IRS Revenue Ruling
1998-39

 Code Sec. 461

<<FULL TEXT>>

Status: Modified by Rev. Proc. 98-60

26 CFR 1.461-1: General rule for taxable year of deduction.
(Also section 451; 1.451-1.)

All events test; cooperative advertising. Under the all events test of
section 461 of the Code, and accrual method manufacturer's liability for
cooperative advertising services of a retailer is incurred in Year 1, the
year the services are performed, provided the manufacturer is able to
reasonably estimate the liability, even though the retailer does not
submit the required claim form until Year 2.


REV. RUL. 98-39

ISSUE

Under the all events test of section 461 of the Internal Revenue Code,
is an accrual method manufacturer's liability to pay a retailer for
cooperative advertising services incurred in Year 1 when those services
are provided by the retailer, or in Year 2 when the retailer submits the
required claim form for those services?


FACTS

X, an accrual method taxpayer using a calendar year as its taxable
year, manufactures various consumer products, including product M.
Retailers engaged in the business of selling merchandise to consumers
purchase product M from X for resale. In August of Year 1, X made a
written offer to pay each of these retailers $1 for each case of product M
that the retailer purchased from X during September, October, and November
of Year 1, provided that the retailer advertised X's product M during
October or November of Year 1. To qualify for X's payment, the advertising
provided by the retailer had to satisfy the requirements set forth in X's
offer regarding the format and content of the advertising (including the
offering of a discount on product M), and the time for performance of the
advertising. X's offer further required that, to obtain payment, the
retailer had to submit a claim form and proofs of performance within 90
days after the date that the advertising was performed, verifying that the
advertising was performed in accordance with the terms of X's offer.

Y, a retailer that accepted X's offer, ordered 1,000 cases of product M
from X during September, October, and November of Year 1, and advertised
product M in November of Year 1 in a manner that satisfied the
requirements of its agreement with X. To obtain payment for that
advertising, Y submitted its claim form and proofs of performance to X in
January of Year 2.

X is able to make a reasonable estimate of the amount that it is liable
to pay Y for the cooperative advertising services performed by Y in Year
1.


LAW AND ANALYSIS

Section 451 provides rules for determining the taxable year of
inclusion for items of gross income.

Section 1.451-1(a) of the Income Tax Regulations provides that under an
accrual method of accounting, income is includible in gross income when
all the events have occurred that fix the right to receive such income and
the amount thereof can be determined with reasonable accuracy.

Section 461(a) provides that the amount of any deduction or credit is
taken for the taxable year that is the proper taxable year under the
method of accounting used in computing taxable income.

Section 461(h) and section 1.461-1(a)(2)(i) provide that, under the
accrual method of accounting, a liability is incurred, and is generally
taken into account for federal income tax purposes, in the taxable year in
which (1) all the events have occurred that establish the fact of the
liability, (2) the amount of the liability can be determined with
reasonable accuracy, and (3) economic performance has occurred with
respect to the liability.

Section 461(h)(2)(A)(i) provides that, if the liability of the taxpayer
arises out of the providing of services to the taxpayer by another person,
economic performance occurs as that person provides the services.

Generally, in a transaction where one taxpayer is accruing a liability
to pay another taxpayer, the last event necessary to establish the fact of
liability under the all events test of section 1.461-1(a)(2)(i) is the
same event that fixes the right to receive income under the all events
test of section 1.451-1(a). See Capital Investments of Hawaii, Inc. v.
Commissioner, T.C. Memo. 1982-80, n. 9 (the reasoning of cases analyzing
section 451 is applicable to an analysis under section 461); Schneer v.
Commissioner, 97 T.C. 643 at 650 (1991) ("the prerequisite of performance
of the services prior to any liability on the part of the obligor is an
essential to satisfying the all-events test. The right to receive income
cannot become fixed before the obligor has an obligation to pay"); see
also Rev. Rul. 79-266, 1979-2 C.B. 203, and Rev. Rul. 79-410, 1979-2 C.B.
213.

Where a taxpayer's obligations are set forth in a written agreement,
the terms of the agreement are relevant in determining the events that fix
the taxpayer's obligation to pay. See, e.g., Decision, Inc. v.
Commissioner, 47 T.C. 58 (1966), acq., 1967-2 C.B. 2.

In general, the event fixing the fact of liability pursuant to an
agreement for the provision of services is performance of the services.
See, e.g., National Bread Wrapping Machine Co. v. Commissioner, 30 T.C.
550 (1958) (performance of services pursuant to a contract was necessary
to establish the taxpayer's liability); Charles Schwab v. Commissioner,
107 T.C. 282 (1996) (execution of a trade pursuant to a customer order
fixes the broker's right to receive the commission income).

Moreover, once the services are performed, the establishment of the
fact of liability under the all events test is not delayed by an
additional requirement in the agreement that a claim or documentation be
submitted to obtain payment, if such act is ministerial. See Dally v.
Commissioner, 227 F.2d 724 (9th Cir. 1955), cert. denied, 351 U.S. 908
(1956) (contractor's right to income was fixed in year it delivered
houses, not in later year when a properly certified invoice was submitted,
even though the contract specifically provided for payment upon the
submission of a properly certified invoice); Frank's Casing Crew & Rental
Tools, Inc. v. Commissioner, T.C. Memo. 1996-413 (contractor's preparation
and sending of the invoices were ministerial acts that did not postpone
accrual of income otherwise earned). See also Continental Tie & Lumber Co.
v. United States, 286 U.S. 290 (1932).

However, in some cases, the requirement that a claim for payment be
filed is a condition precedent that delays satisfaction of the all events
test for section 461 purposes. In United States v. General Dynamics Corp.,
481 U.S. 239 (1987), the Court held that employees must file claims with
the employer to establish the fact of the liability to reimburse employees
for medical expenses under the all events test. The Court noted that some
covered employees fail to file claims with their employer for various
reasons, such that an employee's receipt of covered medical services was
not sufficient to fix the employer's liability. Thus, the filing of the
claim was not a mere technicality.

In the cooperative advertising agreement between X and Y, the
performance required under the agreement is the provision of advertising
services. Y's submission of a claim form and proofs of performance
substantiating that it has performed the advertising according to X's
specifications is merely the mechanism by which Y requests payment for
advertising services already performed. Thus, similar to Dally and Frank's
Casing, Y's submission of the claim form and proofs of performance is a
ministerial act, much like the submission of an invoice. These facts
distinguish the cooperative advertising agreement between X and Y from
General Dynamics and demonstrate that Y's submission to X of the claim
form and proofs of performance is a mere technicality, not a condition
precedent that is necessary to establish X's liability for section 461
purposes.

The last event necessary to establish the fact of X's liability under
the all events test occurred when Y performed the cooperative advertising
services in Year 1 in accordance with the terms of the contract. X can
reasonably estimate the amount of its Year 1 liability for the cooperative
advertising services performed by Y. Economic performance with respect to
X's liability occurred in Year 1 when Y performed the cooperative
advertising services. Accordingly, X may deduct on its Year 1 federal
income tax return its liability for Y's cooperative advertising services.


HOLDING

Under the all events test of section 461, an accrual method
manufacturer's liability to pay a retailer for cooperative advertising
services is incurred in Year 1, the year in which the services are
performed, provided the manufacturer is able to reasonably estimate this
liability, and even though the retailer does not submit the required claim
form until Year 2.


APPLICATION

Any change in a taxpayer's method of accounting to conform with this
revenue ruling is a change in method of accounting to which the provisions
of sections 446 and 481 and the regulations thereunder apply. A taxpayer
wanting to change its method of accounting for its payments for
cooperative advertising services provided by a retailer to conform with
this revenue ruling must follow the automatic change in accounting method
provisions of Rev. Proc. 97-37, 1997-33 I.R.B. 18, except that the scope
limitations in section 4.02, as well as the application procedures in
sections 6.03, 6.04, and 6.05, of Rev. Proc. 97-37 do not apply. However,
if the taxpayer is under examination, before an appeals office, or before
a federal court with respect to any income tax issue, the taxpayer must
provide a copy of the Form 3115, Application for Change in Accounting
Method, to the examining agent(s), appeals officer, or counsel for the
government, as appropriate, at the same time that it files the copy of the
Form 3115 with the national office. The Form 3115 must contain the name(s)
and telephone number(s) of the examining agent(s), appeals officer, or
counsel for the government, as appropriate.


EFFECT ON OTHER DOCUMENTS

Rev. Proc. 97-37 is modified and amplified to include this accounting
method change in the APPENDIX.


DRAFTING INFORMATION

The principal author of this revenue ruling is John P. Moriarty of the
Office of Assistant Chief Counsel (Income Tax and Accounting). For further
information regarding this revenue ruling, contact Mr. Moriarty on (202)
622-4950 (not a toll-free call).

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