average gross receipts for the three previous taxable years did not exceed
$10 million. Petitioner did not do so. The record does not permit us to calculate
petitioner’s actual gross receipts for TYE October 31, 2001 and 2002, two of the
years in the relevant testing periods. Accordingly, we conclude that petitioner has
failed to prove that it met the requirements of the small reseller exception under
section 263A(b)(2)(B) for 2004 and 2005.
The testing period for 2006 includes TYE October 31, 2003 (2003), 2004,
and 2005. During the testing period petitioner had average annual gross receipts
of $12,619,009. Petitioner does not qualify as a small reseller because its average
annual gross receipts for the testing period exceeded $10 million.
- 25 -
Because we conclude that respondent correctly calculated petitioner’s gross
receipts for each taxable year in issue by including the cost of cigarette tax stamps
it purchased and included in the cigarette sale price and because petitioner did not
prove the amounts of its average annual gross receipts for the testing periods
applicable to 2003 and 2004, we find as follows:
Gross receipts Cigarette tax Total gross
TYE per return stamp costs receipts
10/31/01 $9,432,811 Not in record Unable to determine
10/31/02 8,776,695 Not in record Unable to determine
10/31/03 7,604,923 $6,451,143 $14,056,066
10/31/04 6,919,789 5,823,394 12,743,183
10/31/05 6,214,867 4,842,912 11,057,779
On the basis of these findings we conclude that petitioner does not qualify for the
small reseller exception and that it is subject to the UNICAP rules of section 263A
for the taxable years in issue. We therefore must decide whether the cigarette tax
stamp costs petitioner incurred are capitalizable costs for purposes of the UNICAP
rules and if so, how those costs are characterized and allocated to the cigarettes
petitioner acquired for resale.
III. Capitalization of Cigarette Tax Stamp Costs
The UNICAP rules of section 263A require a taxpayer to capitalize the
direct and indirect costs of real or personal property that a taxpayer acquires for
- 26 -
resale. Sec. 263A(a), (b)(2)(A). For resellers, direct costs are acquisition costs.
Sec. 1.263A-1(e)(2)(ii), Income Tax Regs. Indirect costs are costs allocable to
property acquired for resale “when the costs directly benefit or are incurred by
reason of the performance of * * * resale activities.” Sec. 1.263A-1(e)(3)(i),
Income Tax Regs. Capitalizable indirect costs include taxes “otherwise allowable
as a deduction to the extent such taxes are attributable to labor, materials, supplies,
equipment, land, or facilities” used in resale activities. Sec. 1.263A-1(e)(3)(ii)(L),
Income Tax Regs. However, a taxpayer is not required to capitalize certain
indirect costs, including “marketing, selling, advertising, and distribution costs.”19
Sec. 1.263A-1(e)(3)(iii)(A), Income Tax Regs.
Neither party argues that the cigarette tax stamp costs are direct costs.
Respondent contends that the cigarette tax stamp costs are indirect costs that must
be capitalized. Petitioner contends that it is not required to capitalize the cigarette
tax stamp costs because they are neither costs that directly benefit or are incurred
by reason of its performance of resale activities nor taxes attributable to labor,
material, or supplies. Petitioner further contends that the cigarette tax stamp costs
are currently deductible selling expenses. Accordingly, we must decide whether
19
Sec. 1.263A-1(e)(3)(iii)(F), Income Tax Regs., provides that a taxpayer
need not capitalize taxes assessed on the basis of income. Because the cigarette
stamp tax is not assessed on the basis of income, this provision does not apply.
- 27 -
the cigarette tax stamp costs are indirect costs or currently deductible selling
expenses.
A. Indirect Costs: General Definition
As noted supra, indirect costs are costs allocable to property acquired for
resale “when the costs directly benefit or are incurred by reason of the
performance of * * * resale activities.” Sec. 1.263A-1(e)(3)(i), Income Tax Regs.
The U.S. Court of Appeals for the Second Circuit, to which an appeal in this case
would lie, absent a stipulation to the contrary, see sec. 7482(b)(1)(A), (2), has
considered the meaning of the phrases “directly benefit” or “incurred by reason
of”, Robinson Knife Mfg. Co. v. Commissioner, 600 F.3d 121, 127 (2d Cir. 2010),
rev’g T.C. Memo. 2009-9. At issue in Robinson Knife was the proper tax
treatment of royalties paid for the taxpayer’s use of trademarks that it placed on
kitchen items sold to the public. The royalties were payable when the kitchen
items were sold. The Court of Appeals held that for a cost to be a capitalizable
cost, it “must be a but-for cause of the taxpayer’s production activities”. Id. at
131-132. The taxpayer could have produced the same property, albeit without a
trademark, and avoided paying the royalty costs. Id. at 131. The Court of Appeals
held that the royalty costs were not capitalizable costs because the royalty costs
- 28 -
“were calculated as a percentage of net sales” and “were incurred only upon the
sale”. Id. at 134.
Article 20 of the New York Tax Law provides that a stamping agent must
purchase cigarette tax stamps from the commissioner and affix those stamps to the
cigarette packages it possesses for resale. N.Y. Tax Law sec. 471(2). As both a
stamping agent and a corporation engaged in the resale of cigarettes, petitioner
must purchase the cigarette tax stamps.20 But for the purchase of the cigarette tax
stamps, petitioner could not engage in its business of reselling cigarettes. The
cigarette tax stamp costs are incurred by reason of petitioner’s resale activity.
Furthermore, the cigarette tax stamp costs differ from the royalty costs in
Robinson Knife in two important ways. First, while the taxpayer in Robinson
Knife could refuse to pay royalty costs while continuing to produce and sell a
substantially similar product, petitioner could not refuse to purchase cigarette tax
stamps while continuing to possess cigarettes for resale. Second, unlike the
royalty costs in Robinson Knife, the cigarette stamp tax is neither calculated as a
percentage of net sales nor incurred only upon the sale of the cigarettes.
20
While petitioner could argue that its stamping agent activity is separate
from its resale activity and therefore the cigarette stamp tax is a cost allocable
solely to the stamping agent activity, the record supports a finding that its
stamping agent activity was part of its resale activity. Consequently, we find that
the stamping agent activity is an indivisible part of petitioner’s resale activity.
- 29 -
Under New York law petitioner was required to pay the cigarette stamp tax
when it possessed the cigarettes for resale, not upon occurrence of the resale. N.Y.
Tax Law sec. 471(1). Petitioner was obligated to purchase the cigarette tax stamps
and affix them to the cigarette packages as soon as it purchased and took
possession of the cigarettes. The cigarettes could not be sold without a tax stamp
affixed to the package. We therefore find that the cigarette tax stamp costs are
costs incurred by reason of petitioner’s resale activities.
B. Indirect Costs: Taxes
Capitalizable indirect costs include taxes “otherwise allowable as a
deduction to the extent such taxes are attributable to labor, materials, supplies,
equipment, land, or facilities” used in resale activities. Sec. 1.263A-1(e)(3)(ii)(L),
Income Tax Regs. A taxpayer may deduct ordinary and necessary expenses paid
or incurred during the taxable year in carrying on his trade or business. Sec. 162.
Capitalizable indirect costs do not include taxes “assessed on the basis of income”.
Sec. 1.263A-1(e)(3)(iii)(F), Income Tax Regs.
If petitioner did not purchase the cigarette tax stamps and affix them to the
cigarette packages, it could not offer the cigarettes for sale. Therefore the
cigarette tax stamps are materials and supplies that petitioner uses in its business
- 30 -
of reselling cigarettes.21 Furthermore, the cigarette tax stamp costs are otherwise
allowable as a deduction under section 162.22 But for the operation of the
UNICAP rules of section 263A, a taxpayer could deduct the cigarette tax stamp
costs as ordinary and necessary business expenses under section 162.
The cigarette stamp tax is not a tax assessed on the basis of the taxpayer’s
income. New York State and New York City set the price of the cigarette tax
stamps. Therefore, costs of cigarette tax stamps are capitalizable indirect costs as
defined in section 1.263A-1(e)(3)(ii)(L), Income Tax Regs.
C. Cost of Cigarette Tax Stamps Not a Selling Expense
A taxpayer need not capitalize certain indirect costs, including “marketing,
selling, advertising, and distribution costs.” Sec. 1.263A-1(e)(3)(iii)(A), Income
Tax Regs. While selling expenses are excepted from the UNICAP rules, see id., a
taxpayer cannot recharacterize an enumerated capitalizable indirect cost as a
21
Petitioner contends that the cigarette tax stamp costs are not costs
attributable to materials, supplies, or labor, because the cigarette stamp tax
ultimately is imposed on the consumer. However, whether the cigarette stamp tax
ultimately is imposed on the consumer, the stamping agent, or the wholesaler is
irrelevant. To be a capitalizable indirect cost, the tax must be attributable to
materials, supplies, or labor; there is no requirement that the tax be imposed on the
reseller. See sec. 1.263A-1(e)(3)(iii)(A), Income Tax Regs.
22
While sec. 275 prohibits a taxpayer from deducting certain types of taxes,
sec. 275 does not address cigarette stamp taxes.
- 31 -
selling expense, see LOAD, Inc. v. Commissioner, T.C. Memo. 2007-51, aff’d,
559 F.3d 909 (9th Cir. 2009). In LOAD, the taxpayer argued that certain State
taxes were marketing, selling, or distribution expenses excepted from section
263A. In rejecting the taxpayer’s argument, this Court noted that section 1.263A-
1(e)(3)(ii)(L), Income Tax Regs., specifically directed the taxpayer to include such
State taxes in capitalizable indirect costs. Id., slip op. at 11-13.
Similarly, in Robinson Knife Mfg. Co. v. Commissioner, 600 F.3d 121, the
U.S. Court of Appeals for the Second Circuit held that trademark fees are not
selling expenses excepted from the UNICAP rules. The Court of Appeals noted
that the enumerated list of indirect costs specifically includes trademark fees. Id.
at 129. The trademark fees could not be characterized as selling expenses because
an immediate deduction of trademark fees would defeat the purpose of the
UNICAP rules to ensure “that trademark royalties are not deducted during a
taxable year which precedes the year in which the corresponding trademarked
items are sold.” Id. at 130.
The cigarette stamp tax is imposed on “all cigarettes possessed in the state
by any person for sale”. N.Y. Tax Law sec. 471(1). A reseller becomes liable for
the cigarette stamp tax when it purchases cigarettes for resale to customers and not
when it actually sells the cigarettes to customers. Although the reseller is required
- 32 -
by New York law to include the cost of the cigarette tax stamps in the sale price of
the cigarettes, see N.Y. Tax Law sec. 471(3), and effectively is reimbursed for the
cigarette stamp tax it paid when the cigarettes are sold, a reseller is not entitled to
a refund of the cigarette tax if the cigarettes are not sold, see Schwartz, 643
N.Y.S.2d 761, or if the cigarette tax stamps are stolen before the stamping agent
affixes them to the cigarette packages, see Mandel Tobacco Co., 397 N.Y.S.2d 23.
Under this legal structure the cigarette stamp tax cannot properly be characterized
as a selling expense.23
As this Court noted in LOAD, section 1.263A-1(e)(3)(ii)(L), Income Tax
Regs., specifically provides that certain taxes are indirect costs that must be
capitalized. Under section 1.263A-1(e)(3)(ii)(L), Income Tax Regs., the cigarette
tax stamp costs are indirect costs that must be capitalized. Petitioner cannot
recharacterize a capitalizable indirect cost as a selling expense.
23
In arguing that cigarette tax stamps are selling expenses, petitioner relies
solely on Rev. Rul. 79-196, 1979-1 C.B. 181. Rev. Rul. 79-196, 1979-1 C.B. at
182, states that the cost of goods sold does not include proceeds attributable to the
collection of State sales taxes. However, Rev. Rul. 79-196, supra, is inapplicable
to this case because: (1) it addresses the deductibility under sec. 164 of State
general sales taxes, not cigarette stamp taxes, see sec. 164(b)(5)(B); (2) it
addresses installment sale reporting, not inventory reporting; and (3) it was issued
before the enactment of sec. 263A.
- 33 -
Finally, petitioner’s proposed recharacterization would allow it an
immediate deduction for expenses related to future sales. While petitioner
typically purchased cigarette tax stamps and sold the stamped cigarettes within a
matter of days, it had some cigarettes and cigarette tax stamps remaining at the end
of the taxable year. If petitioner deducted the entire cost of the cigarette tax
stamps purchased in year 1 but did not sell all of the stamped cigarette packages
until year 2, it would deduct costs in year 1 with respect to cigarette inventory that
remained unsold at the end of year 1.
Consistent with this analysis, we conclude that the cigarette tax stamp costs
are not selling expenses excepted from the UNICAP rules but instead are
capitalizable indirect costs. We now must decide how to allocate those costs to
petitioner’s activities and how to calculate the portion of those costs that must be
capitalized.
IV. Allocation of the Cigarette Tax Stamp Costs
A. Allocation of Cigarette Tax Stamp Costs to Resale Activities
Section 263A(a)(1)(A) provides that “in the case of property which is
inventory in the hands of the taxpayer”, the taxpayer must include capitalizable
direct and indirect costs in inventory costs. To calculate capitalizable costs, a
taxpayer first must allocate the costs to various activities, such as production or
- 34 -
resale activities. See sec. 1.263A-1(c)(1), Income Tax Regs. Generally, resellers
allocate costs to four categories: (1) purchasing costs, see sec. 1.263A-3(c)(3),
Income Tax Regs.; (2) handling costs, see sec. 1.263A-3(c)(4), Income Tax Regs.;
(3) storage costs, see sec. 1.263A-3(c)(5), Income Tax Regs.; and (4) general and
administrative costs relating to the three prior categories, see sec. 1.263A-3(c)(2),
Income Tax Regs.
Costs attributable to purchasing, handling, and storage activities include
“direct and indirect labor costs * * *; occupancy expenses * * *; materials and
supplies; rent, maintenance, depreciation, and insurance of vehicles and
equipment; tools; telephone;” and travel. Sec. 1.263A-3(c)(2), Income Tax Regs.
Handling costs are “costs attributable to processing, assembling, repackaging,
transporting, and other similar activities with respect to property acquired for
resale”. Sec. 1.263A-3(c)(4)(i), Income Tax Regs. Processing costs are costs a
reseller incurs in making minor changes to a product acquired for resale, such as
monogramming or alterations. See sec. 1.263A-3(c)(4)(ii), Income Tax Regs.
Assembling costs are costs a reseller incurs in readying property for resale, such as
attaching wheels to a bicycle. See sec. 1.263A-3(c)(4)(iii), Income Tax Regs.
Repackaging costs include costs a reseller incurs to package property for resale to
customers. See sec. 1.263A(c)(4)(iv), Income Tax Regs.
- 35 -
The parties’ arguments regarding the proper allocation of the cigarette tax
stamp costs are not entirely clear. In the notice of deficiency respondent
determined that the cigarette tax stamp costs were general and administrative
costs. However, on brief respondent contends that the cigarette tax stamp costs
could be purchasing costs, handling costs, or general and administrative costs.
Petitioner appears to contend that although the cigarette stamp tax costs are a
general and administrative costs, they need not be capitalized because they cannot
be allocated to purchasing, handling, or storage costs. While we agree that the
cigarette tax stamp costs could be characterized as purchasing costs, handling
costs, or general and administrative costs, for the reasons set forth below we find
that the cigarette tax stamp costs are most appropriately classified as handling
costs.
When a stamping agent affixes a cigarette tax stamp to a cigarette package,
the stamping agent makes only a minor change to the product; however, New York
law requires the stamping agent to make this change before sale. See N.Y. Tax
Law sec. 471(2). Therefore, the cost of the cigarette tax stamps is a cost the
reseller incurs to ready or package the cigarettes for resale. The costs related to
purchasing and affixing the cigarette tax stamps are similar to the processing,
assembling, and repackaging costs described in the regulations as handling costs.
- 36 -
While the handling activity related to the cigarette tax stamp differs from the
specific examples in the regulations, the purchasing and affixing of the cigarette
tax stamp is sufficiently similar to the handling activities in the examples to
support a conclusion that the cigarette tax stamp cost is a handling cost under
section 1.263A-3(c)(4), Income Tax Regs. We so hold.
B. Use of the Simplified Resale Method
1. Allocation Methods
After a reseller has allocated costs to its various resale activities, the reseller
must allocate costs to ending inventory. A reseller subject to the UNICAP rules
may use the facts-and-circumstances method, see sec. 1.263A-1(f), Income Tax
Regs., or the simplified resale method, see sec. 1.263A-3(d), Income Tax Regs.
Both methods enable the reseller to calculate the amount of costs that the reseller
must capitalize under the UNICAP rules.
2. The Commissioner’s Use of the Simplified Resale Method
Section 446(b) vests the Commissioner with broad discretion to determine
whether a particular method of accounting clearly reflects income. See Knight-
Ridder Newspapers, Inc. v. United States, 743 F.2d 781, 788 (11th Cir. 1984);
Ansley-Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 370 (1995); RLC
Indus. Co. v. Commissioner, 98 T.C. 457, 491 (1992), aff’d, 58 F.3d 413 (9th Cir.
- 37 -
1995). If a taxpayer fails to use a method of accounting that clearly reflects
income, the Commissioner may reconstruct the taxpayer’s income using any
reasonable method that clearly reflects income. Sec. 446(b).
Petitioner’s method of accounting for income and expenses, including
inventory costs, did not apply the UNICAP rules. Therefore, respondent was
entitled to reconstruct petitioner’s income by any reasonable method that clearly
reflected income. Because section 1.263A-3(d), Income Tax Regs., provides that
resellers may use the simplified resale method to allocate costs, we find that
respondent acted properly in using the simplified resale method to redetermine
petitioner’s income.
3. Application of the Simplified Resale Method
Section 1.263A-3(d)(3), Income Tax Regs., provides procedures for
applying the simplified resale method. The simplified resale method uses several
formulas to calculate the additional capitalizable costs for the taxable year. Id.The general formula is: “combined absorption ratio × section 471 costs remaining
on hand at year end”. Sec. 1.263A-3(d)(3)(i)(A), Income Tax Regs. The product
of this formula is equal to the amount of additional capitalizable costs that the
- 38 -
taxpayer must add to its ending section 471 costs.24 Sec. 1.263A-3(d)(3)(i)(B),
Income Tax Regs. Once the taxpayer adds the additional capitalizable costs to its
ending section 471 costs, the taxpayer calculates total ending inventory for the
taxable year.25
The combined absorption ratio is the sum of the storage and handling costs
absorption ratio and the purchasing costs absorption ratio.26 See sec. 1.263A-
3(d)(3)(i)(C)(1), Income Tax Regs. Section 1.263A-3(d)(3)(i)(D)(1), Income Tax
24
Sec. 471 provides the general rule for inventories.
25
Petitioner contends that in the notice of deficiency respondent erroneously
calculated ending inventory as the product of: (1) the additional capitalizable
costs as determined using the simplified resale method; (2) petitioner’s purported
sec. 471 costs for the year, see supra note 8; and (3) petitioner’s ending inventory.
In his spreadsheets AO Minervini did not include petitioner’s sec. 471 costs for
the year in calculating its ending inventory. Respondent briefly addressed
petitioner’s contention in his reply brief.
Neither party adequately explained his or its position regarding the correct
application of the simplified resale method. As the parties failed to address this
issue, we have confined our analysis to those issues material to the resolution of
this case. We leave for the Rule 155 computation the proper application of the
simplified resale method. If the parties are unable to reach an agreement, we will
address the issue as appropriate in a Rule 155 proceeding or in a supplemental
opinion.
26
The parties stipulated the allocation of all costs except for the allocation of
the cigarette tax stamp costs. Because our decision does not affect the purchasing
cost absorption ratio, see sec. 1.263A-3(d)(3)(i)(E), Income Tax Regs., we do not
address the calculation of that ratio.
- 39 -
Regs., provides that the storage and handling costs absorption ratio is determined
as follows:
Current year’s storage and handling costs
Beginning inventory plus current year’s purchases
The current year’s storage and handling costs include all storage costs and all
handling costs incurred during the taxable year that relate to property the taxpayer
acquired for resale. Sec. 1.263A-3(d)(3)(i)(D)(2), Income Tax Regs. The
beginning inventory equals the section 471 costs of property the taxpayer acquired
for resale that remain unsold as of the beginning of the taxable year. Id. The
current year’s purchases equal the section 471 costs of property the taxpayer
acquired for resale during the taxable year. Id.
As noted supra p. 35, the cigarette tax stamp costs are handling costs.
Petitioner must include the cigarette tax stamp costs incurred during the taxable
year in the numerator27 of the ratio as part of the current year’s storage and
27
Petitioner contends that the annual cigarette tax stamp cost should be
included in both the numerator and denominator of the storage and handling costs
absorption ratio. The denominator includes the sec. 471 costs from the prior
taxable year as well as the current year’s purchases. Although petitioner
purchased cigarette tax stamps during the taxable year, the cigarette tax stamps are
not included in the current year’s purchases because the cigarette tax stamps are
not part of petitioner’s inventory. Rather, the cigarette tax stamps are indirect
costs allocable to the handling of petitioner’s inventory. Therefore, the cigarette
tax stamp cost is included in the numerator only.
- 40 -
handling costs. Accordingly, we conclude that petitioner must include the current
year’s cigarette tax stamp costs in the numerator of the ratio.
V. Conclusion
For purposes of determining eligibility for the small reseller exception,
petitioner must include in gross receipts the entire sale proceeds from the sale of
cigarettes, including the costs of the cigarette tax stamps. Petitioner failed to
prove that it had average annual gross receipts of less than $10 million for the
testing periods applicable to the relevant years, and therefore it is subject to the
UNICAP rules of section 263A. The cigarette stamp tax costs are indirect costs
properly characterized as handling costs. Respondent did not err in using the
simplified resale method to determine the amount of costs properly allocable to
petitioner’s ending inventory under the UNICAP rules.
We have considered all remaining arguments made by the parties28 for
results contrary to those expressed herein, and to the extent not discussed above,
we reject those arguments as irrelevant, moot, or without merit.
28
In its brief petitioner also contends that respondent failed to apply its 2005
overpayment to an appropriate taxable year. As we understand petitioner’s
argument, it is claiming that the overpayment for 2005 has not been applied to
reduce its income tax liability for another year. Petitioner’s argument raises a
computational issue only, and we need not resolve it here. The impact of the 2005
overpayment on the calculation of the 2004 and 2006 deficiencies, if any, will be
considered in the Rule 155 process.
- 41 -
To reflect the foregoing,
Decision will be entered
under Rule 155.