Uncertainty Governs Advance Trade Discounts

EXECUTIVE SUMMARY

• The Ninth Circuit held that advance trade discounts were not income when received by a taxpayer because the taxpayer had an obligation to repay the discounts and therefore did not have an accession to wealth.
• The Third Circuit held that a taxpayer’s advance trade discounts were income when received because the taxpayer controlled whether it was entitled to keep the discounts.
• Rev. Proc. 2007-53 allows qualifying taxpayers to account for certain advance trade discounts for federal income tax purposes in the same way that they are accounted for in the taxpayer’s financial statements.
• In substance, an advance trade discount is an adjustment to the purchase price of goods and should be treated for tax purposes as a reduction of inventory costs.

Taxpayers often find advance trade discounts troubling. These payments, which sellers make to buyers in exchange for the buyers’ promises to make certain volume purchases of goods in the future, frequently impose repayment obligations for buyers that fail to perform as promised. These repayment obligations prevent advance trade discounts from cleanly falling within commonly held notions of income or loans. Perhaps, as discussed below, this difficulty indicates that they represent neither.

Two appellate courts and the Service have recently addressed advance trade discounts; however, they have created more confusion than clarity. In Westpac Pacific Food,¹ the Ninth Circuit, reversing the Tax Court, found that a repayment obligation prevented an advance trade discount from creating an accession to wealth and therefore concluded that it did not constitute gross income when received. In Karns Prime & Fancy Food, Ltd.,² the Third Circuit affirmed the Tax Court and held that a taxpayer must recognize an advance trade discount as gross income when received because the taxpayer’s ability to keep the payment, as long as it fulfilled its purchase commitment, established the taxpayer’s complete dominion over such payment. Days before the filing of the Karns opinion, the Service issued Rev. Proc. 2007-53³ and announced that it would follow Westpac insofar as it would allow taxpayers to follow their financial reporting treatment for certain advance trade discounts.

In light of these developments, taxpayers receiving advance trade discounts now face split circuit opinions and taxpayer-favorable guidance from the Service. This article explains the opinions and guidance, considers the possibility of the Service revoking Rev. Proc. 2007-53 after the government’s victory in Karns, looks at the implications of having conflicting decisions in two circuits, and discusses the alternative of treating advance trade discounts as purchase price adjustments.

Ninth Circuit’s Analysis in Westpac

In Westpac, the Ninth Circuit considered the advance trade discounts received by a partnership (Westpac) organized by three grocery store chains. Westpac entered into four contracts that resulted in Westpac’s receiving up-front cash payments for volume discounts in exchange for Westpac’s respective promises to purchase certain dollar amounts of products annually from each of four vendors. Westpac also agreed to repay the advance trade discounts pro rata to the extent it failed to satisfy its purchase obligations. Westpac did not satisfy its minimum purchase obligations under two contracts and made the required repayments to the appropriate vendors.

In preparing its tax returns for the years during which it received the cash payments, Westpac took a portion of those payments into account in determining its taxable income. The amount accrued by Westpac for a tax year reflected the pro-rata portion of the advance trade discounts attributable to goods purchased during that year under Westpac’s purchase obligations. Westpac subtracted that portion from its cost of goods sold in order to reflect the discount, which had the effect of increasing Westpac’s gross income.

The IRS adjusted Westpac’s gross income to include the entire amount of the cash payments in the years they were received, and the Tax Court upheld the adjustments. The Tax Court reasoned that, considering Westpac’s unfettered use of the cash and the broad definition of gross income under Sec. 61, the advance trade discounts constituted income recognizable when received because Westpac had actual command over the payments.

The Ninth Circuit reversed the Tax Court’s decision in Westpac. The appellate court determined that the issue was whether Westpac must report an advance trade discount, subject to repayment, as income if it had not satisfied its associated purchase commitments by the time it received the payment. Even under the broad definition of gross income, the court concluded that Westpac’s advance trade discounts could not constitute income as long as the repayment obligations remained outstanding.

The Ninth Circuit acknowledged, as did the Tax Court, the broad definition of gross income from the Supreme Court’s decision in Glenshaw Glass Co.⁴ In that decision, the Court characterized gross income as accessions to wealth over which a taxpayer has complete dominion. The Ninth Circuit, however, disagreed with the Tax Court’s holding that under this definition Westpac’s mere unfettered control over the cash receipts meant that it had to recognize income. The court found that this approach lacked any consideration of whether Westpac had an accession to wealth. To illustrate the point, the court explained that a taxpayer could exercise complete dominion over loan proceeds but still not recognize income because its repayment liability would offset the receipt of loan proceeds without affecting the taxpayer’s wealth.

The court concluded that Westpac experienced no accession to wealth when it received the cash payments subject to repayment. It noted that Westpac could only keep those payments to the extent it fulfilled its purchase obligations and, despite holding the cash, “Westpac either has to buy a specified volume of goods for more than it would otherwise pay or pay back the money.”⁵ In either situation, Westpac assumed a liability that offset the value of the cash and hence realized no change in wealth.

The Ninth Circuit in Westpac therefore refused to characterize an advance trade discount as income where the taxpayer concurrently assumed an obligation to either make future purchases or repay the discount. Regardless of the taxpayer’s degree of control over the proceeds, the court found no accession to wealth where the arrangement created a repayable advance against the taxpayer’s obligation.

Third Circuit’s Analysis in Karns

In Karns, the Third Circuit reached the opposite conclusion, creating a split between the circuits. In that case, the taxpayer (Karns) had sought $1.5 million of funding for capital improvements at its grocery stores. Karns therefore approached its principal supplier about a loan, and the supplier agreed to provide the requested financial assistance. Under an established practice with its strategic customers, the supplier required that Karns sign a promissory note and agree to annually purchase a minimum dollar amount of products from the supplier while the note remained outstanding (the supply agreement). The note and supply agreement ensured the supplier’s status as the primary food supplier for Karns.

Karns signed the $1.5 million promissory note with interest payable at prime plus 1% and principal repayable in six annual $250,000 installments. Under the terms of the note, the supplier would forgive each annual installment as long as Karns materially complied with its purchase obligation under the supply agreement for the year preceding the due date for such installment. The supply agreement committed Karns to purchase $16 million of product each year under the supplier’s general policies and practices, which governed product pricing, billing and payment terms, and return and credit allowances.⁶ If Karns defaulted on its obligations under the supply agreement in any way, including a failure to use the supplier as its primary food supplier, then the principal balance on the note would become immediately due and payable.

Karns thereafter met its minimum purchase obligations for three consecutive years before falling short in the fourth year, which triggered a small principal repayment associated with the shortfall. For at least two tax years, Karns reported $250,000 as income resulting from the supplier’s forgiveness of an installment obligation, by including each installment obligation in gross income for the year during which the supplier forgave it.

The Service argued and the Tax Court agreed that Karns should report the entire $1.5 million in the year it signed the promissory note, agreed to the purchase obligations, and received the cash proceeds.⁷ Without referring to its own Westpac decision,⁸ the court found that the agreements in substance left Karns without a repayment obligation unless and until Karns failed to satisfy a minimum purchase obligation. Because Karns received the $1.5 million without an unconditional repayment obligation, the Tax Court concluded that Karns must report that amount as income because it could keep the money as long as it maintained its end of the bargain.

On appeal, the Third Circuit affirmed the Tax Court’s decision. The majority opinion clearly viewed the appellate court as facing the task of characterizing the $1.5 million payment as either income or a loan. The majority reasoned that such amount would represent an item of gross income to the extent Karns had an accession to wealth over which it exercised complete dominion but would represent a loan excludible from gross income to the extent Karns had an unconditional obligation to repay it.

The majority opinion characterized the payment as income based on the logic of the Supreme Court’s opinion in Indianapolis Power & Light Co.⁹ In that case, the Court addressed whether a customer’s security deposit for utility services represented a loan or an advance payment for those services. The Court distinguished advance payments by noting that a recipient of an advance payment would exercise complete dominion over such funds due to a customer’s concurrent commitment to purchase goods or services, which created “some guarantee” that the recipient could keep the funds; in particular, “so long as it fulfills its contractual obligation, the money is its to keep.”¹⁰ The Court noted that no similar guarantee exists with a loan.

Based on the facts and circumstances surrounding the transactions, the Karns majority opinion found the promissory note and purchase obligations analogous to an advance payment described in Indianapolis Power. The $1.5 million payment made to Karns coupled with the $16 million purchase obligation established all the indicia of an advance rebate that Karns could keep as long as it fulfilled its obligations. Accordingly, the majority opinion concluded that Karns must recognize the $1.5 million as income on receipt. The court then summarily criticized, and thereby presumably distinguished, Westpac for failing to address the quoted language above from Indianapolis Power.

The majority opinion also rejected Karns’s argument that any debt forgiveness was a mere condition subsequent to its unconditional repayment obligation under the promissory note. Based on the substance of the transactions, the court noted that Karns alone controlled its repayment obli­gation through its ability to choose whether to fulfill its purchase commitments. Karns’s control belied its characterization of its repayment obligation as unconditional.

A concurring opinion in Karns purported to address Westpac’s conclusion that an advance trade discount provides no accession to wealth. Through a series of hypothetical scenarios, the concurrence used a present value analysis to demonstrate how a recipient achieves an economic benefit to the extent it postpones its tax liability by deferring income recognition for an advance trade discount. Without explaining whether Karns realized an accession to wealth from the receipt of the $1.5 million itself, the concurring opinion expressed its disagreement with the Westpac analysis insofar as it would allow Karns to benefit economically from an unauthorized “tax-deferral shelter.”¹¹

A dissenting opinion characterized the $1.5 million payment as a loan based on Karns’s lack of control over its repayment obligation and the independent nature of the promissory note. The dissent noted that the supplier possessed broad discretion to cancel the supply agreement based on changes in the financial or other conditions, business, or prospects of Karns or its guarantors. If the supplier canceled the agreement, then Karns could not fulfill its purchase obligations and thereby obtain debt forgiveness. Accordingly, the dissent found that Karns lacked exclusive control over its repayment obligation. Moreover, the dissent refused to accept the promissory note as a mere collection mechanism for unearned discounts. It found that a liquidated damages clause in the supply agreement provided a remedy for its own breach, which demonstrated that the repayment obligation under the promissory note remained independent of (albeit linked to) the supply agreement. As such, the dissent characterized the $1.5 million as a bona fide loan from a third party that served dual functions as supplier and creditor.

IRS Guidance on Advance Trade Discounts

Several days before the filing of the Karns opinion, the Service announced that it would follow Westpac for accrual-method taxpayers maintaining inventories and adopting a so-called advance trade discount method. In Rev. Proc. 2007-53, the Service described that method as applying to certain advance trade discounts whereby a taxpayer takes such discounts into account in the same amount, the same manner, and the same tax year as the taxpayer accounts for them in its applicable financial statements.¹² For example, a taxpayer that accounts for an advance trade discount as a cost reduction for related inventory items on its applicable financial statements would generally take the same discount into account in the same manner for that tax year under this method.¹³

The advance trade discount method applies to payments received by a taxpayer where: (1) The taxpayer receives a payment from a seller of merchandise in exchange for the taxpayer’s agreement to purchase a minimum amount of merchandise over a period of five years or less; (2) the payment is intended as a discount of the purchase price for the merchandise; (3) the taxpayer becomes obligated, either in writing or by industry custom, to repay an allocable portion of the payment to the extent it fails to satisfy its minimum purchase obligation; and (4) the taxpayer does not treat the discount as payment for services in its applicable financial statements. These discounts, however, can also include amounts allocable to exclusive supplier arrangements or slotting allowances, which are payments a supplier makes to get a product placed on a retailer’s store shelves.

The issuance of Rev. Proc. 2007-53 18 days before the filing of the Karns opinion creates more uncertainty about the treatment of advance trade discounts. In a footnote to its opinion, the Third Circuit explained how the Department of Justice (DOJ), which litigated Karns, informed the court that it was considering whether to change its position in light of the Service’s revenue procedure. But the court filed its opinion before the DOJ gave notice of any change, and the court invited the DOJ to petition for a rehearing to reflect a change in its position.¹⁴ Taken at its face, Karns appears to reflect the government’s substantive position on those advance trade discounts.

Qualifying taxpayers, however, can still take comfort in the advance trade discount method sanctioned by Rev. Proc. 2007-53. In addition to allowing taxpayers to currently adopt the method, the IRS granted audit protection to taxpayers using the method before the revenue procedure was issued, such that the Service will no longer pursue the issue in an exam, at appeals, or before the Tax Court. Thus, despite the government’s victory in Karns, Rev. Proc. 2007-53 presently provides a significant concession and an effective means to achieve the result of Westpac.

Nevertheless, taxpayers might consider whether the IRS will revoke Rev. Proc. 2007-53 in light of Karns. A revocation might appear reasonable given the willingness of the Third Circuit and the Tax Court to accept a position contrary to Westpac. However, it is noteworthy that the advance trade discounts in Karns would not have qualified under Rev. Proc. 2007-53. The supply agreement containing the minimum purchase obligations in Karns continued for six years, which exceeds the five-year period permitted by the revenue procedure. As a result, the DOJ could continue to support its original position in Karns without contradicting the Service’s published guidance, and the Service could keep Rev. Proc. 2007-53 outstanding and rely on Karns to require income rec-
ognition for ineligible advance trade discounts.

Rev. Proc. 2007-53 perhaps best reflects an exercise of administrative grace. Karns and the Tax Court’s opinions clearly indicate that the IRS might prevail with an immediate income recognition position for advance trade discounts outside the Ninth Circuit. The willingness of the Service to publish taxpayer-favorable guidance, before the filing of the appellate opinion in Karns and in a manner that authorizes a method that follows financial statement reporting, suggests that the Service was motivated in part to use Rev. Proc. 2007-53 to alleviate administrative burdens in accounting for these discounts. As administrative grace, it seems unlikely that the Service will revoke the revenue procedure in light of Karns.

Comparing the Circuit Court Opinions

Outside the Third and Ninth Circuits, taxpayers (as well as the courts) must determine the proper treatment of advance trade discounts to which the advance trade discount method does not apply. The split between the circuits on whether repayable advance trade discounts constitute income on receipt will undoubtedly increase uncertainty in tax reporting. A comparison of the Westpac and Karns decisions, however, suggests that the Ninth Circuit provided a better-reasoned approach that taxpayers and the courts should follow.

The Ninth Circuit in Westpac acknowledged that it needed to find both a taxpayer’s receipt of income (i.e., an accession to wealth) and its complete dominion over that income before the court would require the inclusion of an advance trade discount in gross income. The court essentially ignored the question of complete dominion in that case because, as discussed above, it found that the repayment obligation prevented an accession to wealth. By using this two-pronged inquiry, the court reached the right result.

In contrast, the Third Circuit seemingly ignored the question about Karns’s accession to wealth. The majority opinion never explicitly addressed the question, and the concurring opinion addressed only the economic benefit of a supposed tax deferral.¹⁵ Instead, the Third Circuit unjustifiably relied on Indianapolis Power to conclude that Karns’s complete dominion over the cash required the recognition of income. Although no clear demarcation exists between wealth accession and complete dominion issues, the Third Circuit read Indianapolis Power too broadly.

At most, Indianapolis Power suggests that Karns received an advance trade discount rather than a loan. The Court in Indianapolis Power considered the utility company’s complete dominion over the security deposits in order to determine whether they represented advance payments or loans. The Court’s analysis indicates that where a taxpayer receives amounts for goods or services and the taxpayer has some guarantee that it can keep the amounts received, they are advance payments. A comparable analysis, as performed by the Third Circuit, suggests that Karns’s receipt of cash, which it has some guarantee that it can keep, constitutes an advance trade discount.

Unfortunately, the Third Circuit read Indianapolis Power to imply that a taxpayer must include an advance trade discount, like an advance payment, in gross income. The Supreme Court, however, started its analysis with the utility company’s acknowledgment that advance payments represent taxable income. That acknowledgment makes sense because a prepayment for goods or services clearly represents income. The Court therefore focused its attention on the utility company’s rights and obligations relative to the deposits. The Court’s focus admittedly reflected its prior decisions on determining income either through a taxpayer’s complete dominion over an accession to wealth or a taxpayer’s receipt of income held under a claim of right. However, because of the utility company’s acknowledgment that advance payments represent income, the Court addressed only the question of whether the utility company’s rights and obligations relative to the security deposits justified their characterization as advance payments. The Third Circuit drew an unwarranted conclusion from Indianapolis Power that payments analogous to advance payments necessarily represent gross income, which ignores the utility company’s acknowledgment.¹⁶

By directly addressing the initial question of whether an advance trade discount constitutes income on receipt, Westpac provides a better-reasoned approach to analyzing these discounts. Nevertheless, the court gave an unconvincing rationale to explain why the payments were not income. In particular, the Ninth Cir-cuit found no accession to wealth where the partnership assumed an offsetting obligation to either purchase products or repay the funds it received. Curiously, a recipient of any advance payment could make the same argument. The recipient would assume an obligation to either provide goods (or services) or repay the funds it received. Therefore, contrary to the Ninth Circuit’s suggestion, that attribute alone does not satisfactorily resolve the issue of whether an advance trade discount represents income.

Instead, the exclusion of such discounts from gross income seems compelled by the court’s impression that businesses make money by selling, not buying, goods. It is easier to see why a vendor recognizes income when it receives cash today in exchange for a promise to deliver goods in the future than why a customer recognizes no income when it receives fungible cash today from a vendor in exchange for a promise to pay the vendor a greater amount of cash in the future in order to purchase the vendor’s goods. In the former situation, the vendor receives a portion of the total sales price up front and will receive the balance later, which will equal the amount realized from the sale. In the latter situation, the customer receives cash with a commitment to purchase goods in the future at a price that, once netted with the cash receipt, will equal an agreed-on discounted purchase price. The shifting of cash between the parties in connection with an advance trade discount serves, like a rebate or refund, as a mechanism for achieving a particular purchase price rather than as income received for property rights or services.

To the extent taxpayers hope to reconcile Karns and Westpac, they might argue that both courts applied similar concepts to factually distinguishable situations. Although neither court articulated this rationale, based on all facts and circumstances in each situation, it is reasonable to regard Karns as requiring income recognition because the court believed the taxpayer had a fixed right to income subject to a condition subsequent and Westpac as rejecting income recognition because the court felt a condition precedent prevented the partnership from having a fixed right to income. Given the various contract provisions, testimony, business practices, and industry customs considered by the courts, it is difficult to precisely identify the factors that motivated their decisions.¹⁷ Accordingly, the analyses in the opinions arguably reflect the results desired by the courts based on their impressions of the commercial intentions. In any event, the cases help to illustrate the factually intensive nature of the process for determining the treatment of advance trade discounts as well as the importance of properly structuring these transactions to achieve the desired tax consequences.

Advance Trade Discounts as Purchase Price Adjustments

An alternative approach for determining the treatment of advance trade discounts would recognize them as adjustments used to reach an agreed-on purchase price. Both Karns and Westpac addressed questions of income recognition by essentially viewing advance trade discounts in isolation. The substance of the transactions, however, makes their analyses seem misguided because the payments represented volume discounts on the purchase of goods. Such discounts allow the parties to establish an acceptable purchase price. In fact, the Third Circuit seemed cognizant of that fact insofar as it described the Karns transactions as having all the indicia of an advance rebate. As purchase price adjustments, the payments affect the cost basis of acquired goods without constituting or raising questions about separate payments of income.¹⁸

Surprisingly, only the Tax Court opinion in Westpac touched on this concept. In the lower court, Westpacargued that its inventory cost (not gross income) should reflect its advance trade discounts under Regs. Sec. 1.471-3(b), which defines inventory cost as an invoice price less trade discounts. The Tax Court rejected this position by finding that the regulations require a discount to arise contemporaneously with the purchase of specific goods. That requirement, according to the court, made the regulations inapplicable to an “advance” trade discount.

In that part of its opinion, the Tax Court appears to have taken an overly formalistic approach to advance trade discounts. The court introduced this contemporaneous requirement based on a separate reference to a “net invoice price” in the regulations,¹⁹ which the court inferred to mean net of any trade discount applicable to purchased goods. That approach largely ignores the substance of a transaction whereby the parties intend to use a discount, regardless of when paid, to establish a desired price for such goods.²⁰ That approach similarly attaches too much significance to an “advance trade discount” label used to describe the payments. Regardless of whether the parties call such payments discounts, allowances, rebates, or refunds, a well-established line of cases following the principle of Pittsburg Milk Co.²¹ indicates that a purchase price should reflect the economic reality of a transaction, which is designed to achieve a net price, regardless of the time or manner of any adjustment.²²

The Tax Court itself concluded that inventory costs should reflect the receipt of comparable trade discounts in Computervision International Corp.²³ In that case, the taxpayer received a stock warrant from a seller as an inducement to purchase computer workstations such that the warrant effectively reduced the overall cost of the purchased goods. The warrant became exercisable once the taxpayer purchased a sufficient dollar volume of workstations from the seller during a multiyear period. Although the taxpayer argued for long-term capital gain treatment on the exercise of the warrant, the Service urged the court to treat the warrant as a trade discount under Regs. Sec. 1.471-3(b). The Tax Court agreed with the Service that the warrant represented a trade discount primarily due to its nature as a purchase incentive and its connection to the taxpayer’s dollar volume of purchases. Having determined the warrant’s status as a trade discount, the court recited the proposition that such discounts—whether paid in cash or property—reduce the cost of purchased inventory remaining on hand and would be reported as gross income only where the inventory’s cost had previously been included in the cost of goods sold. The Tax Court’s reasoning and conclusion in Computervision thus contradict its later holding in Westpac.

The economic reality of the transactions as well as the logic of Computervision suggest that the taxpayers in both Westpac and Karns should treat their advance trade discounts as reductions to inventory costs.²⁴ Such treatment would avoid the confusing issue of whether advance trade discounts can constitute gross income, which led to the nagging question in Westpac and the awkward response in the Karns concurrence about how a taxpayer could make money by purchasing goods. Moreover, such treatment would reflect the commercial intention to use these discounts as an integrated mechanism for adjusting the purchase price of goods.

Conclusions

With a split between the circuits and the Service’s publication of Rev. Proc. 2007-53, taxpayers might feel more uncertain about the treatment of advance trade discounts than before these authorities and guidance appeared. Absent a published change in the Service’s position, taxpayers might often prefer to report eligible advance trade discounts under the advance trade discount method in order to take advantage of a relatively taxpayer-favorable method that they know is permitted by the IRS.

Other taxpayers intending to rely on the case law should recall the factual nature of the inquiries in Westpac and Karns. Where commercially practical, the parties to a transaction should structure the form, as well as the substance, of a transaction to reflect an unconditional repayment obligation for any advance payment to the extent that a buyer wants to avoid income recognition. Alternatively, keeping in mind the Tax Court’s contemporaneous requirement, taxpayers (especially FIFO-method taxpayers) might consider whether they can report any such payments as reductions to inventory costs in order to minimize current income inclusions.

For information about this article, contact Prof. Walberg at walbergg@uncw.edu.

Editor’s Note: This article was awarded The Tax Adviser‘s Best Article Award for 2008 by The Tax Adviser Editorial Advisory Board.

Notes

¹ Westpac Pacific Food, 451 F3d 970 (9th Cir. 2006), rev’g TC Memo 2001-175.

² Karns Prime & Fancy Food, Ltd., 494 F3d 404 (3d Cir. 2007), aff’g TC Memo 2005-233.

³ Rev. Proc. 2007-53, 2007-30 IRB 233.

⁴ Glenshaw Glass Co., 348 US 426 (1955).

⁵ Westpac, 451 F3d at 976.

⁶ Karns and the supplier later modified the supply agreement and issued another promissory note; however, these aspects are not critical to this discussion.

⁷ Although the record indicates that the three events occurred on different dates, they all occurred within the same tax year. For consistency, the text will collectively refer to these events as the receipt of the cash.

⁸ The Tax Court issued its opinion in Karns before the Ninth Circuit reversed the Tax Court in Westpac.

⁹ Indianapolis Power & Light Co., 493 US 203 (1990).

¹⁰ Id. at 210.

¹¹ Karns, 494 F3d at 413 (Ambro, J., concurring).

¹² Applicable financial statements, in order of priority, are (1) a financial statement required to be filed with the Securities and Exchange Commission, (2) a certified audited financial statement accompanied by an independent CPA’s report used for credit, shareholder reporting, or other substantial nontax purposes, or (3) a financial statement (other than a tax return) required to be provided to a government or a government agency. See Rev. Proc. 2007-53 at §4.06. A taxpayer without an applicable financial statement must reduce the cost of specific inventory items to which a discount relates as the taxpayer purchases the inventory. See id. at §4.02.

¹³ A taxpayer must reduce the cost of purchased inventory by the discount as it purchases the inventory if such treatment results in the discount’s tax recognition earlier than its applicable financial statements account for the discount. See id. at §4.01.

¹⁴ Karns, 494 F3d at 412 n.3.

¹⁵ Tax-deferral characterization is appropriate only for a delayed reporting of payments properly characterized as items of gross income. See generally Illinois Power Co., 792 F2d 683 (7th Cir. 1986).

¹⁶ See Karns, 494 F3d at 410: “Therefore, the funds provided to Karns were in substance a projected rebate for products to be supplied, analogous to an advance payment, and as such were taxable income.”

¹⁷ Cf. Erickson Post Acquisition, Inc., TC Memo 2003-218, which characterized a vendor advance as a loan despite the forgiveness of annual payments as long as a dealer supply agreement remained in effect.

¹⁸ See Baillif, “Sales Price Adjustments: The Continuing Conundrum,” 57 Tax Law. 571 (2004): “The essential inquiry in distinguishing transfers that rise to a level of sale price adjustments from separate payments that must be treated independently is the fundamental question of whether the purpose of the payments is to reduce the selling price or is to achieve some other goal.”

¹⁹ Regs. Sec. 1.471-3(b).

²⁰ Compare Seago, “Do Advance Trade Discounts Represent a Liability or Income?” 105 J. Tax. 144 (2006), questioning whether the Service concurs with the contemporaneous requirement based on post-purchase rebates addressed in TAM 200605010 (10/20/05), with Conjura and Zuber, “New Rev. Proc. for Automatic Accounting Method Changes Goes a Long Way Toward Simplification,” 96 J. Tax. 139 (2002) (noting that the Service limits Regs. Sec. 1.471-3(b) to discounts received with or after a delivery of goods), and FSA 2006-28-01F (5/10/06) (relying on the contemporaneous requirement to reject a trade discount characterization for an advance discount).

²¹ Pittsburg Milk Co., 26 TC 707 (1956), nonacq. in part and acq. in part, 1982-2 CB 1.

²² See, e.g., Atzingen-Whitehouse Dairy, Inc., 36 TC 173 (1961), nonacq. in part and acq. in part, 1982-2 CB 1, concluding that bargained-for rebates paid months in advance of actual milk sales offset invoice prices to establish the actual sale prices.

²³ Computervision Int’l Corp., TC Memo 1996-131.

²⁴ The taxpayer in Westpac arguably achieved that result by reducing its cost of goods sold by apro-rata portion of the advance trade discount attributable to goods purchased during a tax year. The appropriateness of reducing the cost of goods sold by the entire portion, however, would depend on Westpac’s cost-flow assumptions for its inventory. The Ninth Circuit did not specifically address the appropriateness of these adjustments.