1977 U.S. Tax Ct. LEXIS 6">*6 Decision will be entered under Rule 155.
Petitioner was a wholesale liquor dealer. In violation of State law, petitioner made sales to selected customers at posted prices with the understanding that such customers would be entitled to credit to be used for the purchase of additional liquors, or to an additional bottle for each case purchased. When deliveries were made of the additional liquors, the cost thereof was charged to the cost of sales and deducted in arriving at petitioner's gross income: Held, the cost of such additional liquors is deductible from gross income as part of the cost of goods sold and is not, therefore, a deduction which may be disallowed under
69 T.C. 477">*477 This proceeding involves the redetermination of deficiencies in income taxes of petitioner as follows:
| FYE Jan. 31 -- | Deficiency |
| 1973 | $ 72,468 |
| 1974 | 59,487 |
| 1975 | 42,410 |
As a result of concessions by the parties, the sole question for 69 T.C. 477">*478 decision is whether the petitioner is precluded from charging as a cost or deducting under
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Max Sobel Wholesale Liquors (hereinafter referred to as petitioner) 1977 U.S. Tax Ct. LEXIS 6">*9 is a California corporation with its principal place of business in San Francisco, Calif. At all times material herein, petitioner was engaged in the distribution and sale, at wholesale, of liquor, wine, and other alcoholic beverages in and around the Bay area of San Francisco. Its Federal income tax returns for the fiscal years ended January 31, 1973 to 1975, inclusive, were filed with the Internal Revenue Service, Fresno, Calif.
The petitioner's books and records were maintained on the accrual basis of accounting, and petitioner reported its income for Federal income tax purposes on that basis. In computing its costs of sales, purchases of liquor and wine were carried in inventory at petitioner's cost. Delivery of liquor and wine to its customers were made out of such inventory, thereby reflecting the cost of such deliveries as a part of the cost of sales.
The business of distributing and selling liquor at wholesale was regulated under California law. The enforcement of such laws was delegated to the Department of Alcoholic Beverage Control of the State of California (hereinafter referred to as ABC).
Price lists; filing; contents; compliance. Every distilled spirits manufacturer, brandy manufacturer, rectifier, and wholesaler shall file and maintain with the department a price list showing the prices at which distilled spirits are sold to retailers by the licensee. Sales of distilled spirits to retailers by each distilled spirits manufacturer, brandy manufacturer, rectifier, and wholesaler shall be made in compliance with the price list of the licensee on file with the department.
69 T.C. 477">*479
As a wholesaler of liquor and wine, the petitioner was required to file or to post each month the selling prices for the liquor and wine to be sold by it in accordance with
During the period involved in this proceeding, the petitioner evolved a procedure whereby certain selected customers might purchase liquor and wine from the petitioner on a basis more favorable than the selling prices for such liquor and wine posted by the petitioner with the ABC. An agreement was entered into with such customers pursuant to which, with each purchase of liquor or wine, the customer would be entitled to a credit of a stated percent of the total purchase, which amount would be available to be used by such customer in the purchase of additional quantities of liquor or wine. In other instances, the agreement provided that with the purchase of a case of certain liquors or wines, the purchaser would be entitled to receive an additional bottle of that liquor or wine.
The petitioner maintained1977 U.S. Tax Ct. LEXIS 6">*12 a "black book" setting forth the name of the customer, the purchases by such customer, and the credit to which the customer was entitled. Periodically, such credits would be availed of by the customer to purchase additional liquor or wine or the customer would be supplied with the additional bottles to which the customer became entitled under the agreement of purchase.
When the petitioner received a regular order from its customers, the order was filled and delivered by the petitioner out of inventory. As a part of petitioner's accounting and billing system, a sales invoice was prepared with respect to each sales 69 T.C. 477">*480 transaction which listed thereon the brand and quantity of the spirits sold and the sales price, along with any posted discount. The billing price for liquor and wine listed on such sales invoice conformed to the prices posted with the ABC as required by California law.
When the petitioner received an order for use of the "credit" from one of the selected customers to whom the petitioner had agreed to give such credit, a document was prepared identifying the retailer, the type of spirits, brand name, quantity, and amount. A copy of this document, referred to1977 U.S. Tax Ct. LEXIS 6">*13 as a "drop tag," was transmitted to the employee in charge of maintaining the inventory records in order that he might remove the designated quantity from inventory. Another copy of the "drop tag" was sent to the warehouse in order that the goods would be released for pickup by the retailer or for delivery. The additional goods supplied to the customer were thus removed from inventory and automatically charged as a part of the cost of sales. The credits and deliveries made on account thereof were recorded in the "black book" but did not otherwise appear in the petitioner's accounting records.
The practice whereby the petitioner gave rebates, credits, or additional merchandise to selected customers, without reflecting such in the prices posted by petitioner with the ABC, was in violation of the laws of the State of California.
An "Accusation" was filed by the State of California against the petitioner alleging violations of
During the fiscal year ended January 31, 1973, petitioner delivered to the selected customers at no additional charge, in satisfaction of the credits recorded in the "black book," liquor and wine from its inventory having a cost to petitioner in the amount of $ 121,218. During the fiscal year ended January 31, 1974, similar deliveries were made out of inventory having a cost to petitioner of $ 13,757. The practice was discontinued in April 1973 due to a Federal grand jury investigation.
69 T.C. 477">*481 In his notice of deficiency, respondent increased petitioner's income as reported for the years ending January 31, 1973 and 1974, in the amounts of $ 121,218 and $ 13,757, on account of the additional spirits charged to the cost of goods sold.
OPINION
The petitioner was a wholesale liquor dealer in the San Francisco Bay area. Under California law, the business was subject to regulation by the Alcoholic Beverage Control Board. Petitioner was required to file monthly price1977 U.S. Tax Ct. LEXIS 6">*15 lists with the ABC and was prohibited from selling below the posted prices. The prices at which the petitioner was supposed to sell spirits were "suggested" by its suppliers. If the petitioner posted prices different from those suggested by the suppliers, petitioner ran the risk of having its distributorship terminated by the supplier.
Notwithstanding the posted prices, wholesale liquor dealers in the San Francisco Bay area offered credits, discounts, or rebates to selected customers in order to keep their business. In the case of the petitioner, selected customers were advised that the purchase of stated quantities of designated brands of spirits would entitle the purchaser to a credit, either stated in dollars or in kind, whereby the purchaser could acquire additional spirits up to the amount credited in a secret account maintained for each of such purchasers. The practice constituted a violation of the California law regulating the pricing of alcoholic beverages and could be interpreted as a violation of Federal law prohibiting the distribution of "free goods" as an inducement to the sale of such beverages.
Sales of spirits were reflected on the books of the petitioner at invoice1977 U.S. Tax Ct. LEXIS 6">*16 prices in conformity with the schedule of prices filed with the ABC. The additional spirits which the customers obtained by credits earned on such purchases were delivered out of inventory and the cost thereof was automatically reflected in the cost of sales. While respondent seeks to distinguish between the granting of a rebate payable in merchandise and a rebate payable in cash, the result is the same. In fact, the case of one of petitioner's competitors who granted cash rebates "under the table" is also before this Court. 2 The basic question is whether 69 T.C. 477">*482 such rebates, regardless of form, come within the scope of
Insofar as applicable hereto,
(c) Illegal Bribes, Kickbacks, and Other Payments. --
* * * *
(2) Other illegal payments. -- No deduction shall be allowed under subsection (a) for any payment (other than a payment described in paragraph (1)) made, directly or indirectly, to any person, if 1977 U.S. Tax Ct. LEXIS 6">*17 the payment constitutes an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty or the loss of license or privilege to engage in a trade or business. For purposes of this paragraph, a kickback includes a payment in consideration of the referral of a client, patient, or customer. The burden of proof in respect of the issue, for purposes of this paragraph, as to whether a payment constitutes an illegal bribe, illegal kickback, or other illegal payment shall be upon the Secretary to the same extent as he bears the burden of proof under
The practice of illegally rebating did not originate with these San Francisco wholesale liquor dealers. This practice first came before the Tax Court in the case of rebates granted contrary to State law in the sale of milk.
1977 U.S. Tax Ct. LEXIS 6">*19 In the Pittsburgh Milk case (and the cases which followed that decision), this Court distinguished between a discount or rebate 69 T.C. 477">*483 to which the customers became entitled at the time of sale and costs incurred in the form of illegal payments, or payments to the third parties, which were not made pursuant to agreement between the buyer and the seller. Where the rebate was a part of the transaction of sale, this Court held that the deductibility of such payment was not the question. The rebate was a reduction in gross income. This principle was reaffirmed in
Raum, Judge: (1) We have concluded on the evidence that the actual prices at which petitioner sold its products were the invoice prices minus the discounts agreed upon between petitioner and its customers. Accordingly, the problem before us is not whether such discounts are deductible as "ordinary and necessary" business expenses from gross income in arriving at net income, cf.
Respondent urges that the decision in the Pittsburgh Milk Co. case be reconsidered. He made a similar contention in two other cases, in which the holding in the Pittsburgh Milk Co. case was reaffirmed and followed in memorandum opinions by this Court. Moreover, the theory of the Pittsburgh Milk Co. case has been applied, at the respondent's urging, in
Respondent argues that the Pittsburgh Milk case was overruled by
In his brief, respondent also contends that in accounting for the additional spirits supplied by petitioner to its customers pursuant to the illegal rebates, the cost of such spirits was treated as a part of the cost of sales by the petitioner and is, therefore, distinguishable from the rebates involved in the Pittsburgh Milk line of cases. Those cases did not, however, look to the manner in which the taxpayer entered the transaction in its books in order to conceal the illegal rebate. Bookkeeping entries were ignored. In the Pittsburgh Milk case, the illegal rebates were charged to1977 U.S. Tax Ct. LEXIS 6">*23 "advertising" and deducted as such. In the Rosedale Dairy case, the illegal rebates were deducted as "freight and hauling." In the Harmony Dairy case, the payments were disguised as "advertising or other operational expenditures." In the Atzingen-Whitehouse Dairy case, the illegal rebates were charged to "selling expense-sales promotion."
Finally, there is the question whether subsequent amendment of
We must assume that1977 U.S. Tax Ct. LEXIS 6">*24 Congress was aware of the decision of this Court in the Pittsburgh Milk case. At the time that the legislation was enacted, the respondent had acquiesced in that 69 T.C. 477">*485 decision. If Congress had intended to overrule the Pittsburgh Milk case, it is only reasonable to expect that the amendment would have been more specific in so doing or that the congressional intent would find expression in the report of the Finance Committee accompanying the bill. No mention of any such intent is made in the report of the Finance Committee accompanying the bill. S. Rept. 92-437, 92d Cong., 1st Sess. 72-73.
Notwithstanding, respondent has changed his position in an effort to extend the statute to exclude bribes, kickbacks, and other illegal payments which might otherwise be chargeable to the cost of goods sold. See
In our opinion, assuming the validity of the regulations, the rule stated would not apply in the case before the Court. Depending upon the nature of the business, the cost of goods sold may include material, labor, and overhead. There may be certain expenses of a dual character which may be chargeable either to overhead in the cost of goods sold or deducted as administrative or sales expense. In any event, the Court would limit the regulations as to preclude the deductibility of an illegal payment charged to overhead in the cost of sales of the type which might otherwise be deductible as administrative or sales expenses. A typical example would be a bribe given for the purpose of obtaining goods or for the purpose of expediting its delivery to the taxpayer for manufacture and resale.
In the case before the Court, we are not confronted with that type of expense. In effect, the petitioner's agreement with its selected customers provided for the sale of spirits1977 U.S. Tax Ct. LEXIS 6">*26 priced at $ 102.50 for $ 100 or for the sale of 13 bottles of wine for the price of 12 bottles. The additional quantity supplied came out of inventory and was automatically reflected in the cost of sales. Such costs are not an overhead or indirect expense charged to 69 T.C. 477">*486 the cost of sales and were not "of a type" for which a deduction would be disallowed under
In view of the foregoing, it is the opinion of the Court that the Pittsburgh Milk line of cases has not been overruled either by subsequent decisions of this Court or any other court, and that no congressional intent to overrule that line of cases can be inferred from its legislative enactment of
Petitioner argues that respondent has not met the burden of proof with respect to the enforcement of the California law, as required by
Petitioner also reserved the right to claim and to present proof of reasonable attorney fees. It is the position of this Court that Pub. L. 94-559, 90 Stat. 2641, amending
Decision will be entered under Rule 155.
Drennen, J., dissenting: I do not disagree with the principles expressed in the majority opinion; nevertheless, I would reach the opposite conclusion in this case for a reason not discussed in the majority opinion. Stated briefly, I would reduce the cost1977 U.S. Tax Ct. LEXIS 6">*28 of goods sold by the cost to the taxpayer of the "credit" merchandise which I conclude was not sold by the taxpayer.
69 T.C. 477">*487 A "sale" was defined by the Supreme Court in
1977 U.S. Tax Ct. LEXIS 6">*29 There is no specific provision in the Code that allows a reduction in, or deduction from, income for cost of goods sold. The Commissioner of Internal Revenue and the courts have simply recognized that no more than gross income can be subjected to income tax and that the cost of goods sold must be deducted from gross receipts in order to arrive at gross income, the starting point for an income tax.
I doubt that the majority would allow this credit as a deduction under
Footnotes
1. All statutory references are to the Internal Revenue Code of 1954, unless otherwise indicated.↩
2. Haas Brothers v. Commissioner↩, docket No. 5219-76.
3. See also
Atzingen-Whitehouse Dairy, Inc. v. Commissioner, 36 T.C. 173">36 T.C. 173 (1961);Harmony Dairy Co. v. Commissioner, 19 T.C.M. 582 (1960) ;Rosedale Dairy Co. v. Commissioner, 16 T.C.M. 1121↩ (1957) .4. Respondent had unsuccessfully argued that the Tank Truck Rentals case overruled the Pittsburgh Milk case in
Harmony Dairy Co. v. Commissioner, supra↩ , which was decided on May 31, 1960.1. It is not clear whether the charge to cost of goods sold was made at the time of the sale or at the time the credit merchandise was delivered. This would make a difference only if the two events occurred in different taxable years.↩
2. These and similar cases denied the exclusion from cost of goods sold of payments for goods in excess of amounts allowed by law. Here, of course, we are not concerned with illegal payments made by Sobel. The cases do, however, establish the principle for which they are cited.↩