Pay Now or Defer: No Income Deferral If Services Are Involved

EXECUTIVE SUMMARY * THE DEFERRAL OF TRADE DISCOUNTS BY RETAILERS has caused the INS to closely police whether allowances contingent on services performed are really trade discounts. If a discount is strictly volume-related, receiving it in advance should not prevent deferral. But it may be very difficult to convince the INS that an advance discount is not tied to services. * MANY RETAILERS RECEIVE COOPERATIVE advertising allowances that are volume-based. The INS interprets these arrangements as vendor payments for advertising services rendered by the retailers. * SLOTTING FEES PAID BY MANUFACTURERS may be viewed as a way for retailers to negotiate the lowest inventory costs. But the INS usually views them as a performance related service that should be treated as income as shelf space is made available. * PERFORMANCE-RELATED ALLOWANCES may be deferred if they are structured as loans. IRS Publication 3106 outlines how payments received under an image upgrade program can be treated as a nontaxable loan. There appears to be no reason that other advances such as cooperative advertising could not also be structured as loans. * THE EMERGING ISSUES TASK FORCE (EITF) has established a presumption that cooperative advertising allowances are to be deferred in inventory unless it is clear they are payment for services. Since the INS presumption is precisely the opposite, there is a conflict between these positions. ********** Walk into your favorite grocery store and it's clear that some products get preferential treatment. One brand of soup may be at eye level, while others are on the bottom shelf, or a new product may be on prominent display at the end of an aisle. In many cases these product placements are not accidental; manufacturers may be paying the grocery chain for prime positions. Such payments are known as and have become common in other business sectors such as computer software, books and magazines, tobacco products and automotive parts. Slotting is a generic term for a variety of fees paid by product manufacturers, including display, pay-to-stay failure and presentation fees. Retailers of all kinds receive money from manufacturers not only for slotting allowances, but also for purchase volume rebates and cooperative advertising allowances. The tax treatment of these promotion allowances has spawned a debate between retailers and the IRS. Some of the controversy arises from timing issues such as when payment is received and when claims are submitted, but IRS efforts to accelerate the taxation of these allowances usually is tied to its position that they are for services rendered by the retailer. In this article CPAs will learn when the IRS acceleration argument is vulnerable and how structuring advances as loans can result in deferral of income. TRADE DISCOUNTS In most cases discounts, allowances and rebates are tied to the volume that manufacturers and other vendors sell. Revenue ruling 84-41 defines trade discounts as a vendor's reduction of the purchase price depending on the quantity purchased. Regulations section 1.471-3(b) requires a trade discount to be treated as a reduction in purchase price of inventory rather than as an item of gross income. This treatment results in income deferral to the extent the discounted goods remain in inventory at year-end. This deferral-of-income opportunity prompted the IRS to take an aggressive stance on allowances that are paid up front or that are contingent on services performed by the retailer. ALLOWANCES FOR SERVICES Retailers often obtain reimbursements of a portion of advertising costs from vendors under cooperative advertising plans, where they receive allowances based on their volume of business with a particular vendor. These agreements may stipulate the media to be used, the time of the ads and other conditions and require certain documentation. …