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Current deduction vs. capitalization of fees for shelf space - IRS circulates draft proposed coordinated issue paper.

Food manufacturers that incur costs to obtain shelf space in retail outlets may have to capitalize these costs, based on a recently circulated IRS draft proposed coordinated issues paper. These expenditures, otherwise known as "slotting allowances," may be paid in the form of cash, product or product discounts.

Proposed IRS position

The Service concluded in its draft coordinated issues paper that slotting allowances are generally nondeductible capital expenditures, since they provide a benefit substantially beyond the tax year in which incurred. The IRS explained that INDOPCO, 112 Sup. Ct. 1039 (1992), gave more prominence to the presence of a significant future benefit as the predominant test for requiring capitalization of a business expenditure.

If the Service ultimately adopts this position, food manufacturers would be required to capitalize slotting allowances in all circumstances other than those in which the manufacturer is specifically required by contract to pay an annual fee to retain the right to shelf space for the following year. The manufacturer would be able to amortize amounts that are capitalized, but only to the extent that it can establish that the right to shelf space will expire after a limited time specified in the contract. in the absence of such an agreement, the expenditure would have an indeterminable useful life and no cost recovery would be allowed unless (and until) either the product fails or the shelf space is vacated.

Arguments against proposed IRS position

In many circumstances, the nature of any potential future benefit from an allotment of shelf space is comparable to that inherent in any other advertising expenditure. As such, the tax treatment of slotting allowances arguably should be governed by Rev. Rul. 92-80, which held that INDOPCO did not affect the current deductibility of ordinary product advertising expenses.

In Rev. Rul. 92-80, the IRS stated that "[o]nly in the unusual circumstance where advertising is directed towards obtaining future benefits significantly beyond those traditionally associated with ordinary product advertising or with institutional or goodwill advertising, must the costs of that advertising be capitalized." Arguably, slotting allowances that do not provide the manufacturer with a specific contractual right to an allotment of shelf space beyond the year immediately following the year of the expenditure would follow this rationale; the nature of any potential future benefit of such an expenditure is virtually indistinguishable from that inherent in other advertising costs.

Furthermore, although an initial payment to obtain shelf space in a store (without any rights beyond one year) may be a necessary charge for the manufacturer to sell its merchandise in a store, the manufacturer's ongoing right to shelf space is merely a consequence of the success of its product. That success is just as likely to be attributable to television and other forms of advertising as it is to the presence of the item on the shelf. Under Rev. Rul. 92-80, none of these other forms of advertising expenditures were required to be capitalized. Because the initial purchase of a shelf allotment does not benefit the product to a greater extent than any of these other forms of advertising, capitalization should not be required.

To the extent that a shelf allotment expenditure gives the taxpayer a specific right to shelf space for more than 12 months beyond the tax year in which incurred, capitalization would be appropriate.

If the Service requires capitalization in the case of a slotting agreement that does not establish a useful life, it would be appropriate for the IRS to create a deemed useful life for the capitalized expenditure similar to that created for package design costs.

Tax planning in light of proposed IRS position

Manufacturers with a specific right to shelf space for more than 12 months beyond the tax year in which the shelf allotment expenditure was incurred, and that have been expensing these payments in the year incurred, should consider filing a Form 3115, Application for Change in Accounting Method, under Rev. Proc. 92-20 to voluntarily change to a capitalization method of accounting. Due to the highly factual nature of the issue, these voluntary changes should be eligible for the more favorable terms and conditions applicable to "Category B" methods, including a six-year Sec. 481(a) adjustment period and a current year of change.
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Article Details
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Author:Blumenreich, Richard
Publication:The Tax Adviser
Date:Jun 1, 1993
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