In Giant Eagle Inc. v. Commissioner, the Third Circuit has ruled that the Tax Court misapplied the "all events" test when it disallowed deductions claimed by a supermarket chain based on rewards shoppers had earned but not yet redeemed.

Facts

Giant Eagle operates a chain of supermarkets, pharmacies, gas stations and convenience stores, and is an accrual method taxpayer. In 1991, Giant Eagle established a customer-loyalty program called Advantage Cards. It revised that program in 2004 to create "fuelperks!" under which customers with an Advantage Card received a discount of 10 cents per gallon on gas for every $50 spent on qualifying groceries. A brochure distributed by Giant Eagle to customers explained that the discounts expired on the last day of the month, three months after they were earned.

On its corporate income tax returns for 2006 and 2007, Giant Eagle claimed deductions for the discounts its customers had accumulated, but had not applied to fuel purchases by the end of the year. Giant Eagle determined its deductions by: (1) determining the total dollar amount spent at its supermarkets on qualifying groceries; (2) dividing that amount by 50 to determine the number of outstanding accumulated discounts; and (3) multiplying that amount by .10 to determine the face value of the discounts. Giant Eagle then multiplied the face value by the historical redemption rate of the discounts in the month of expiration and multiplied that amount by the average number of gallons purchased in a discounted fuel sale. To compute the deductions, Giant Eagle tracked the redemption of accumulated discounts and used historical averages.

The IRS disallowed the deductions and Giant Eagle petitioned the Tax Court. The Tax Court ruled that Giant Eagle's deductions did not meet the "all events" test "because the purchase of gasoline functioned as a condition precedent to customers' redemption of discounts earned at checkout." Thus, the Tax Court found that a "fuelperks!" related liability only became fixed when customers applied the discounts to a fuel purchase.

Holding

The Commissioner conceded that the "fuelperks!" rewards are a "'rebate, refund, or similar payment' and a 'recurring expense' subject to the less onerous 'economic performance' requirement." The Commissioner also conceded that Giant Eagle computed its anticipated "fuelperks!" liability with reasonable accuracy and economic performance had occurred by the time Giant Eagle filed its tax returns.

Accordingly, the Third Circuit only considered whether the fact of liability was fixed by the end of the year.

The Third Circuit agreed with Giant Eagle that the issuance of "fuelperks!" rewards was a unilateral contract formed at checkout and made Giant Eagle liable to its customers for the rewards they accrued. The court found that for "purposes of the 'all events' test's fixed liability prong, it is irrelevant that neither the total amount of Giant Eagle's anticipated liability nor the identity of all the customers who eventually applied discounts toward gasoline purchases could be conclusively identified at year's end." Giant Eagle mitigated the risk that its claimed deductions would overstate the value of the rewards redeemed by tracking the monthly redemption rates and offsetting its deductions to account for potential non-redeemers. The court also observed that Giant Eagle computed the possibility of non-redemption "with reasonable accuracy" and, thus, Giant Eagle showed that it had "an absolute liability and a near-certainty that the liability would soon be discharged by payment."

Citing United States v. Hughes Properties, Inc., 476 U.S. 593, 601-02 (1986), and Lukens Steel Co. v. Commissioner, 442 F.2d 1131, 1134-35 (3d Cir. 1971), the Third Circuit reversed the Tax Court and held that Giant Eagle was entitled to the deductions for the "fuelperks!" liabilities incurred in 2006 and 2007. The Third Circuit also remanded the case to the Tax Court with instructions to grant judgment in favor of Giant Eagle.

In a dissenting opinion, Judge Hardiman concluded that Giant Eagle's "fuelperks!" liabilities were not fixed until redeemed by customers because, once the rewards expired, Giant Eagle had no obligation to honor the redemption of those rewards.

Implications

This decision governs taxpayers with significantly similar fact patterns in the Third Circuit. However, we believe the IRS National Office is unlikely to grant a method change consistent with the conclusion reached by the Great Eagle court, at least for taxpayers outside of the Third Circuit. As a practical matter, the fact pattern at issue in this case is not the most prevalent from the perspective of the relatively short, three-month period that the loyalty program "fuelperks!" were available for redemption to customers before expiration. Many entities offer programs with rewards that are available to be redeemed for a much longer period of time than three months, although EY is aware of certain entities (e.g., certain grocery chains) that provide for a similarly short redemption period. Please contact National Tax to discuss further implications in the context of any particular set of facts, for example, such as those that may be analogous to Great Eagle.

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