BGBC Partners, LLP Tax Update: Update on Loyalty Discount Programs
A large operator of supermarkets, pharmacies, and gas stations that issues loyalty discounts to its customers had its day in court against the IRS – and won! However, this ruling provides little comfort to other taxpayers with similar circumstances. That’s because the IRS has announced its nonacquiescence with the U.S. Court of Appeals, Third Circuit, decision. This means the IRS intends to ignore the decision as applied to other taxpayers with facts and circumstances similar to those in the case called Giant Eagle, Inc., 117 AFTR 2d (2016).
The case involves the retailer, Giant Eagle, and its loyalty discount program under which customers purchasing qualifying groceries earn a 10¢ per-gallon discount on gasoline purchases for every $50 of grocery purchases. Giant Eagle accrued liabilities under its accrual method of accounting for the discounts its customers had accumulated, but had not yet applied to fuel purchases. It claimed tax deductions for these accrued liabilities amounting to $3.4 million for tax year 2006 and $313,490 for 2007. The IRS disallowed the deduction, and Giant Eagle challenged the disallowance in Tax Court.
Under Internal Revenue Code Section 461(a), and the accompanying Treasury Regulations, an accrual method taxpayer can take a deduction for an accrued liability in the tax year in which the liability passes the “all events test.” The test has three basic elements that need to be satisfied- All events have occurred that establish the fact of the liability
- The amount of the liability can be determined with reasonable accuracy; an
- Economic performance has occurred with respect to the liability.
In the case of a loyalty discount program, economic performance generally occurs as payment is made to the customer (in the present case, when the customer redeems the discount as gasoline is purchased). The Code allows a recurring item exception whereby recurring items can be deducted for a tax year, even if economic performance has not yet been met. Giant Eagle argued in Tax Court that it met the “all events test” because it could, through its accounting system, estimate its liability with reasonable accuracy. It also argued that the accrual results in better matching of the liability against the income to which it relates than would result from accruing in the tax year in which economic performance occurs, thus invoking the recurring item exception. The Tax Court disagreed, deciding the case in favor of the IRS. The Court said the purchase of gas had to happen before Giant Eagle could claim the deduction.
Giant Eagle appealed to the Third Circuit Court of Appeals. The Third Circuit reversed the Tax Court decision, saying it was convinced that Giant Eagle proved the existence of an absolute liability, reasonably estimated it, and demonstrated a near-certainty the liability would soon be discharged by redemption of the discount. The Court found Giant Eagle’s method for calculating the accrual reasonably took into account the chance of non-redemption, and that’s all that is needed to satisfy the “all events test.” However, the dissenting judge in the case believed that Giant Eagle wasn’t absolutely liable unless and until the discount rewards were redeemed.
Well what does all of this mean to you as a grocer? Since the IRS has announced it will not adhere to the Third Circuit’s decision in all cases, it is important to make sure customer loyalty programs use a well-thought method of calculating liability accruals. A competent CPA should be able to help formulate a program plan that properly considers a reasonable estimate of the liability, as well as historical redemption rates of the discounts.
