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Writeoff nixed where inventory sale not bona fide.

Rexnord, Inc., a manufacturer, sold its slow-moving and obsolete inventory to S.R. Sales, a company whose main business was to buy and hold goods for later repurchase by the seller. The inventory was marked with Rexnord's inventory numbers for easy identification for repurchase.

Under the sales contract, S.R. Sales had the right to sell the inventory to others. Rexnord, however, was S.R. Sales's best customer, and bought back 95% (in value) of the inventory S.R. Sales was able to resell.

Rexnord reduced its 1977 and 1978 ending inventory by the goods it had sold to S.R. Sales, thus increasing its cost of goods sold and reducing its taxable income. The IRS claimed the reduction in ending inventory was not valid because the sale were not genuine, and the dispute over the $250,000 deficiency ended up in district court.

The Seventh Circuit Court of Appeals said the "sales" were an attempt to get around the U.S. Supreme Court's decision in Thor Power Tool Co. (taxpayer may not write off excess inventory it physically retains) and later cases in which manufacturers tried to write off excess inventory while keeping control over it. Rexnord claimed its sales were real because S.R. Sales had the right to resell the goods.

Result: The district court and the appellate court both held the sales were not bona fide. The economic reality was Rexnord maintained control over the inventory. Thus, the inventory writeoffs were not allowed.
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Article Details
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Author:Wagenbrenner, Anne
Publication:Journal of Accountancy
Date:Nov 1, 1991
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