Court Opinion

ID: 9627109
Source: CourtListenerOpinion
Date Created: 2023-08-22 08:34:56.209322+00
Date Added: 2024-06-11T18:06:39.678035
License: Public Domain

*413AMBRO, Circuit Judge,
concurring.
I join Judge Sloviter’s opinion in full. I write separately to supplement, from the accounting side, why I believe the result she reaches is correct and that of the Ninth Circuit (and by implication, that of our dissenting colleague) is unpersuasive.
As a preliminary comment, this case is about timing. The value of money depends on when it is received. Both loans and advance payments confer an economic benefit on recipients because they allow the recipient “both immediate use of the money (with the chance to realize earnings thereon) and the opportunity to make a profit by providing goods or services at a cost lower than the amount of the payment.” Comm’r v. Indianapolis Power & Light Co., 493 U.S. 203, 207, 110 S.Ct. 589, 107 L.Ed.2d 591 (1990) (emphasis in original). Yet, under our laws the tax consequences for these two types of money transfers differ. Whereas loans are not taxable upon receipt, advance payments are. Id. at 208 n. 3, 110 S.Ct. 589 (citations omitted); Oak Indus., Inc. v. Comm’r, 96 T.C. 559, 563-64, 1991 WL 47410 (1991).
I. Contrary Decisions in the Ninth Circuit
In Westpac Pacific Food v. Comm’r, the Ninth Circuit concluded that an up-front payment with a conditional pro rata repayment liability was a nontaxable loan. 451 F.3d 970, 975 (9th Cir.2006).4 It based its decision on assertions that (1) there was no absolute repayment obligation, Id., and (2) “[tjhere was no accession to wealth when Westpac got the cash ...,” Id. at 977. The opinion for the majority here has dealt with the first part of this reasoning (as Earns, not Super Rite, controlled whether the obligation to repay would occur); I address the second part.
For the Westpac Court, the case was very “simple,” as told through the following hypothetical:
Harry Homeowner goes to the furniture store, spots just the right dining room chairs for $500 each, and says “I’ll take four, if you give me a discount.” Negotiating a 25% discount, he pays only $1,500 for the chairs. He has not made $500, he has spent $1,500. Now suppose Harry Homeowner is short on cash, and negotiates a deal where the furniture store gives him a 20% discount as a cash advance instead of the 25% off. This means the store gives him $400 “cash back” today, and he pays $2,000 for the four chairs when they are delivered shortly after the first of the year. Harry cannot go home and say “I made $400 today” unless he plans to skip out on his obligation to pay for the four chairs. *414Even though he receives the cash, he has not made money by buying the chairs. He has to sell the chairs for more than $1,600 if he wants to make money on them. The reason why the $400 “cash back” is not income is that, like a loan, the money is encumbered, with a repayment obligation to the furniture store and the “cash back” must be repaid if Harry does not perform his obligation.
Id. at 971-72 (emphasis added). “This case is that simple,” the Court reiterated, “except that it involves a little more math and a lot more money....” Convinced that the agreement in that case was a nontaxable loan, the Westpac Court commented that “[i]t is hard to think of a way to make money by buying things.” Id. at 971. Let’s check that out.
II. The Ninth Circuit Tax Shelter, or How to Make Money By Buying Things
Consider a hypothetical involving Hal Homeowner, who would like to open a grocery distribution center out of his garage. Hal goes to the supermarket and, like Harry, is short on cash. Also consider what happens when Hal Homeowner files his taxes, which makes any simple hypothetical more complex. We will suppose that Hal makes a 100% profit on the value of each carton, meaning that for every $2,000 worth of food he buys he resells for $4,000. We will also assume a typical corporate tax rate of 34% (which the Government applied to Earns) applies here.

Scenario 1

Hal Homeowner walks into a supermarket and eyes cartons of food for $400 each that would be ideal for his garage mini-mart. The store owner sees what Hal Homeowner has in mind, and when it becomes clear that Hal has no money but a lot of potential, the owner puts this offer on the table: “I will give you 20% off now if you agree to buy five cartons ($2,000 worth of food) each year for the next six years.” Under this scheme, Hal pays each year just $1,600 for five cartons. This is an example of a “volume supply discount” similar to the one that Harry Homeowner negotiated; Hal has gotten a 20%-off deal, except there is no cash advance involved here, which makes the tax calculation straightforward. Each year, Hal simply pays $1,600 for $2,000 worth of goods. He deducts that $1,600 in business expenses and reports $4,000 in resale to yield a taxable income of $2,400, which carries a tax liability of $816 per year.

Scenario 2

Now suppose the store owner proposes this: “I will give you $400 now if you buy $2,000 worth of food each year for the next six years. This will get you started with your business, and you can just pay me back the $400 at the end of the year from your resale proceeds.” Hal cannot go home and say “I made $400 today,” because he has an unconditional obligation to repay the $400 loan at the end of the year. At the end of the first year, Hal duly pays back the loan, and on his tax forms he simply deducts $2,000 as business expenses from his total resale proceeds of $4,000 to yield a taxable income of $2,000, which carries a tax liability of $680 each year. This is $136 per year less than the tax liability in Scenario 1, which makes sense because Hal makes $400 less each year.
The reason that the $400 was not income is that it was subject to an unconditional repayment obligation, notwithstanding whether Hal performed on his contract by meeting minimum purchase requirements. In other words, it was a bona fide loan.

*415
Scenario 3

Suppose the store owner proposes this: “I’ll give you $400 now if you agree to buy five cartons ($2,000 worth of food) each year for the next six years. If you can manage that, you don’t have to worry about paying me back at the end of the year.” This seems like quite a deal to Hal, who readily agrees. At the end of the first year, Hal deducts on his tax returns $1,600 in business expenses ($2,000 for the food minus $400 “cash back” off the full purchase price given in exchange for the purchase commitment), and reports $4,000 in resale proceeds to yield a gross income of $2,400, which carries a tax liability of $816. This is the same as the tax liability in Scenario 1, for Hal has made the same amount. In subsequent years, Hal deducts $2,000 in business expenses and reports $4,000 in resale proceeds to yield a gross income of $2,000 each year, which carries an annual tax liability of $680.
When he first made the deal, Hal could go home and say, “I made $400 today,” because he did not plan to skip out on his obligation to buy five cartons each year, was confident that he would resell the goods for profit, and thus had some assurance that he could keep his money and make back the rest from the proceeds of his resale. With this understanding, the $400 given to him at the outset was an advance payment that was taxable income when received.
So far, there is little cause for controversy over how Hal has done his taxes. He reported his profits as gross income in Scenario 1 (the volume supply discount without a cash advance); he repaid his loan and then reported his profits as gross income in Scenario 2 (the loan); and he reported his profits, along with the amount of cash he received up front, as gross income in Scenario 3 (the advance payment). What happens if Hal wants to do his taxes a little differently in Scenario 3 in order to save some money?

Scenario 4

The facts are the same as Scenario 3, but Hal does his tax reporting differently. Instead of deducting $1,600 in the first year, Hal deducts $2,000 in business expenses and reports resale proceeds of $4,000 to yield a gross income of $2,000 in the first year, which carries a $680 tax liability. Hal plans on waiting until the end of his six-year term to pay tax on the $400 as “other income” (i.e., “loan” forgiveness). He has realized a $136 tax savings (the difference between $816 due on $2,400 in Scenario 3 and $680 due on $2,000 in this scenario).
By deferring the taxes due on the $400, Hal is able to take advantage now of $2,400 (the up-front cash plus the $2,000 he makes in profits) without paying taxes on that full amount. Put differently, this means that he is able to take advantage of a $136 tax savings in the first year. If he pays taxes on the $400 as income in the year of receipt (as in Scenario 3), the present value of his tax liability over the course of the six-year deal is $3,368.35.5 *416But if Hal defers payment of taxes on the $400 until the end of Year 6 (as in Scenario 4), the present value of his tax liability will be only $3,331.87 over this same period. The present value of his total tax savings is a difference of $36.48 ($3,368.35 in Scenario 3 minus $3,331.87 in Scenario 4), which is negligible when dealing in amounts so small. But the amount grows when dealing in millions.
In Karns’s case, the deferral of the tax payment resulted in a savings of about $500,000 by Year 6 — the same amount that the Government argues is owed in back taxes. This sort of difference demonstrates how advance payments confer an economic benefit. As noted, they allow the recipient “immediate use of the money [or savings] ... and the opportunity to make a profit by providing goods or services at a cost lower than the amount of the payment.” Indianapolis Power, 493 U.S. at 208, 110 S.Ct. 589 (emphasis in original). For in Scenario 4 Hal’s business expenses actually are only $1,600 ($2,000 minus the $400 advance), and by reporting his expenses as $2,000, he inflates his business deductions. He has gained immediate use of the up-front money and is able to profit by providing goods at a cost lower than the amount of the payment, resulting in a $136 tax savings in the first year. The arrangement in this case is similar. The lesson: when taxes on funds advanced in Year 1 are deferred and goods purchased in Year 1 are resold for profit, money indeed can be made by buying things.
III. Conclusion
At first blush, both tax payment schemes — pay now or pay later — may appear to be merely alternate ways of doing the math, because Hal Homeowner and Earns will eventually pay taxes on the upfront money. But we cannot view the “pay later” method as just another way of calculating taxes, because our laws require otherwise. First, Earns avails itself of an economic benefit through this method, which functions like a tax-deferral shelter that the Code has not authorized. Second, Earns’s attempt to consider as a loan money that it will never have to repay contravenes the requirement that “an accrual-basis taxpayer [which Earns is] ... [must] treat advance payments as income in the year of receipt.” Indianapolis Power, 493 U.S. at 207 n. 3, 110 S.Ct. 589 (citations omitted).
In sum, I am not persuaded by the analysis in the Ninth Circuit. It is the first and only Court of Appeals to conclude that trade discounts paid by the supplier to a taxpayer to offset the taxpayer’s required minimum purchases are loans rather than advance payments. Its conclusion contradicts our own emphasis (both before and after Indianapolis Power) that income may be considered to be a “loan” only when there is an unconditional repayment obligation. See, e.g., Geftman v. Comm’r, 154 F.3d 61, 68 (3d Cir.1998); Diamond Bros. v. Comm’r, 322 F.2d 725, 731 (3d Cir.1963).
To reiterate, when understood this way, our case is about timing. Funds received with no unconditional repayment obligation result in one set of profit margins and tax liabilities, and deferred tax payment on those same funds results in another set. For practical and policy reasons, our Tax *417Code and most decisions interpreting it require taxpayers to pay taxes for the year of receipt on funds advanced to them by suppliers when any purported repayment obligation is conditional on acts controlled by taxpayers — ie., when there is no unconditional repayment obligation. Because there was no unconditional obligation to repay the money here, I believe that the $1.5 million received up front by Earns was an advance payment, taxable upon receipt. I therefore concur in affirming the Tax Court’s assessment of taxes owed.
ANITA B. BRODY, District Judge.
Because the agreements between Super Rite and Earns provided no guarantee that Super Rite would allow Earns to keep the money it received as a loan from Super Rite, I respectfully dissent from the majority’s conclusion that the loan was taxable income in the year it was received.
According to the majority, the agreement between retailer Earns and supplier Super Rite is functionally a single advance rebate formally divided into two parts: a loan with a multi-year repayment period; and a multi-year Supply Agreement. Super Rite would pay the advance rebate in the form of a loan, and would forgive the loan in annual installments as long as Earns annually bought the requisite amount of product under the Supply Agreement. The majority concludes that the money was taxable when received because Earns was never obligated to repay the loan and always had control over whether it would keep the money. That Earns might not be able to meet its obligations in the Supply Agreement is of no moment to the majority, which views Earns’ ability to perform its contractual obligations as under Earns’ “control” for tax law purposes.
As the majority recognizes, this decision holds that all advance trade rebates are taxable in the year received, in direct opposition to the Ninth Circuit’s opinion in Westpac Pacific Food v. C.I.R., 451 F.3d 970 (2006) (Kleinfeld, J.) I would not reach that broader question because the facts of Westpac are distinguishable: in this case, the transactions gave the taxpayer less control over the money than in the pure advance rebate in Westpac. In Westpac, the retailer was guaranteed to be able to keep the funds upon completion of its purchase obligations. But here, the loan provided no advance guarantee of forgiveness even if Earns made every effort to complete the purchases required by the Supply Agreement.6
It is true that Earns’ annual loan payment would be forgiven as long as Earns was “in compliance” with the Supply Agreement for the year, and that the two transactions are linked. App. at 49 (“Promissory Note”). But Super Rite (in its role as supplier) had immense latitude to cancel the Supply Agreement. Under Section 5(vi) of the Supply Agreement, Super Rite could cancel the agreement
Immediately upon the occurrence of a material adverse change in the condition (financial or otherwise), business or prospects of the Retailer or any guarantor of the Retailer’s liabilities and obligations hereunder.
App. at 52 (emphasis added).
This broad discretion to cancel the Supply Agreement for almost any kind of change in Earns or its guarantors’ “condition” renders nigh illusory any control Earns might have had over the continued *418existence of the Supply Agreement.7 If Super Rite cancelled the Supply Agreement, Karns would be required to repay the loan. Karns, then, had little meaningful control or “guarantee” that its loan would be forgiven at the time it received the loan. Karns’ actions (meeting the Supply Agreement’s purchase amount requirements) would have some role in determining whether the loan would be forgiven. But rather than being under Karns’ exclusive control, forgiveness was ultimately subject to lender Super - Rite’s discretion over the Supply Agreement. As such, it cannot be said that Karns had a “guarantee” that it would be able to keep the money. See Comm’r v. Indianapolis Power & Light Co., 493 U.S. 203, 210, 110 S.Ct. 589, 107 L.Ed.2d 591 (1990) (“In determining whether [money is taxable income when received], the crucial point is ... whether the taxpayer has some guarantee that he will be allowed to keep the money”)
The Supply Agreement also contained a liquidated damages clause:
[T]he parties agree that upon Super Rite’s cancellation of this agreement pursuant to Sections 2 or 5 of this Agreement, the Retailer will pay Super Rite as liquidated damages an amount equal to 1.0% of the product of (i) the Retailer’s aggregate purchases from Super Rite during the preceding calendar year multiplied by (ii) the number of years remaining in the term of this Agreement.
App. at 53 (Section 7 of Supply Agreement). That a remedy for breach of the Supply Agreement is contained within the Supply Agreement itself belies the view that the loan and the Supply Agreement were one unitary advance rebate, with the loan simply functioning as a mechanism for quick collection of any unearned rebates. Instead, the loan was an independent transaction with all the characteristics of a bona fide loan.
The retail grocery business is a low-margin, cash-intensive endeavor. See Supermarket News 9, Credit Crunch (July 30, 2001), 2001 WLNR 9062811; National Governors Association Center for Best Practices, Case Study: Pennsylvania’s Fresh Food Financing Initiative (noting that “[a]s communities become less dense, it is harder for grocery stores to remain viable.”).8 As such, access to credit is extremely important to retailers like Karns, and it makes sense that suppliers might step in to provide that credit. That Super Rite served dual functions of supplier and creditor does not mean that in this case, the loan was not a loan.

. The Ninth Circuit reached an outcome similar to the one in Westpac in Milenbach v. Comm’r, 318 F.3d 924, 935-37 (9th Cir.2003) (concluding that $6.7 million paid by the Los Angeles Memorial Coliseum Commission to the Los Angeles Raiders to develop the Coliseum was a loan rather than taxable income upon receipt even though the Raiders never built the Coliseum or repaid the money, because the contract specified a repayment obligation and did not contain a loan-forgiveness clause).

. The present value of money (at some future time) is calculated by dividing the monetary amount (here: $816 'in taxes on a $2,400 income) by the following: the product of the number of years (here: 1) and the discount rate (assumed: 7%) raised to the power of the number of years (here: 1).
Thus, the present value of an $816 tax liability for Year 1 at the end of the first year at a 7% rate is $762.62; the present values of a $680 tax liability for Years 2-6 are $593.94 at the end of the second year, $555.08 at the end of the third year, $518.77 at the end of the fourth year, $484.83 at the end of the fifth year, and $453.11 at the end of the sixth year. *416Added together, this yields a sum of $3,368.35.
By contrast, the present value of an $816 tax liability for Year 1 at the end of the sixth year at a 7% rate is $543.74; the present values of a $680 tax liability for Years 1-5 are $635.51 at the end of the first year, plus — as before — $593.94 at the end of the second year, $555.08 at the end of the third year, $518.77 at the end of the fourth year, and $484.83 at the end of the fifth year. Added together, this yields a sum of $3,331.87.

. I also disagree with the majority — Westpac was correctly decided. Advance rebates should be considered income only when they are actually earned through completed purchases.

. This is not to say that the Supply Agreement is unenforceable as a matter of contract law-— this is a federal law tax case, not a state law contract case. The degree of control Karns had over the continued existence of the Supply Agreement is relevant here only to show that Karns had no meaningful "guarantee” that the Supply Agreement would continue.

. Available online at http://www.nga.org/Files/ pdl/0510ACTIVELIVINGPA.PDF.