Does your business operate (or are you considering) a loyalty or customer rewards program? If so, you should know that a Tax Court ruling was recently reversed in favor of a prominent grocery retail store chain. The Tax Court had originally disallowed accrued deductions totaling more than $3.6 million. The outcome of this case helps support tax deductions related to customer loyalty/rewards programs utilized in your business.
Facts of the Case
Giant Eagle Inc., had implemented a customer loyalty program that awarded gasoline discounts to customers spending certain amounts at the company grocery stores. Giant Eagle applied various statistical analysis to determine year-end liabilities for unused customer discounts. The Tax Court found Giant Eagle Inc., a corporation operating a chain of retail supermarkets, gas stations and convenience stores, could not claim deductions for the customer service loyalty program, since the customers hadn’t yet claimed the rewards earned. The Tax Court had held for the IRS that a customer loyalty program reserve did not satisfy the “all events” test and therefore must be treated as a non-deductible general reserve for income tax reporting.
Judge Roth of the Third Circuit Court of Appeals reversed the IRS Tax Court victory in her recent opinion in Giant Eagle, Inc. v. Commissioner of Internal Revenue, 2016 BL 145260, 3rd Cir. No. 14-03961, 5/6/16. At the Tax Court, Giant Eagle argued that the discounts accumulated but not applied by year’s end satisfied the “all events” test because Giant Eagle’s liability became fixed upon issuance of the discounts.
The Tax Court disagreed, finding that the company’s claimed deductions didn’t satisfy the “all events” test because the purchase of gasoline functioned as a condition precedent to a customers’ redemption of discounts earned at the grocery store checkout. Accordingly, the Tax Court reasoned, any liability became fixed only after customers applied the accumulated discounts to a fuel purchase, which, in the case of the disallowed deductions, occurred after the end of the tax year.
Judge Roth indicated that, according to the “all events test” found in tax code Section 461(h)(4), accrual method taxpayers are expressly permitted to deduct expenses before they are paid, so long as all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy. According to Judge Roth, Giant Eagle was entitled to deduct the gasoline-related liabilities for the years at issue, indicating the Tax Court misapplied the “all events” test as it applies to recurring expenses.
“Giant Eagle characterizes its issuance of fuelperks! rewards as a unilateral contract formed at checkout, which conferred instant liability on the supermarket chain to its customers for the rewards they accrued,” Judge Roth said.
Roth added that it was irrelevant that neither the total amount of the company’s anticipated liability nor the identity of all the customers who eventually applied for the discounts toward gasoline could be identified by year’s end.
In applying the recurring item exception to the Giant Eagle facts, Roth indicated the only inquiry necessary was whether the “fact of liability” was fixed as of year-end. The Appeals Court analyzed other similar cases and concluded under contract law principles that a fixed liability was incurred under state law at the time of the grocery purchase even though the total amount of the liability nor the identity of each customer could be conclusively identified at year end. All that is demanded in the all events test is that the chance of non-redemption be calculated with reasonable accuracy. Giant Eagle’s statistical analysis and continued review of customer monthly redemption rates was adequate to calculate the liability at year end with reasonable accuracy.
A strong dissent was written by Judge Hardiman largely disagreeing with the majority opinion because Giant Eagle’s liability was general in nature, contained a three-month expiration period, and there was not a strict obligation to afford benefits to identified persons. He would have disallowed satisfaction of the all events test saying the obligation was contingent on claiming the fuel reduction benefit at the pump.
Implications for Taxpayers
Taxpayers may want to review the tax treatment of significant reserves booked in their financial statements. This might include a review of current tax treatment of reserves as deductible and utilize the Giant Eagle decision to support the position for current deductibility. Taxpayers who have taken a conservative approach and disallowed similar reserves may want to review making a favorable accounting method change application.
Contact Paul Simons, Tax Principal at DS+B, for more information or to discuss your applicable business situation.