Advertising and salary credits received from vendors.

In Field Service Advice (FSA) Memorandum 9915011, the IRS concluded that the advertising and salary credits received by a retailer from various vendors were properly treated as accessions to wealth includible in income. They could not be treated as nontaxable trade discounts, but were (in essence) allowances for the provision of services.

A retailer using the accrual method of accounting received various reimbursements or offsets (called credits) from certain vendors, with two credits at issue. One was an advertising credit provided to the taxpayer for cooperative advertising; the other was a salary credit for the taxpayer's sales staff. The credits were realized by the taxpayer through offsets to products purchased from vendors offering the credits.

The advertising credits were negotiated between the taxpayer's buyers and the vendors' representatives. The agreements between the taxpayer and the vendors were verbal contracts. The credits were typically based on a percentage of purchases, but could also be a fixed amount for the year. They were commonly referred to as cooperative advertising, an arrangement by which a product is generally advertised with the names of both the vendor and the retailer. The arrangement ,usually requires advertising as well as other promotions, the cost of which is shared by the vendor and retailer or borne entirely by the vendor. The credits were listed as an advertising reduction on the taxpayer's payment vouchers and were posted to its general ledger; they were recorded for book purposes as an offset to advertising costs.

Salary credits were negotiated by first-tier managers. These credits often involved multiple-year agreements (usually written contracts). They typically offered a credit based on a percentage of the sales of the vendor's product, rather than on purchases by the taxpayer. The contracts were usually entered into when a new store opened or a new line was introduced, and offered a use of credit on payment vouchers. Certain marketing considerations, such as counter space, staffing and pay incentives, were required of the taxpayer to qualify for the credit. Accordingly, the salary credit was provided to encourage more space and sales staff dedicated to promoting the vendor's product. The basic salary credit was determined based on a percentage of sales of the vendor's product. The salary credits were posted to the taxpayer's general ledger accounts as an offset to salary costs.

The taxpayer accounted for the credits as trade discounts under Regs. Sec. 1.471-3(b), arguing that they had the effect of reducing the cost of merchandise purchased. Trade discounts are treated as reductions to purchase price granted by a vendor, and are not included in gross income. They simply represent adjustments to purchase price granted by the vendor to certain purchasers. The Service did not agree with this characterization of the credits.

The IRS held that cooperative advertising was offered by a vendor to encourage local advertising or store, displays by the retailer of the vendor's product. In form, such credits appear to be for services provided and not based on volume or quantity. In substance, the advertising credits were a reimbursement of the taxpayer's cost, benefitting both the vendor and the taxpayer. The taxpayer performed a service for which it was compensated by property. Because it provided a service, the taxpayer had to recognize the credits/ discounts as an accession to wealth, requiring inclusion as gross income under Secs. 61 and 451.

The Service held that the salary credits were determined based on a percentage of sales of the vendor's product (although some salary credits were determined using projected sales and then computed as a percentage of certain employees' salaries). They were used to provide bonuses or other financial rewards to the taxpayer's employees for selling the vendor's product and were provided by the vendor to support a level of service in the specified departments that exceeded other departments in the store. The vendors were making specific marketing demands as to product placement and the number and pay (through incentives) of the salespeople who promoted such merchandise. Accordingly, in both form and substance, the taxpayer was performing extra marketing services (in terms of space, staffing and location) and in return received from the vendor a credit offsetting the extra cost of such services (fewer sales stag available in other departments, less counter space available). The salary credit was contingent on the performance of those services and the resulting increase in sales. Because the taxpayer was performing an extraordinary service for the vendor, the credits did not qualify for trade discounts under Regs. Sec. 1.471-3 and had to be accounted for as gross income.

FROM BRIAN E. KELLER, CPA, OAK BROOK, IL