Westpac Pacific Food v. Commissioner

451 F.3d 970 (9th Cir. 2006)

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Nature of the Case

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Facts

Westpac (D) promised to buy a lot of items and received cash in advance as its discount on its future, high-volume purchases. Using accrual accounting, D treated the upfront cash discount as a liability when it was received, just like a loan. As goods were sold, the taxpayer applied the discount pro rata to the full purchase price it paid. The net effect was that D reduced its cost of goods sold and increased its reported profit (and thus its taxable income). D reported pro rata amounts without matching sales as miscellaneous or other income. D 's method was consistent with generally accepted accounting principles. 'Revenue is usually recognized when the earning process is complete, and an exchange has taken place.' The Tax Court concluded that the cash discount received in advance was income, noting that tax principles do not serve the same purposes as accounting principles, such as reflecting to shareholders how their company is performing. D made four contracts to buy inventory and receive cash in advance. D promised to buy a minimum quantity of merchandise and received a volume discount in the form of cash up front. If Westpac bought too few lightbulbs, spices, greeting cards, etc., then it was obligated to pay back the cash advance pro rata. D could not resell enough lightbulbs to meet the minimum volume the GTE lightbulb contract called for, so it terminated the arrangement. The termination letter acknowledged its obligation to pay back a pro-rated portion of the Westpac Allowance, and it repaid $861,857 to GTE Sylvania in December. Ambassador agreed to pay D $4,572,000 up front as a volume discount. The contract provided for pro rata reimbursement of the cash advance if Westpac did not meet its volume commitment. In 1997, D and Ambassador discussed termination because of D's inadequate purchasing volume, and Ambassador sent D a letter stating how much of the cash advance D would be required to repay upon termination. D got an advance on its American Greetings contract, and the volume requirement was not met, and the contract was terminated by mutual consent. Although the contract did not have an explicit provision for pro rata reimbursement of the upfront, cash payment, both parties recognized the repayment obligation, evidently because of the customs of the grocery trade. American Greetings calculated D's pro rata repayment obligation at $406,243, and D paid it. D failed to satisfy the entire $50 million volume purchase commitment with McCormick. Nothing in the record reflects that this contract was ever terminated or that D made any pro rata repayments. D accounted for the upfront cash as a liability at the time it received the cash. When D purchased goods for which it had the volume obligations, it subtracted pro rata portions of the advance cash discounts from what it paid. This reduced the cost of goods sold (and increasing the taxable profits from sales). P took the position that D under-reported over $5.5 million in gross income for 1990 and over $4.9 million for 1991 because they did not report the cash advances as gross income. Relying on Glenshaw Glass Co., the Tax Court held that the cash advance discounts were 'income' under section 61 of the Internal Revenue Code. D appealed.