Affiliated Foods, Inc. v. C.I.R., 97-60504

• Citation: 154 F.3d 527
• Decision Date: 25 September 1998
• Docket Number: No. 97-60504,97-60504
• Parties: -6357, 98-2 USTC P 50,750 AFFILIATED FOODS, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

Page 527

154 F.3d 527

82 A.F.T.R.2d 98-6357, 98-2 USTC P 50,750

AFFILIATED FOODS, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 97-60504.

United States Court of Appeals, Fifth Circuit.

Sept. 25, 1998.

William A. Hoy, Mullin, Hoard & Brown, Amarillo, TX, for Petitioner-Appellant.

Bridget Maria Rowan, Richard Bradshaw Farber, U.S. Dept. of Justice, Tax Div., Washington, DC, Charles Casazza, Clerk, U.S. Tax Court, Washington, DC, Stuart L. Brown, Chief Counsel, IRS, Washington, DC, Loretta Argrett, Asst. U.S. Atty. Gen., U.S. Dept. of Justice, Tax Div., App. Section, Washington, DC for Respondent-Appellee.

Appeal from the Decision of the United States Tax Court.

Before POLITZ, Chief Judge, and JONES and DUH, Circuit Judges.

EDITH H. JONES, Circuit Judge:

Affiliated Foods, Inc. ("Affiliated"), the organizational company for a non-exempt cooperative of small grocery stores, instituted the present action for a refund of alleged tax deficiencies for taxable years 1989 and 1990. Following a trial on the merits, the Tax Court found that Affiliated had earned income through its management of certain advertising funds destined for its shareholders. Affiliated has appealed. For the reasons stated below, this court affirms in part, reverses in part, and remands the case to the Tax Court.

I. FACTS

Affiliated operates a wholesale food purchasing cooperative for the purpose of supplying food and other consumer products to retail grocery stores owned by Affiliated shareholders ("Members"). By pooling their resources and using Affiliated as their purchasing agent for thousands of manufacturers and suppliers ("Vendors"), the Members achieve economies of scale otherwise unattainable by them through independent operation.

A. The Promotional Accounts

In order to increase the retail sales of Members, the Vendors encourage promotion of their products. Often, Vendors reimburse Members directly for the costs of these promotions. However, Vendors also maintain promotional accounts with Affiliated. ¹ When received, the promotional account funds are deposited in Affiliated's general operating account with Amarillo National Bank. While the promotional account monies are commingled with funds used by Affiliated in day-to-day operations, meticulous records are maintained with respect to the promotional accounts. Indeed, each Vendor receives a regular statement itemizing receipts and disbursements of its promotional account funds from Affiliated's account.

The manner in which the promotional account funds were disbursed was contested in the Tax Court. Adopting the Commissioner's theory of the case, the court found that Affiliated essentially provided advertising services to Vendors in exchange for the promotional account funds. In particular, the court focused on the size of Affiliated's advertising department and the amount of promotional account funds ultimately directed to that department. The court discredited the testimony of Affiliated's witnesses regarding when and why promotional account funds were released. The court did, however, recognize that release of the funds in the promotional accounts was contingent upon compliance with standards placed on Affiliated by Vendors--either written or oral.

B. The Food Show

Each year, Affiliated conducts a Food Show open only to Members. At these Food Shows, Vendor representatives promote Vendor products by setting up booths, offering product samples, and providing special discounts for products. In order to participate in this event, Affiliated requires that Vendors offer special cash discounts for Members. Many Members agree to purchase an entire year's requirement of a Vendor's products at the Food Show. For this reason, Vendor representatives must have an ample supply of available cash.

Vendors supply the funds for the cash rebates in several different ways. Vendors may directly supply the cash to representatives. More often than not, however, Vendors write checks to Affiliated or use the funds in their promotional accounts as a means of supplying Vendor representatives with the necessary rebate cash. The Vendors' checks are deposited in Affiliated's general operating account. When the Food Show begins, the Vendor funds are dispensed from Affiliated's general operating account to the Vendor representatives. At the conclusion of the Food Show, the Vendor representatives return the remaining funds to Affiliated. Affiliated returns these funds to Vendors or accounts for the funds in the respective Vendor's promotional account. As with the promotional accounts, Affiliated maintained meticulous records on the amount of funds received from Vendors and the amounts returned to each Vendor's promotional account.

The Tax Court found that the Food Show cash rebates were actually disguised patronage dividends. Distinguishing the cash rebates as payments made from Vendors to Members, the court determined that Affiliated retained substantial control over the funds before, during, and after the Food Show. The court construed the deposit of Vendor funds in Affiliated's general operating account as "earnings of the cooperative from business done with or for its patrons." The Tax Court noted that normally the income received from the Food Show rebates would have been deductible as a "patronage dividend" when returned by Affiliated to the Members. However, because Affiliated was unable to meet the statutory requirements for a patronage dividend deduction, ² the adjusted income was not deductible.

II. DISCUSSION

Affiliated is a non-exempt cooperative taxed pursuant to 26 U.S.C. §§ 1381-83. At year-end, Affiliated may avoid taxation by distributing income to Members in the form of patronage dividends. See 26 U.S.C. §§ 1382(b), 1388. Once these patronage dividends are paid, Members must report the dividends as income. See 26 U.S.C. § 1385(a). To the extent Affiliated retains income at year-end, the cooperative must report the amount as gross income.

The IRS adjusted Affiliated's 1989 and 1990 gross income to include the year-end balances of the promotional accounts and the total amount of cash distributed by Vendors to Members at the Food Shows. The IRS construed all monies paid into the Affiliated promotional accounts as income. However, Affiliated was allowed a deduction for the amount of funds expended on promotions. Thus, only the year-end balances remained as taxable income. With respect to the Food Show payments, all of the money which passed through Affiliated's general operating account to Members was included as gross income.

A. Standard of Review

The Tax Court's resolution of the disputed factual issues in this matter is subject to the clearly erroneous standard of review. See Fed.R.Civ.P. 52(a). Under the clearly erroneous standard, this court will reverse the decision of a lower court only if "left with the definite and firm conviction that a mistake has been made." Streber v. Commissioner, 138 F.3d 216, 219 (5th Cir.1998). So long as there is evidence which supports a court's plausible account of the evidence, this court must affirm "even though convinced that had it been sitting as the trier of fact, it would have weighed the evidence differently." Justiss Oil Co. v. Kerr-McGee Ref. Corp., 75 F.3d 1057, 1062 (5th Cir.1996).

The imposition of tax by the Commissioner is presumptively correct therefore, the petitioner must shoulder the burden of proving that the tax assessment was improper. See Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933). Because the Tax Court's discussion of Affiliated's promotional accounts fundamentally misconstrues the operations of the cooperative, this court reverses the Commissioner's imposition of tax on the year-end balances of the promotional accounts. However, because Affiliated was unable to present records detailing the amount of Food Show rebates payable to individual Members, this court affirms the Tax Court's decision regarding the adjustment to Affiliated's gross income for the Food Show rebates.

B. The Promotional Accounts

1. The Tax Treatment of Promotional Accounts

In a line of cases beginning with Seven-Up Co. v. Commissioner, the Tax Court set forth the standard controlling the present dispute. 14 T.C. 965, 1950 WL 201 (1950). In Seven-Up, the manufacturer of 7-Up extract established a national advertising fund for the beverage produced from the extract. See id. at 968-69, 1950 WL 201. 7-Up bottlers that participated in the national advertising program ³ made payments to the manufacturer based on the number of gallons of extract purchased. See id. at 974, 1950 WL 201. The manufacturer placed these funds in one or more regular operating accounts--commingling the advertising funds with operating funds. See id. Although no separate bank account was established for the funds, the manufacturer maintained the advertising funds separately on its books as accounts payable. See id. The advertising funds were viewed by the manufacturer as a whole--no individual bottler retained the right to the funds after payment. See id. The advertising agency in charge of the campaign billed the manufacturer; however, the parties involved understood that the advertising funds remitted from bottlers actually paid the advertising expenses. See id. at 972, 1950 WL 201. If a balance remained in the advertising fund at year-end, the amount was carried over as an account payable for the next tax year. See id. at 975, 1950 WL 201.

On these facts, the Tax Court found that the advertising funds channeled through the manufacturer to the advertising agency did not constitute gross income. See id. at 979, 1950 WL 201. The court noted,

The payments made by the participating bottlers were not for services rendered or to be rendered by [the manufacturer]. Neither were they part of the purchase price of the extract. They did not, therefore, constitute earnings received by the petitioner under a claim of...