The Third Circuit held that a grocery store/gasoline retailer could take a deduction in the current tax year for discounts on gasoline purchases that the store's customers had accrued but not yet taken at the end of the year.
Background
In April 2004, Giant Eagle, a grocery store chain in the Northeast and Midwest with retail gasoline outlets at its stores, reworked its existing gasoline discount card program into a new program called "fuelperks!," a reward program that linked customers' rewards at the pump to prior grocery purchases, i.e., for every $50 spent on qualifying groceries, a customer enrolled in the program earned a 10-cents-per-gallon discount on gas. Discounts earned expired three months after they were earned, and under the program terms Giant Eagle could (although it did not) end the program at any time without prior notice. The combination of gasoline discounts and advertising for fuelperks! led to a dramatic increase in Giant Eagle's supermarket sales.
For the years at issue, 2006 and 2007, Giant Eagle claimed a deduction on its corporate income tax returns for the discounts its customers had accumulated but, at year's end, had not yet applied to fuel purchases. Giant Eagle computed the deduction by a formula incorporating the gross discounts customers earned by qualifying purchases, historical discount redemption rates, and the average number of gallons purchased in a discounted fuel sale.
From the outset of the fuelperks! program, Giant Eagle tracked customers' redemption of accumulated discounts and used the historical averages to determine the amount of the claimed deductions. As a result, it did not base its computations on the number of discounts actually redeemed or the number of gallons of gasoline actually sold in the three months after year's end. The IRS disallowed the deductions Giant Eagle took for the program in 2006 and 2007.
This treatment ruffled Giant Eagle's feathers, and the company petitioned the Tax Court to redetermine its 2006 and 2007 income tax liabilities on two grounds. First, it argued that the discounts accumulated but not applied by year's end satisfied the all-events test because its liability for the discounts became fixed upon their issuance at checkout. Alternatively, Giant Eagle urged that the accrued discounts be treated as sales accompanying "trading stamps or premium coupons," enabling it to offset the estimated costs against gross receipts from grocery sales.
The Tax Court rejected both arguments and sustained the IRS's determinations. It found that Giant Eagle's claimed deductions did not satisfy the all-events test because the purchase of gasoline functioned as a condition precedent to customers' redemption of discounts earned at checkout. Accordingly, the court reasoned, any fuelperks!-related 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. Additionally, the Tax Court held that the regulation governing "trading stamps" did not apply to the discounts that Giant Eagle customers accrued through fuelperks! because the gasoline discounts were not "redeemable in merchandise, cash, or other property," as required under Rev. Rul. 78-212.
Giant Eagle appealed the decision to the Third Circuit.
The All-Events Test
Regs. Sec. 1.461-1(a)(2)(i) states:
Under an accrual method of accounting, a liability . . . is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which 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.
Generally, economic performance occurs as payment of the liability is made. However, if a liability qualifies as a recurring item, a liability is incurred in the tax year if the all-events test is met for the item during that year and economic performance occurs within the shorter of the date the taxpayer files a timely (including extensions) return for the tax year or 8½ months after the close of the tax year.
The Issue at Hand
The IRS did not contest that fuel-perks! rewards were recurring items. It also agreed with Giant Eagle that the company had calculated its anticipated liability for rewards under the program with reasonable accuracy and that economic performance had occurred by the time the company filed its tax returns for the years in question. Thus, the only issue before the Third Circuit on appeal was whether the "fact of the liability" was fixed at year end as required by Sec. 461 and the regulations. (The court did not address Giant Eagle's argument that the deductions were offsets to income that qualified under the trading stamps exception to the all-events test, but even the dissent agreed with the Tax Court that this exception did not apply.)
The Third Circuit's Decision
The Third Circuit found that the IRS had misapplied the all-events test as it pertains to recurring expenses and held that the company was entitled to the previously disallowed deductions. The court based its determination of whether the fuelperks! rewards were deductible on its holding in Lukens Steel Co., 442 F.2d 1131 (3d Cir. 1971).
In Lukens Steel, the Third Circuit held that an accrual-method taxpayer was entitled to deduct contingent payments even though the taxpayer would not pay them out immediately or at a specified time, so long as the taxpayer had an unconditional obligation under contract law to make the contingent payments in a reasonable period of time. Therefore, the court looked to see whether the anticipated liability of Giant Eagle, a Pennsylvania company, for fuelperks! rewards was fixed at year's end under Pennsylvania contract law principles.
Giant Eagle characterized 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. The court observed that a unilateral contract was one where a contract was formed when one party (the offeror) makes a promise in exchange for the other party's (the offeree's) act or performance, and is unenforceable until the offeree completes performance. Reviewing Pennsylvania case law, the court found that the manifested intent of the offeror—and not the offeror's subjective intent—controlled which parties had the power to accept an offer in the unilateral contract context.
After looking at various promotional materials for fuelperks! in evidence, the court concluded that a Giant Eagle customer would anticipate that by making a certain volume of purchases, he or she had been promised to receive the rewards discounts, subject to the three-month expiration provision. Thus, the court found that the customer had entered into a unilateral contract with Giant Eagle, and the liability attached upon the customer's performance (i.e., paying for the requisite amount of purchases at checkout).
The Third Circuit further asserted that it was irrelevant that Giant Eagle did not know the total amount of the ultimate liability or the customers who would receive the discounts. Through its formula for calculating the deduction, which involved adjustments based on historical redemption rates, the company had demonstrated to the court's satisfaction "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" (slip op. at 18). In addition, as the IRS conceded, Giant Eagle had calculated the chance of nonredemption with reasonable accuracy. According to the court "[t]he 'all events' test demands no more" (id.). Consequently, it found that Giant Eagle could deduct its liability for the earned but unredeemed fuelperks! discounts.
Reflections
Although the majority makes a good argument based on its assessment of the facts, the dissent makes an equally plausible argument in its opinion. The majority found that Giant Eagle had an absolute liability to pay the reward discounts. However, the dissent pointed out that, although Giant Eagle apparently could not retract the reward discounts, the fact that they nonetheless expired after three months belied the majority's conclusion.
The dissent also asserted that to make its analysis work, the majority had made the error of converting Giant Eagle's individual liabilities to its customers into a group liability. This was a critical error because, as the Federal Circuit had stated in Massachusetts Mutual Life Insurance Co., 782 F.3d 1354 (Fed. Cir. 2015), whether liability is fixed on an individual or collective basis is a significant fact that has the potential to dictate different outcomes in a case, which the dissent thought it did in Giant Eagle's case.
The dissent maintained that determining whether the all-events test was met relied on 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 of the expiration rules for fuelperks! rewards, the dissent found that the answer to this question was plainly "no." Therefore, Giant Eagle did not meet the all-events test for the earned but unredeemed awards and should not have been able to deduct them.
Giant Eagle, Inc., No. 14-3961 (3d Cir. 5/6/16)
