The a majority of the panel from the Third Circuit Court of Appeals determined that the Tax Court had misapplied the all events test in the case of Giant Eagle, Inc. v. Commissioner, Case No. 14-3961, CA3, reversing TC Memo 2014‑146.
Original Tax Court Decision
The IRS and the taxpayer disagreed over whether the taxpayer could claim a deduction related to the unredeemed balance due on its customer rewards program.
Customers who made qualifying purchases at the taxpayer’s grocery stores would earn “fuelperks!” that were redeemable as a discount against gasoline purchased at gas stations owned by the taxpayer. The taxpayer was accruing the estimated redemption amount of such “fuelperks!” against its income as of the end of the year.
Generally the proportion of rewards that will eventually be redeemed by customers can be very accurately predicted by the issuer. And, generally, the entity will need to accrue that estimated redemption amount as a liability on the entity’s GAAP financial statements.
However under the tax law the potential liability has to generally satisfy the “all events” test under IRC §461 found at Reg. § 1.461‑1(a)(2)(i) requires the taxpayer to show:
· All the events have occurred that establish the fact of the liability;
· The amount of the liability can be determined with reasonable accuracy; and
· Economic performance has occurred with respect to the liability.
The IRS argued that the first of these requirements had not been met—until a customer purchases fuel, all events that establish the fact of the taxpayer’s liability have not yet been established.
The Tax Court looked at two key cases from the Supreme Court. In United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987) the Supreme Court held that an employer could not deduct amounts due under its self-insured medical plan until employees had actually submitted claims. The court found that no liability existed until a claim was submitted, since for various reasons a person might not file a claim to which he/she is entitled.
Alternatively, in the case of United States v. Hughes Props., Inc., 476 U.S. 593 (1986) the Court found that a casino could deduct the outstanding liability for a progressive slot-machine jackpot where state law forbid the casino from reducing the payout on such a slot machine until it was actually paid out to someone. The fact that it might not be paid out for a long time, or perhaps never if the casino went out of business, did not cause the Court to find the fact of the liability had not been established, even though the casino could not know to whom the jackpot would eventually be paid.
The Court found that this case was more in line with the General Dynamics fact pattern—until customers actually bought gasoline, there was no liability.
The taxpayer then turned to a backup position they had—that their program was covered by the “trading stamps” regulation found at Reg. §1.451‑1(a)(1). That regulation provides:
If an accrual method taxpayer issues trading stamps or premium coupons with sales, or an accrual method taxpayer is engaged in the business of selling trading stamps or premium coupons, and such stamps or coupons are redeemable by such taxpayer in merchandise, cash, or other property, the taxpayer should, in computing the income from such sales, subtract from gross receipts with respect to sales of such stamps or coupons (or from gross receipts with respect to sales with which trading stamps or coupons are issued) an amount equal to--
(i) The cost to the taxpayer of merchandise, cash, and other property used for redemption in the taxable year,
(ii) Plus the net addition to the provision for future redemptions during the taxable year (or less the net subtraction from the provision for future redemptions during the taxable year).
The taxpayer argued their program was like the trading stamps described in the regulation.
The Tax Court did not agree. Rather the Court found persuasive the position outlined by the IRS in Revenue Ruling 78‑212 that a program of issuing discount coupons that were not directly redeemable in merchandise, cash or other property, but rather simply gave discounts, was not a program described by the above regulation. A customer generally needs to purchase product from the taxpayer (in this case gasoline) in order to obtain the benefit.
The taxpayer argued that if a customer obtained enough “fuelperks!” that he/she could end up a free tank of gas. The Court held that the mere possibility that someone could obtain the free tank wasn’t enough. As the Court pointed out, that still required another transaction, and obtaining a free tank depended on the price of fuel when redemption was sought, since each “fuelperk!” gave the customer a 10 cent per gallon reduction in price.
Third Circuit Reversal
Giant Eagle appealed the Tax Court’s decision, and 2 of the three judges on the panel agreed that the Tax Court had come to the wrong conclusion. The majority concluded that Giant Eagle had met all requirements to claim the deduction at year end, rather than needing to wait until the customers actually redeemed their rewards.
The majority held:
For purposes of the "all events" test's fixed liability prong, it is irrelevant that neither the total amount of Giant Eagle's anticipated liability nor the identity of all the customers who eventually applied discounts toward gasoline purchases could be conclusively identified at year's end.40 And while there remained an "extremely remote and speculative possibility" that the amount of Giant Eagle's claimed deductions would overstate the value of the rewards its customers ultimately redeemed,41 Giant Eagle significantly mitigated that risk by tracking its customers' monthly redemption rates and offsetting the deductions accordingly to account for prospective non-redeemers. Giant Eagle amply demonstrated the existence -- as of year's end -- of both an absolute liability and a near-certainty that the liability would soon be discharged by payment. The chance of non-redemption had been calculated by Giant Eagle "with reasonable accuracy" as conceded by the Commissioner. The "all events" test demands no more. We hold, therefore, that following Hughes Props. and Lukens Steel, Giant Eagle was entitled to deduct fuelperks!-related liabilities incurred during the tax years at issue.
However, one member of the panel (Judge Hardiman) disagreed that Giant Eagle’s program should be treated similarly to the programs in the other cases the majority mentioned. Specifically, Judge Hardiman noted that Giant Eagle’s program imposed a requirement that customers use their rewards within 3 months or lose them.
As the dissent noted:
Nonetheless, the liabilities that accrued to Giant Eagle on account of its fuelperks! program were not absolute. The casino in Hughes Properties, the insurance company in Massachusetts Mutual, and the steel company in Lukens Steel all operated under a set of rules that offered no hope of escape from their fixed liabilities. In each case, those liabilities had to remain on their books until discharged by payment. Here, in contrast, Giant Eagle made each liability temporary by providing that "fuelperks! discounts expire 3 months after the last day of the month in which they're earned." App. 1161. If a shopper failed to redeem fuelperks! within that timeframe, the discounts were lost and Giant Eagle had no obligation to honor a belated attempt at redemption. After acknowledging this fact, the Majority offers reasons why we should nonetheless conclude that Giant Eagle faced "an absolute liability." Maj. Typescript at 16. After careful consideration of those reasons, I remain unconvinced.
The dissent was also critical of the majority’s reasoning in arriving at the conclusion noted above, arguing:
In my view, this comment reveals an analytical error, i.e., a conversion of Giant Eagle's individual liabilities into a group liability. In order to establish that Giant Eagle faced a fixed liability, the Majority applies Cobaugh to conclude that the company entered into a unilateral contract at checkout with -- and therefore became liable to provide discounted gas to -- each shopper. Consequently, its liabilities were several and fixed on an individual basis. But the Majority later departs from that reality by treating the company's numerous individual liabilities as an amalgamation. See Maj. Typescript at 15 (citing Lukens Steel and Massachusetts Mutual, cases that each involved a single group liability); see also id. at 16 ("Giant Eagle amply demonstrated the existence -- as of year's end -- of . . . an absolute liability" (emphasis added)). This errant tack is critical because whether liability is fixed on an individual or collective basis is a "significant" fact with the potential to "dictate . . . different outcome[s]" in our cases. Mass. Mut., 782 F.3d at 1364. Accordingly, I cannot agree with the Majority's analysis, which perceives Giant Eagle's liability as being fixed both on an individual and collective basis.
As I see it, the question for our resolution is whether Giant Eagle's liability to any individual shopper with accrued-but-not-yet-redeemed fuelperks! was certain to continue under the rules applicable to that liability until it was paid. Because one of those rules allowed for the expiration of each shopper's fuelperks! (and Giant Eagle's corresponding liability to that shopper), the answer is plainly "no." While Giant Eagle became liable to a shopper at checkout, it did not become absolutely liable to that shopper unless and until the shopper redeemed fuelperks! prior to their expiration. For that reason, I would hold that, at the close of the 2006 and 2007 taxable years, Giant Eagle faced many fixed liabilities for yet-to-be-redeemed fuelperks!, but none that were "determine[d] in fact" because each was contingent upon future redemption by the shopper.
In the Third Circuit the majority’s view will prevail, but only time will tell if the other circuits (especially those that issued the cases relied upon on this case) will go along with the majority or minority view on whether such a limit on redemption is or is not fatal to a deduction.