Affiliated Foods, Inc. v. Comm'r of Internal Revenue

• Decision Date: 29 March 2007
• Docket Number: No. 12846–04.,12846–04.
• Parties: AFFILIATED FOODS, INC., A Corporation, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

128 T.C. 62

128 T.C. No. 7

AFFILIATED FOODS, INC., A Corporation, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 12846–04.

United States Tax Court.

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 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.

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.

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 (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).

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.

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 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...