United States: Rewards Program Liability Fixed Under All-Events Test

In Giant Eagle v. Commissioner, No. 14-3961 (3d Cir. 2016), the 3rd Circuit Court of Appeals reversed and remanded the Tax Court's order denying the taxpayer's fuel rewards program deductions on the grounds that the deductions were permissible under the all events test. The 3rd Circuit, in a 2-to-1 decision, found the liability to be fixed at the time the discount was earned.

The taxpayer, Giant Eagle Inc., operates a chain of retail supermarkets, pharmacies, gas stations and convenience stores in the U.S. The taxpayer established a fuel rewards program in 1991. The taxpayer's current version of the program, fuelperks!, links customers' rewards at the gas pump to prior grocery purchases. For example, for every $50 of groceries purchased, a cardholder earns a 10- cents-per-gallon discount on gas. The brochure distributed to customers describing the program indicated that the discounts expired on the last day of the month, three months after they are earned, and that the promotion was valid for a limited time and could end without prior notice.

For the years at issue, 2006 and 2007, the taxpayer didn't end the promotion or revoke any accumulated discounts. The appeals court determined that none of the published program parameters suggested that the taxpayer had the right to retract rewards that customers had already accrued, nor had such retroactive termination occurred or been contemplated during the history of the program.

On its 2006 and 2007 income tax returns, Giant Eagle, which is an accrual basis taxpayer, deducted under the recurring item exception the discounts its customers had accumulated at year end based on a formula that considered historical redemptions rates. From the outset of the fuelperks! program, the taxpayer tracked the customers' redemption of accumulated discounts. The IRS, however, disallowed the taxpayer's deductions.

At the Tax Court, Giant Eagle argued that the discounts that had accumulated but weren't applied by year's end satisfied the all-events test because the liability became fixed when the discounts were issued. Alternatively, the taxpayer argued that the accrued discounts should be treated as sales- accompanying "trade stamps or premium coupons," enabling Giant Eagle to offset the estimated costs against gross receipts from grocery sales. The Tax Court rejected these arguments, reasoning that the deductions didn't satisfy the all-events test, because the purchase of gasoline functioned as a condition precedent to customers' redemption of discounts earned at checkout and the liability was fixed only after customers applied the accumulated discounts to a fuel purchase. Furthermore, the Tax Court held that the regulations governing trading stamps didn't apply to the discounts, because the gasoline discounts couldn't be redeemed in "merchandise, cash, or other property."

At issue before the 3rd Circuit was whether the fact of the liability was fixed at yearend. The court considered several applicable cases including U.S. v. Hughes Properties, Inc., 476 U.S. 593 (1986) and its own decision in Lukens Steel Co. v. Commissioner, 442 F.2d 1131 (3d Cir. 1971). In Hughes Properties, a casino operator was entitled to deduct the annual increase in its progressive jackpot because the anticipated liability was fixed under Nevada law, which required a payoff. In Lukens Steel, the 3rd Circuit allowed a deduction for a contingent liability account where a collective bargaining agreement made payment certain.

As in Lukens Steel, the court determined whether the taxpayer's anticipated liability was fixed at yearend with reference to contract law principles. The court agreed with the taxpayer's characterizations of the fuelperks! rewards as a unilateral contract formed at checkout, which conferred a liability upon performance (in this case, at checkout). The court reasoned that it was irrelevant that neither the total amount of the anticipated liability nor the identity of all of the customers who eventually applied discounts toward gasoline purchased could be conclusively identified at yearend. Furthermore, the court indicated that the taxpayer mitigated the risk of overstating the value of the rewards redeemed by tracking and accounting for prospective nonredeemers.

The circuit court also said that Giant Eagle demonstrated the existence of both an absolute liability and a near certainty that the liability would soon be discharged by payment. Additionally, the IRS conceded that the chance of nonredemption had been calculated reasonably accurately. The court concluded that the all-events test demands no more. Accordingly, the 3rd Circuit concluded that following Hughes Properties and Lukens Steel, Giant Eagle was entitled to deduct the fuelperks! related liability incurred during the years at issue.

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