Affiliated Foods, Inc., A Corporation v. Commissioner , 128 T.C. No. 7 ( 2007 )


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    128 T.C. No. 7
    UNITED STATES TAX COURT
    AFFILIATED FOODS, INC., A CORPORATION, Petitioner v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent
    Docket No. 12846-04.                Filed March 29, 2007.
    P, a wholesale food purchasing cooperative, holds
    one or more food shows a year at which member stores
    and vendors selling to P meet. The vendors offer
    special show discounts to member stores placing orders
    with P for the vendors’ products at the food shows.
    The special discount sometimes takes the form of a cash
    payment from the vendor to the member store based on
    the quantity of the vendor’s products ordered. Vendors
    not bringing currency to the shows obtain cash for
    those payments from promotional allowance accounts
    established by the vendors with P or from checks given
    to P and cashed by P. R treats such P-delivered
    currency as, first, being received by P as a vendor
    rebate, second, being returned by P to the vendor, and,
    third, being paid by the vendor to the member store. R
    considers the first step to result in a reduction in
    P’s cost of goods sold and the third step to be the
    payment by P of a defective (nondeductible) patronage
    dividend. According to R, the defect is that the
    payment is not out of P’s net earnings. The net result
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    of R’s adjustments is an increase in P’s gross income
    for each of the years in question in the amount of P-
    delivered currency paid by vendors to member stores.
    1. Held: P is not collaterally estopped from
    challenging R’s adjustments by our report in Affiliated
    Foods, Inc. v. Commissioner, T.C. Memo. 1996-505, affd.
    in part, revd. in part and remanded 
    154 F.3d 527
    (5th
    Cir. 1998).
    2. Held, further, the payments that R charges P
    with making to member stores are properly characterized
    as trade discounts. They were not paid with reference
    to P’s net earnings but merely passed along the price
    adjustments that P was entitled to on account of the
    orders placed by the member stores at the food shows.
    They reduce P’s gross sales and are not defective
    patronage dividends.
    William A. Hoy, for petitioner.
    George E. Gaspar and Mark E. O’Leary, for respondent.
    HALPERN, Judge:   By notice of deficiency dated April 22,
    2004, respondent determined deficiencies in petitioner’s Federal
    income tax of $143,978, $166,493, and $11,101 for petitioner’s
    taxable (fiscal) years ended September 30, 1991, October 2, 1992,
    and October 1, 1993, respectively (the audit years).   Petitioner
    is a corporation operating on a cooperative basis (a purchasing
    cooperative), whose shareholder-patrons operate retail grocery
    stores.   The issues for decision concern the proper treatment of
    certain payments made to petitioner’s shareholder-patrons at food
    shows petitioner conducted during the audit years.
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    Respondent increased petitioner’s gross income for each of
    the audit years on account of those payments and denied
    petitioner any offsetting deductions on the ground that the
    payments are nondeductible patronage dividends.   In part,
    respondent defends against petitioner’s assignments of error by
    claiming that petitioner is precluded from challenging
    respondent’s adjustments on the basis of the outcome in
    Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505,
    affd. in part, revd. in part and remanded 
    154 F.3d 527
    (5th Cir.
    1998); on remand T.C. Memo. 1999-136.   Petitioner denies that it
    is precluded from challenging the adjustments and claims that it
    did not receive the payments, but, if it did, the payments either
    did not increase its gross income because of offsetting
    adjustments or, if they did increase its gross income, it was
    entitled to offsetting deductions.
    Unless otherwise indicated, all section references are to
    the Internal Revenue Code as in effect for the audit years.    The
    references to subchapter T are to that subchapter (sections 1381
    through 1388) of chapter 1 of subtitle A of the Internal Revenue
    Code.   Subchapter T deals with cooperatives and their patrons.
    - 4 -
    FINDINGS OF FACT
    Some facts are stipulated and are so found.     The stipulation
    of facts, with accompanying exhibits, is incorporated herein by
    this reference.
    Petitioner
    Petitioner is a wholesale food purchasing cooperative that
    resells a variety of products to retail grocery stores in Texas,
    New Mexico, Oklahoma, Kansas, Colorado, and Arizona.     At the time
    the petition was filed, petitioner maintained its principal place
    of business in Amarillo, Texas.     Petitioner was incorporated in
    1946 under the cooperative laws of the State of Texas to increase
    the bargaining power of member stores in their dealings with
    vendors.1    As of the time of the trial, petitioner had more than
    239 shareholder-patrons, who operated approximately 715 member
    stores.     Petitioner does not own any interest in any member
    store.
    Petitioner computes its taxable income using an accrual
    method of accounting and pursuant to the provisions of part I
    1
    The parties have stipulated that the term “member stores”
    refers to retail grocery stores that individually or as a group
    of related and associated retail grocery stores purchase food and
    other consumer products from or through petitioner and that are
    members of, or shareholders in, petitioner’s cooperative system.
    They have further stipulated that the term “vendor” refers to
    manufacturers or other producers of food and other products sold
    to petitioner and member stores. We shall adopt those locutions
    for purposes of this report.
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    (sections 1381 through 1383) of subchapter T, which addresses the
    tax treatment of cooperatives.
    At the end of its fiscal year, petitioner returns the
    profits from its wholesale grocery purchasing business to its
    shareholder-patrons as patronage dividends.
    Member Stores
    Member stores determine independently of petitioner the
    types, brands, and quantities of the commodities that they
    purchase for resale to customers.
    Promotional Allowance Accounts
    From time to time, petitioner receives from some vendors and
    vendor representatives (without distinction, vendors)2 funds to
    be spent in promoting the sale of products offered by those
    vendors.   Petitioner deposits the funds in its own bank account
    and, on its books, treats the deposits as liabilities owed to the
    contributing vendors.   Petitioner identifies the balance on hand
    for each contributing vendor in a set of accounts that it has
    designated the “promotional allowance accounts” (promotional
    allowance accounts).
    2
    The parties have stipulated that the term “vendor
    representative” refers to an individual or entity who solicits
    and concludes sales of food and food products to petitioner and
    member stores on behalf of vendors, including all independent
    distributors, brokers, sales representatives, and agents of
    vendors. We shall adopt that locution for purposes of this
    report.
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    Discounts and Allowances
    Petitioner negotiates with individual vendors to obtain
    discounts and allowances (without distinction, discounts) from
    the list prices advertised by the vendors.   Thus, for example,
    for a limited time, a vendor of canned goods may offer $1 off on
    each case of its 16-oz. cans of peaches ordered.
    Except with respect to certain special price discounts
    offered by vendors only at the food shows and described in the
    next paragraph, vendor discounts on merchandise purchased by
    petitioner reduce the price paid by (invoiced to) petitioner and
    are referred to by petitioner as “off-invoice” (off-invoice)
    discounts.   Petitioner passes on to member stores off-invoice
    discounts it obtains from vendors unless the associated
    administrative costs exceed the amount of the discount.
    Hereafter, we shall use the term “usual discount” to describe any
    vendor discount other than the special price discounts offered
    only at the food shows.
    Food Shows-–General
    Beginning in 1984 and extending at least through the audit
    years, petitioner held one or more food shows a year at which
    vendors and member stores met.    One purpose of those shows was to
    encourage member stores to place orders with petitioner for the
    products that vendors promoted at the shows.   The food shows held
    during the audit years were held in Amarillo, Texas.
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    Several weeks before each food show, petitioner sent
    invitations to member stores and vendors.   Attendance at the
    shows by members, and participation in the shows by vendors, was
    voluntary.   A vendor wishing to participate in a food show
    entered into an agreement with petitioner under which the vendor
    agreed to pay a participation fee, rent and decorate a booth at
    the show, and offer to member stores discounts on the products
    that the vendor offered at the show.   Those discounts, although
    negotiable, were subject to petitioner’s approval and had to be
    greater than the usual discounts.   The special show discounts,
    although limited to orders placed at the food shows, were, like
    the usual discounts, based on the quantity of merchandise
    ordered.
    Also, in preparation for each food show, each participating
    vendor provided petitioner with a “deal data sheet”, which, among
    other things, showed the products the vendor was promoting and
    the per-unit show discount (referred to by petitioner as “show
    money” (show money)) offered for each product.    Petitioner had
    the right to reject individual product items.    Vendors had
    discretion to make show money available to member stores in one
    of two ways: (1) a credit against the purchase price of the
    product to be reflected on the invoice to be issued to the member
    store by petitioner on fulfillment of the order after the food
    show (i.e., an off-invoice discount), or (2) an immediate payment
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    at the food show, in currency or by check, from the vendor to the
    member store.   In the case of an off-invoice discount, petitioner
    stood as an intermediary between the vendor and the member store,
    reducing the price it charged the member store to reflect the
    off-invoice discount and receiving an equal reduction from the
    vendor in the price it charged petitioner.   Petitioner made no
    explicit price reduction if the vendor agreed to pay show money
    directly to the member at the food show.
    Vendors exercised their discretion with respect to show
    money by indicating their choices on the deal data sheets they
    submitted.   Information from deal data sheets was transferred by
    petitioner to individual sheets for each vendor.   Those sheets
    were then reproduced and bound into books (show books) for
    distribution to members attending the food show.
    Each sheet in the show book had attached to it a perforated
    strip (tear strip) that the member store could detach and use to
    order from petitioner an item (or items) described on the
    associated sheet.   The member store delivered the tear strip to
    the appropriate vendor, who, if an immediate payment of show
    money was called for, made that payment and then delivered the
    tear strip to petitioner for fulfillment of the order.
    Petitioner entered the necessary information from the tear strip
    into its billing and accounting records and, in most cases, then
    discarded the tear strips.   Petitioner ordered additional
    - 9 -
    merchandise from the vendor, if necessary, and filled the order
    on the date requested by the member store.   Petitioner invoiced
    the member store for the shipment, reflecting on the invoice
    credit for the appropriate amount of show money if, and only if,
    that amount had not already been paid by the vendor to the member
    store.
    A member store had discretion not to receive show money in
    currency or by check from a vendor who had elected to offer show
    money that way.   A member store had no discretion, however, to
    demand a payment from a vendor if the vendor had elected the off-
    invoice method of offering show money.
    Petitioner’s Profit on Sales to Member Stores
    Petitioner profits on sales to member stores by marking up
    the prices it charges member stores from the prices it pays
    vendors.   Except with respect to off-invoice discounts resulting
    from show money offered at the food shows, petitioner applies its
    customary markup to the price it charges a member store; i.e.,
    the markup is applied to the vendor’s list price less the usual
    discount obtained by petitioner.   With respect to show money,
    petitioner applies any off-invoice discount only after adding its
    own markup.   Thus, petitioner calculates that its margin (the
    difference between the cost and selling price) and its markup on
    food show orders are the same if a member store receives show
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    money in currency or check or if the member store elects an off-
    invoice credit.3
    3
    The following table is based on a table prepared by
    Tammie Coffee, petitioner’s chief financial officer, to
    illustrate the point in the text.
    Consolidated Foods, Inc.
    Comparison of gross profit on AFI’s ledger of off-invoice/at-show
    payment:
    Item #27024
    Off invoice    At show
    Sale to AFI customer:
    List price                                   $76.20       $76.20
    Less: usual discount                           1.20         1.20
    Subtotal: Price before markup               75.00        75.00
    Add Markup: 7.5%                               5.25         5.25
    Subtotal                                    80.25        80.25
    Less: Off-invoice show money discount           .75          n/a
    Total amount billed to member store         79.50        80.25
    AFI purchase price from vendor:
    List cost                                     76.20         76.20
    Less:
    Usual discount                               1.20          1.20
    Off-invoice show money discount               .75           n/a
    Total cost of goods sold                  74.25         75.00
    Gross profit on AFI general
    ledger (margin):
    1
    Amount billed to member store                   79.50         80.25
    Less: cost of goods sold                        74.25         75.00
    Total margin                                   5.25          5.25
    1
    We note that,   if it is assumed that the member store
    receives a payment of   $0.75 at the food show, it would have to
    subtract that receipt   ($0.75) from the amount it pays petitioner
    ($80.25) to determine   its cost for the goods it purchased
    ($79.50).
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    Food Shows; Currency
    The currency used by vendors to pay show money had three
    possible sources: (1) the vendor’s promotional allowance account,
    if the vendor gave petitioner written instructions to charge a
    specific amount against the account and to deliver currency in
    that amount to the vendor at the food show, (2) a vendor’s check,
    given by the vendor to petitioner for the specific purpose of
    providing currency to the vendor at the food show, and (3)
    currency brought to the food show by the vendor and taken from an
    account of the vendor unknown to petitioner.   In the first two
    cases, petitioner obtained the necessary currency from the
    Amarillo National Bank (the bank).
    Petitioner obtained currency from the bank in denominations
    sufficient to meet the individual vendors’ requests for currency
    in specific denominations.   Petitioner placed the currency in
    locked bank bags identified with numbers unique to each vendor.
    Immediately before a food show began, vendors retrieved their
    bags from petitioner at a central location after, first,
    verifying that the bag’s contents were as expected and, second,
    signing a receipt.
    At the conclusion of the food show, vendors who had received
    bank bags from petitioner returned to petitioner those bags and
    any currency they wanted to deliver to petitioner.   Petitioner
    issued written receipts for the bank bags and currency returned.
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    Respondent’s Adjustments
    Respondent attached to the notice of deficiency an
    explanation of his adjustments to petitioner’s tax liabilities
    for the audit years.   The explanation states that respondent has
    determined that “the food show distributions” to petitioner’s
    shareholders are both income to petitioner and nondeductible
    patronage dividends paid by it to its members.   Therefore, the
    explanation continues, petitioner’s taxable income is increased
    by $421,973, $489,685, and $144,122, for 1991, 1992, and 1993,
    respectively.
    OPINION
    I.   Introduction
    During the audit years, petitioner, a wholesale food
    purchasing cooperative, conducted one or more food shows a year
    at which member stores met with vendors.   Among other things, the
    food shows were designed to encourage member stores to order from
    petitioner the vendors’ products offered at the shows.     Pursuant
    to an agreement with petitioner, each vendor attending a show was
    required to offer member stores special show discounts on the
    vendor’s products offered at the show.   Petitioner referred to
    those special show discounts as “show money”.    Vendors could make
    show money available to member stores in one of two ways.    First,
    a vendor could offer a member store a discount on an order placed
    with petitioner at the show, petitioner having agreed to honor
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    the discount (referred to by petitioner as an “off-invoice”
    discount) when it invoiced the member store upon fulfillment of
    the order after the show.   Petitioner would receive an identical
    discount from the vendor.   Second, instead, the vendor could
    offer to pay the member an amount equal to the off-invoice
    discount immediately upon its executing an order to be placed
    with petitioner.   In that case, no invoice either from petitioner
    to the member store or from the vendor to petitioner would
    reflect the payment.
    We are concerned here only with show money made available to
    member stores in the second way; i.e., by an immediate payment by
    a vendor to a member store.   Moreover, we are concerned with
    those payments only if they were made in currency (i.e., not by
    check), and then only if the currency was delivered by petitioner
    to the vendor at the start of the food show.   We are not,
    therefore, concerned with payments out of currency brought to a
    food show by a vendor.   The currency delivered by petitioner to a
    vendor at the start of a food show (which we shall refer to as
    petitioner-delivered currency) had one or perhaps both of two
    sources: (1) a charge against the vendor’s promotional allowance
    account, at the direction of the vendor, for the specific purpose
    of providing the vendor with currency at the food show, and, (2)
    checks received from the vendor and cashed by petitioner for the
    same purpose.   We shall use the terms “promotional-allowance
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    currency” and “vendor-check currency” to refer to petitioner-
    delivered currency attributable to the former and the latter of
    those sources, respectively.
    While, in the notice of deficiency, respondent explained
    that his adjustments to petitioner’s Federal income tax for the
    audit years were based on his determination that petitioner’s
    “food show distributions” to its shareholders are income to
    petitioner (and nondeductible patronage dividends paid to its
    members), respondent did not explain how he computed those
    adjustments.   The parties have stipulated respondent’s method of
    computation:
    Respondent increased Petitioner’s taxable income
    in each of the years in issue by an amount equal to the
    difference between: (a) the sum of (i) the cash amounts
    withdrawn from the Promotional Allowance Accounts and
    (ii) the checks delivered to Petitioner by Vendors
    * * * in anticipation of the Food Shows, over (b) the
    cash returned to the Petitioner at the conclusion of
    the Food Shows by the same Vendors * * * .[4]
    We shall first address respondent’s claim that petitioner is
    precluded from challenging respondent’s adjustments.   Since we
    believe that petitioner is not so precluded, we shall then
    address the parties’ other claims.
    4
    The parties’ stipulation repeats the explanation as
    follows: “Respondent’s adjustment to Petitioner’s income for the
    years in issue is, therefore, the difference between the checks
    and withdrawals from the Promotional Allowance Accounts provided
    by Vendors * * * to Petitioner reduced by the cash returned by
    the Vendors * * * at the conclusion of the Food Shows.”
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    II.   Issue Preclusion
    A.   Introduction
    Respondent asserts that the Court in Affiliated Foods, Inc.
    v. Commissioner, T.C. Memo. 1996-505, found that payments by
    vendors to member stores of petitioner-delivered currency during
    petitioner’s 1989 and 1990 tax years were both gross income to
    petitioner and nondeductible payments of patronage dividends by
    petitioner to its shareholders.    Relying on the doctrine of issue
    preclusion (or collateral estoppel), respondent argues that
    petitioner is precluded from relitigating those issues.   Since,
    during the audit years, vendors also made payments of petitioner-
    delivered currency to member stores, respondent argues that those
    payments are items of gross income to petitioner for those years
    and nondeductible payments of patronage dividends.
    B.   The Doctrine of Issue Preclusion
    In Monahan v. Commissioner, 
    109 T.C. 235
    , 240 (1997), we
    said:
    The doctrine of issue preclusion, or collateral
    estoppel, provides that, once an issue of fact or law
    is “actually and necessarily determined by a court of
    competent jurisdiction, that determination is
    conclusive in subsequent suits based on a different
    cause of action involving a party to the prior
    litigation.” Montana v. United States, 
    440 U.S. 147
    ,
    153 (1979) (citing Parklane Hosiery Co. v. Shore, 
    439 U.S. 322
    , 326 n.5 (1979)). Issue preclusion is a
    judicially created equitable doctrine whose purposes
    are to protect parties from unnecessary and redundant
    litigation, to conserve judicial resources, and to
    foster certainty in and reliance on judicial action.
    See, e.g., 
    id. at 153-154;
    United States v. ITT
    - 16 -
    Rayonier, Inc., 
    627 F.2d 996
    , 1000 (9th Cir. 1980).
    This Court in Peck v. Commissioner, 
    90 T.C. 162
    ,
    166-167 (1988), affd. 
    904 F.2d 525
    (9th Cir. 1990), set
    forth the following five conditions that must be
    satisfied prior to application of issue preclusion in
    the context of a factual dispute * * * :
    “(1) The issue in the second suit must be
    identical in all respects with the one decided in the
    first suit.
    (2) There must be a final judgment rendered by a
    court of competent jurisdiction.
    (3) Collateral estoppel may be invoked against
    parties and their privies to the prior judgment.
    (4) The parties must actually have litigated the
    issues and the resolution of these issues must have
    been essential to the prior decision.
    (5) The controlling facts and applicable legal
    rules must remain unchanged from those in the prior
    litigation. * * * ”
    C.   Discussion
    1.   Petitioner’s Argument
    Petitioner concedes that the first three conditions are
    satisfied.   Petitioner argues that the fourth condition is not
    satisfied since, by assigning error to respondent’s failure to
    allow it offsetting deductions or adjustments to gross income
    from sales--if we should decide in the first place that
    petitioner received anything on account of the vendors’ payments
    to members of petitioner-delivered currency--petitioner has
    raised issues that were neither litigated nor resolved in the
    prior litigation.   Petitioner argues that the fifth condition is
    not satisfied since the controlling facts in this case are not
    the same as in the prior case.
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    2.   Points Not at Issue in the Prior Litigation
    “Collateral estoppel applies only to an issue that was
    actually litigated and determined in a prior action, not to an
    issue that might have been litigated.”     Anderson, Clayton & Co.
    v. United States, 
    562 F.2d 972
    , 992 (5th Cir. 1977); see also
    Commissioner v. Sunnen, 
    333 U.S. 591
    , 597-598 (1948).     As put by
    the Supreme Court in Commissioner v. Sunnen, supra at 598:
    “Since the cause of action involved in the second proceeding is
    not swallowed by the judgment in the prior suit, the parties are
    free to litigate points which were not at issue in the first
    proceeding, even though such points might have tendered and
    decided at that time.”   Moreover, it is well settled that each
    taxable year is the origin of a new liability and of a separate
    cause of action.   Id.; see also Estate of Hunt v. United States,
    
    309 F.2d 146
    , 148 (5th Cir. 1962).     In Cloud v. Commissioner,
    T.C. Memo. 1976-27, we held that the taxpayers were not
    collaterally estopped from challenging the Commissioner’s
    disallowance of their deductions of certain expenses under a
    theory different from the losing theory they had advanced in
    litigation concerning the same types of expenses for prior years.
    Petitioner’s assignments of error to respondent’s failure to
    allow it offsetting deductions or adjustments to gross income
    from sales do raise issues that were neither litigated nor
    resolved in the prior litigation.    Although petitioner did raise
    - 18 -
    the issue of an offsetting deduction in Affiliated Foods, Inc. v.
    
    Commissioner, supra
    , and was sustained on that issue with respect
    to petitioner-delivered currency given to one vendor, petitioner
    failed on brief to argue the issue with respect to vendors
    generally and, on account of that failure, was deemed to have
    conceded the issue.   
    Id. n.11. The
    issue of offsetting
    deductions was not fully litigated in the prior litigation, and
    petitioner is not precluded from raising it here. See Coors v.
    Commissioner, 
    60 T.C. 368
    , 392 (1973) (Commissioner not barred
    from litigating capitalization issue that, in prior litigation
    between parties, he had abandoned, where no findings had been
    made by Court with regard to issue, and it was not necessary to
    result reached), affd. 
    519 F.2d 1280
    (10th Cir. 1975).      Nor is
    petitioner precluded from arguing for an offsetting adjustment to
    gross income from sales, because that issue was not raised in the
    prior litigation.   See Monahan v. 
    Commissioner, supra
    at 240.
    3.   Difference in Controlling Facts
    The fact that petitioner is free to argue for offsetting
    deductions or adjustments does not mean that it is free to argue
    that it has no gross income (or no gross receipts) on account of
    vendor payments to member stores of petitioner-delivered currency
    if that issue was settled in the prior litigation.   See Jaggard
    v. Commissioner, 
    76 T.C. 222
    , 224 (1981) (issue-by-issue
    determination of whether collateral estoppel applies).
    - 19 -
    Nevertheless, petitioner claims that it is free to so argue since
    the facts controlling the issue here are different from those in
    Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505.      In
    that case, we found facts that, in much the same terms we use
    today, describe food shows petitioner put on during its 1989 and
    1990 taxable years (1989 and 1990, respectively).    We described
    show money (although we did not use that term) much as we
    describe it today, although we included no specific description
    of off-invoice discounts.    We described the order forms (deal
    data sheets) submitted by vendors and said “there was no
    negotiating” after the order forms were submitted.    We described
    the procedures for supplying petitioner-delivered currency much
    as we describe them today.    We also said:
    In both instances [i.e., in the case of both
    promotional-allowance currency and vendor-check
    currency], petitioner required the vendors to sign for
    the cash received, and, most importantly, it also
    required any unused cash to be returned to it at the
    end of the food show. This was not a check-cashing
    service. Unlike a check-cashing service, petitioner
    ensured that the check proceeds were either paid to its
    shareholders or returned to it. [Emphasis added.]
    We ended our discussion of petitioner-delivered currency by
    concluding:
    Petitioner was not a nontaxable intermediary with
    respect to the food show cash disbursements arising
    from the promotional accounts. * * * Similarly, as
    for the food show cash disbursements arising from the
    check-cashing transactions, petitioner exercised
    dominion and control over these funds, as evidenced by
    the return of any “unused” cash. Thus, these amounts
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    must also be included in petitioner’s income.   * * *
    [Emphasis added.]
    Petitioner argues that the important facts we relied on in
    Affiliated Foods, Inc. v. 
    Commissioner, supra
    , to support our
    conclusion that it exercised dominion and control over the
    petitioner-delivered currency are not present in this case.
    Petitioner claims that, unlike what we found for 1989 and 1990,
    during the audit years, (1) it did not require vendors to return
    to it any remaining petitioner-delivered currency not paid to
    member stores, and (2) although it had the final say, it did
    negotiate with vendors the amounts of show money the vendor would
    give.    It also claims that, with respect to its 1993 food shows,
    vendors gave it no checks.    While we are not certain about
    petitioner’s third claim, we have made findings consistent with
    its first two claims.    With respect to its first claim, we have
    found:    “At the conclusion of the food show, vendors who had
    received bank bags from petitioner returned to petitioner those
    bags and any currency they wanted to deliver to petitioner.”     See
    supra p. 11 (emphasis added).    Our finding is almost a verbatim
    recitation of a stipulated fact.    From that stipulation, we draw
    the inference that vendors had discretion to, but were not
    required to, return to petitioner at the end of a food show any
    undistributed petitioner-delivered currency, and we so find.
    Whatever limited power vendors had to negotiate food show
    money and, more importantly, their right to retain any
    - 21 -
    undistributed petitioner-delivered currency distinguish the facts
    before us from the facts we relied on in Affiliated Foods, Inc.
    v. 
    Commissioner, supra
    .   In the prior litigation, we found “most”
    important the requirement that undistributed petitioner-delivered
    currency be returned; that requirement evidenced to us
    petitioner’s exercise of dominion and control over petitioner-
    delivered currency.5   The return requirement ensured that
    petitioner-delivered currency would either be paid to member
    stores or returned to petitioner.   In the present litigation, we
    cannot be equally confident that petitioner-delivered currency
    not returned to petitioner was paid to member stores, since
    5
    In Affiliated Foods, Inc. v. Commissioner, T.C. Memo.
    1996-505, affd. in part, revd. in part and remanded 
    154 F.3d 527
    (5th Cir. 1998), we found that amounts received from vendors and
    credited to the vendors’ promotional allowance accounts were
    items of gross income to petitioner when received. We were
    reversed on that point by the Court of Appeals for the Fifth
    Circuit. Affiliated Foods, Inc. v. Commissioner, 
    154 F.3d 527
    (5th Cir. 1998). Respondent has made no adjustments for amounts
    similarly received during the audit years, and we assume that, at
    least for purposes of this case, respondent accepts the Court of
    Appeals’ conclusion that vendors retained control of funds
    credited to the promotional allowance accounts and receipt of
    those funds did not give rise to gross income to petitioner.
    
    Id. at 533.
    We assume further that an amount equal to any
    petitioner-delivered currency that a vendor chose to return to
    petitioner following a food show during the audit years was
    either returned to the vendor or credited to its promotional
    allowance account (and, therefore, petitioner retained no control
    over any currency returned to it). We make those assumptions
    because, for the audit years, respondent has increased
    petitioner’s income by only the excess of the petitioner-
    delivered currency over the amount of cash returned by vendors to
    petitioner at the conclusion of the food show.
    - 22 -
    vendors were under no obligation to return to petitioner any
    petitioner-delivered currency not paid to member stores or to
    account to petitioner for their disposition of petitioner-
    delivered currency.      Petitioner’s dominion and control over
    petitioner-delivered currency was different in the audit years
    than it was in the years subject to the prior litigation.
    Denying a party the right to litigate an issue is a matter that
    requires circumspection.      Monahan v. Commissioner, 
    109 T.C. 242
    .    On balance, we think that the interests of justice are
    better served by allowing petitioner to litigate the control
    issue afresh, in the light of the difference in facts from the
    prior litigation.     See, e.g., Alexander v. Commissioner, 
    224 F.2d 788
    , 793 (5th Cir. 1955) (interests of justice not served by
    holding barring taxpayer from showing change in facts concerning
    partnership agreement subject to prior proceeding), affg. in
    part, revg. in part and remanding 
    22 T.C. 318
    (1954).
    Affiliated Foods, Inc. v. 
    Commissioner, supra
    , does not preclude
    petitioner from litigating the inclusion in gross income of
    petitioner-delivered currency.
    D.   Conclusion
    Respondent’s affirmative defense of issue preclusion fails.
    - 23 -
    III.       Discussion
    A.     Arguments of the Parties
    Respondent argues that, for each of the audit years,
    petitioner has an item of gross income on account of petitioner-
    delivered currency because petitioner “asserted control over
    those funds and used the vendor representatives as conduits to
    make ‘disguised patronage dividends’ to its member stores at the
    food shows.”       Respondent lists the following as among the
    important operative facts:6
    Petitioner negotiated for the food show rebates
    and thereby provided for the direct payment of monies
    from vendors to members that would otherwise have
    accrued to Affiliated as earnings, i.e., rebates from
    vendors to Affiliated for product purchased by
    Affiliated.
    A member received food show rebates based on the
    amount of product purchased at the show. The greater
    the product purchases meant more food show rebates.
    Members committed to make purchases at the food
    show and subsequently bought the product through
    Affiliated.
    In this manner, a member received rebates based on
    the amount of product purchased through Affiliated, and
    Affiliated was able to provide a patronage dividend
    without complying with the statutory requirements.
    While petitioner disagrees that it paid any patronage
    dividends or asserted control over the petitioner-delivered
    currency (petitioner argues that it was only delivering to
    6
    Paragraph numbers and citations of respondent’s proposed
    findings of fact are omitted.
    - 24 -
    vendors their own money, either reducing the balance of a
    vendor’s promotional allowance account or delivering the proceeds
    of a vendor’s check), its description of the facts does not
    differ markedly from respondent’s:
    The payments in question were simply price rebates; no
    different than the price discounts and rebates afforded
    Member Stores on a day-to-day basis throughout the
    year. The day-to-day rebates and price discounts also
    represented value passing from Petitioner, who granted
    them, to the Member Stores, who purchased the goods to
    which the rebates and discounts attached. * * *
    If we should find that petitioner exercised sufficient
    control over the petitioner-delivered currency to cause us to
    conclude that petitioner had a receipt in an equal amount,
    petitioner argues that either the receipt did not increase its
    gross income because of an offsetting adjustment (either an
    increase in petitioner’s cost of goods sold or a reduction in the
    amount of its receipts from sales to member stores) or, if the
    receipt did increase its gross income, it had an offsetting
    deduction.
    B.   Discussion
    1.   Control
    Petitioner organized the food shows and required vendors
    wishing to participate to offer special deals (show money) on
    their products offered and ordered at the show.   In the case of
    an off-invoice discount, petitioner accorded the member store the
    discount and, in turn, was accorded an equal discount by the
    - 25 -
    vendor.    A vendor could choose, however, to make an immediate
    payment of show money to a member store, either in currency or by
    check.    If the vendor chose currency, the currency either had
    come from petitioner (i.e., petitioner-delivered currency) or was
    provided by the vendor itself (vendor-provided currency).    If
    payment was of petitioner-delivered currency, respondent’s
    argument is that the vendor was not using its own money to pay
    show money:    The vendor was using petitioner’s money to pay show
    money.    As respondent sees it, simultaneously with the vendor’s
    making a payment of petitioner-delivered currency to a member
    store, the vendor rebated an equal amount to petitioner, which
    petitioner returned to the vendor under an earlier direction that
    the vendor pay the amount to the member store on petitioner’s
    behalf.
    Respondent justifies such indirection on the ground that
    petitioner asserted sufficient control over the circumstances
    surrounding the vendors’ receipts of petitioner-delivered
    currency that the vendors should be viewed as nothing more than
    petitioner’s agents engaged to pay to the member stores rebates
    from moneys (rebates) first received by petitioner.    Respondent
    does not pin down the nature of that control, however, and the
    fact that respondent does not similarly treat the vendors as
    petitioner’s agents in the case of vendor-provided currency or
    checks (hereafter, without distinction, vendor-provided currency)
    - 26 -
    paid to member stores leaves us less than clear as to the
    substance of respondent’s argument concerning control.
    As set 
    forth supra
    in section III.A., respondent claims as a
    fact:   “Petitioner negotiated for the food show rebates and
    thereby provided for the direct payment of moneys from vendors to
    members that would otherwise have accrued to Affiliated as
    earnings, i.e., rebated from vendors to Affiliated for product
    purchased for sale by Affiliated.”     While it is true that
    petitioner negotiated with respect to show money and had the
    right to final approval and, therefore, exercised some control
    over show money, petitioner’s authority and rights were the same
    irrespective of whether the vendor chose to use petitioner-
    delivered or vendor-provided currency to pay show money to member
    stores.   Yet respondent’s adjustments increasing petitioner’s
    income on account of rebates petitioner is deemed to have
    received is made only with regard to petitioner-delivered
    currency (and without regard to vendor-provided currency).     If
    negotiation and approval with respect to show money signify
    control, then we do not see why those factors do not equally
    signify control with respect to vendor-delivered currency.     The
    singular distinction between petitioner-delivered and vendor-
    provided currency is that the former came to vendors from
    petitioner’s hands.   As explained in the next two paragraphs, we
    do not see that distinction as justifying different treatment.
    - 27 -
    With respect to each vendor receiving petitioner-delivered
    currency, the delivery was of either, or both of, promotional-
    allowance currency or vendor-check currency.   A vendor retained
    control of its promotional allowance account,7 and only upon its
    specific instruction was petitioner authorized to charge the
    account and deliver a specified amount of currency to the vendor
    at the food show.   Petitioner had no discretion in the matter.
    Petitioner likewise lacked discretion with respect to the
    proceeds of a vendor’s check that it delivered to the vendor at
    the food show.   In N. Am. Oil Consol. v. Burnet, 
    286 U.S. 417
    ,
    424 (1932), the Supreme Court announced what has been termed the
    “claim-of-right” doctrine:
    If a taxpayer receives earnings under a claim of right
    and without restriction as to its disposition, he has
    received income which he is required to return, even
    though it may still be claimed that he is not entitled
    to retain the money, and even though he may still be
    adjudged liable to restore its equivalent. * * *
    The doctrine does not apply to amounts a taxpayer receives as a
    mere conduit or agent for transmittal to another.    E.g.,
    Apothaker v. Commissioner, T.C. Memo. 1985-445.     Indeed, in a
    case predating subchapter T and upholding the payer corporation’s
    exclusion from gross income of patronage based refunds, the Court
    of Appeals for the Fifth Circuit grounded its analysis in part on
    the following proposition:   “‘[I]n order for receipts to
    7
    See supra note 5.
    - 28 -
    constitute taxable income to a taxpayer there must be (1) the
    presence of a claim * * * [of] right to such receipts, and (2)
    the absence of a definite, unconditional obligation to pay the
    same to another.’”   United States v. Miss. Chem. Co., 
    326 F.2d 569
    , 573 (5th Cir. 1964) (quoting Farmers Coop. Co. v.
    Birmingham, 
    86 F. Supp. 201
    , 214 (N.D. Iowa 1949) (citing
    Commissioner v. Wilcox, 
    327 U.S. 404
    (1946))).
    Petitioner-delivered currency came into petitioner’s hands
    on the understanding that petitioner would in short order deliver
    the currency to the vendors whose promotional allowance accounts
    had been debited, or whose checks had been cashed, to provide the
    currency.   Petitioner lacked meaningful control over petitioner-
    delivered currency, and neither its receipt of checks from
    vendors, its withdrawal of currency from the bank, nor its
    delivery of that currency to vendors can, alone or together,
    serve as the basis for charging petitioner with having received
    rebates from vendors.   With respect to this narrow aspect of the
    show money operation, petitioner merely served as a conduit,
    providing the vendors with liquidity from their own funds.    We do
    not see that petitioner effectively exercised any more control
    over petitioner-delivered currency than it did over vendor-
    provided currency.
    We end our discussion of control inconclusively because, so
    far as we understand respondent’s control argument, it is
    - 29 -
    unpersuasive:   We do not see a sufficient difference between
    petitioner’s control over petitioner-delivered and vendor-
    provided currency that they should be treated differently, yet
    that is what respondent has done.   Nevertheless, we are mindful
    that in affirming our prior treatment of show money in Affiliated
    Foods, Inc. v. 
    Commissioner, 154 F.3d at 533
    , the Court of
    Appeals remarked that, by negotiating the terms of show money
    payments, petitioner provided for the direct payment of moneys
    from vendors to member stores that otherwise would have accrued
    to petitioner as earnings.   Even were we to ignore respondent’s
    failure to treat petitioner-delivered and vendor-provided
    currency equivalently, however, and to credit petitioner with
    control over petitioner-delivered currency, we believe that
    petitioner prevails for the reasons stated below.
    2.   Rebates
    Both petitioner and the member stores are merchants.    A
    merchant computes its gross income from sales during a year by
    subtracting from its revenue from sales the cost of the goods
    sold.   See sec. 1.61-3(a), Income Tax Regs.   A purchase price
    adjustment or a price rebate that a taxpayer receives with
    respect to goods that it has purchased for resale is not, itself,
    an item of gross income but, instead, is treated as a reduction
    in the cost of the goods sold.   See, e.g., Dixie Dairies Corp. v.
    Commissioner, 
    74 T.C. 476
    , 492 (1980).
    - 30 -
    In his reply brief, respondent describes how petitioner
    should have accounted for the rebates that respondent deems
    petitioner received on account of the vendors’ currency payments
    to member stores.   Without distinguishing between petitioner-
    delivered and vendor-provided currency, respondent states:
    “Affiliated should have reduced its cost of goods sold to reflect
    these currency rebates and thereby increased its income.   This is
    what happened, for example, with those rebates that took the form
    for a reduction in the invoice price (i.e., ‘off invoice’).”
    That, however, is not what happened with respect to off-invoice
    discounts.   Petitioner’s chief financial officer, Tammie Coffee,
    gave uncontradicted and convincing testimony that, in the case of
    show money paid by way of an off-invoice discount, the discount
    reduced both the cost of the goods sold and petitioner’s receipt
    from the sale of the goods (its gross receipt).   The net effect,
    of course, is that any off-invoice discount had no effect on
    petitioner’s gross income.8   Nor did any payment of show money
    from vendor-provided currency have any effect on gross income,
    since petitioner ignored it in determining both the cost of the
    8
    Because petitioner had a fixed right to reimbursement at
    the time it accorded an off-invoice discount to a member store,
    there should be no difference between the time it accrued the
    receipt from the sale and the time it reduced its cost for the
    goods sold. See Rev. Rul. 84-41, 1984-1 C.B. 130 (citing Wolfors
    v. Commissioner, 
    69 T.C. 975
    , 983-985 (1978)).
    - 31 -
    goods sold and the gross receipt from the sale, and respondent
    has not challenged that treatment.
    While he has misunderstood how petitioner accounted for the
    off-invoice discounts, we assume that respondent would agree
    that, as between petitioner and the vendors, any off-invoice
    discounts or deemed rebates were trade discounts, which reduced
    the cost to petitioner of merchandise purchased from the vendors.
    See sec. 1.471-3(b), Income Tax Regs. (cost of merchandise
    purchased during taxable year is invoice price less “trade” and
    certain other discounts); Rev. Rul. 84-41, 1984-1 C.B. 130, 130
    (“Trade discounts represent adjustments to the purchase price
    granted by a vendor.”).   Putting aside for the moment
    petitioner’s status as a cooperative corporation, it is difficult
    to see why the rebates that respondent deems petitioner received
    from vendors and passed on without alteration to member stores on
    sales made to those stores should not also be deemed to reduce
    petitioner’s receipts from those sales.    We have found that the
    special show discounts were based on the quantity of merchandise
    member stores ordered from petitioner at the food shows.   The
    discounts were an inducement to greater sales.   If petitioner is
    deemed to have paid any show money, its purpose was to increase
    sales (and profits9) by reducing prices.   Those deemed payments,
    9
    Petitioner ignored special show discounts in applying its
    markup to food show sales. See supra note 3.
    - 32 -
    therefore, should be considered as reducing its receipts from
    sales.
    We cannot improve on the Commissioner’s explanation in Rev.
    Rul. 2005-28, 2005-1 C.B. 997, as to why any deemed payments
    should be considered as reducing petitioner’s receipts from
    sales.   In that revenue ruling, the Commissioner holds that
    Medicaid rebates incurred by a pharmaceutical manufacturer are
    purchase price adjustments that are subtracted from gross
    receipts in determining gross income.   The Commissioner states:
    In Pittsburgh Milk Co. v. Commissioner, 
    26 T.C. 707
         (1956), * * * the Tax Court addressed whether
    allowances, discounts, or rebates paid by a milk
    producer to certain purchasers of its milk, in willful
    violation of state law, are adjustments to the purchase
    price of the milk resulting in a reduced sales price,
    or ordinary and necessary business expenses under § 162
    (in which case no deduction would be allowed under the
    rules of § 162(c)). The court reasoned that for income
    derived from the sale of property, in determining gain,
    the amount realized must be based on the actual price
    or consideration for which the property was sold and
    not on some greater price for which it possibly should
    have been, but was not, sold. The court focused on the
    facts and circumstances of the transaction, what the
    parties intended, and the purpose or consideration for
    which the allowance was made. The court found that the
    allowances were part of the sales transaction and
    concluded that gross income must be computed with
    respect to the agreed net prices for which the milk was
    actually sold. Thus, under Pittsburgh Milk, where a
    payment is made from a seller to a purchaser, and the
    purpose and intent of the parties is to reach an agreed
    upon net selling price, the payment is properly viewed
    as an adjustment to the purchase price that reduces
    gross sales. [Id., 2005-1 C.B. at 997; emphasis
    added.]
    - 33 -
    We must, therefore, consider whether petitioner’s status as
    a cooperative requires a different result.
    3.   Cooperative Status
    a.   Introduction
    Section 1382 addresses the taxable income of cooperatives,
    such as petitioner, to which section 1381 applies (individually,
    a subchapter T cooperative).     Section 1382(a) addresses the gross
    income of subchapter T cooperatives.     In pertinent part, it
    provides:
    SEC. 1382(a). Gross Income.–-Except as provided
    in subsection (b), the gross income of any organization
    to which this part applies shall be determined without
    any adjustment (as a reduction in gross receipts, an
    increase in cost of goods sold, or otherwise) by reason
    of any allocation or distribution to a patron out of
    the net earnings of such organization * * * .
    Subsection (b)(1) of section 1382 provides an exception that, in
    effect, allows a deduction from gross income for the payment of
    “patronage dividends”.    That term, in pertinent part, is defined
    in section 1388(a) to mean amounts paid by a subchapter T
    cooperative:
    (1) on the basis of quantity or value of business
    done with or for such patron,
    (2) under an obligation of such organization to
    pay such amount, which obligation existed before the
    organization received the amount so paid, and
    (3) which is determined by reference to the net
    earnings of the organization from business done with or
    for its patrons.
    - 34 -
    b.   Respondent’s Argument:   Defective Patronage
    Dividends
    As we understand respondent’s argument, it is that the trade
    discounts that respondent deems petitioner to have received from
    the vendors and to have passed on without alteration to member
    stores on sales made to those stores do not reduce petitioner’s
    gross receipts from those sales because those passed-on rebates
    were defective patronage dividends.
    According to respondent, the passed-on rebates resembled
    patronage dividends in two respects.      First, they were patronage
    based.   Indeed, respondent proposes that we find that the deemed
    rebates “were based on the amount of product purchased, or
    business done, by [petitioner’s shareholder-patrons]”.      Second,
    they were prearranged, at least in the sense that they were part
    of the negotiated sale price of merchandise ordered by member
    stores at the trade shows and were consistent with petitioner’s
    policy of passing on to member stores discounts obtained from
    vendors.    Respondent argues, however: “[P]etitoner cannot show
    that the dividends were calculated by reference to the net
    earnings of the cooperative from business done with or for its
    patrons.”    Therefore, respondent concludes:    “The amounts in
    question do not qualify for the patronage dividend deductions.”
    Respondent adds:    “Once it has been determined that the amounts
    at issue were disguised [we would say “defective”] patronage
    dividends the analysis should stop.”
    - 35 -
    But if the analysis stops there, then respondent may well
    lose.        If the passed-on rebates are defective patronage dividends
    because petitioner cannot show that they were calculated with
    reference to its patronage-based net earnings, then, perhaps,
    they were not calculated with reference to those earnings.       If
    not, then it would appear that section 1382(a) imposes no
    restriction on petitioner’s reducing its gross receipts from
    sales to member stores to reflect what respondent must concede
    are price adjustments (i.e., trade discounts).10       Nor has
    respondent advanced an argument separate from his defective
    patronage dividend argument that any provision of subchapter T
    prevents a subchapter T cooperative from subtracting trade
    10
    Moreover, in Pittsburgh Milk Co. v. Commissioner, 
    26 T.C. 707
    (1956), and cases following that decision, the Tax Court
    has held that when, as added consideration for a sale, a seller
    rebates part of a customer’s purchase price or pays that customer
    cash from a separate account, the amount of the rebate is not a
    business expense, potentially deductible under sec. 162, but,
    rather, a reduction of selling price. Regardless of whether the
    rebate is legal (viz, whether sec. 162(c) would disallow
    deduction of such an illegal rebate by that seller/taxpayer), the
    seller is treated as if it never received more than the net
    selling price (i.e., the stated selling price, less the rebate);
    the amount of the rebate is excluded from the seller’s gross
    income. See generally Max Sobel Wholesale Liquors v.
    Commissioner, 
    630 F.2d 670
    , 671-672 (9th Cir. 1980), affg. 
    69 T.C. 477
    (1977). In Max 
    Sobel, 630 F.2d at 672
    , the Court of
    Appeals for the Ninth Circuit further observed: “The Pittsburgh
    Milk doctrine has the obvious merit of reflecting economic
    reality.” The Commissioner has acquiesced to the Tax Court’s
    holdings in Max Sobel and Pittsburgh Milk. See 1982-2 C.B. 2, 4;
    see also Rev. Rul. 82-149, 1982-2 C.B. 56.
    - 36 -
    discounts accorded patrons from the purchase price it charges
    those patrons in determining gross receipts.
    We shall consider further the nature of patronage dividends.
    c.   Patronage Dividends Considered Price Adjusments
    We have said:   “Patronage dividends are considered rebates
    on purchases or deferred payments on sales, allocated or
    distributed pursuant to a preexisting obligation of the
    cooperative, and, as such, do not constitute taxable income to
    the cooperative.”    Buckeye Countrymark, Inc. v. Commissioner, 
    103 T.C. 547
    , 558 (1994).
    The notion that a cooperative should not be taxed on
    patronage-based payments because those payments amount to nothing
    more than price adjustments is a longstanding rationale
    underlying the Federal income tax treatment of patronage
    dividends.   Subchapter T was added to the Internal Revenue Code
    by the Revenue Act of 1962 (the 1962 Act), Pub. L. 87-834,
    section 17, 76 Stat. 1045.   Before the 1962 Act, non-tax-exempt
    cooperatives were taxed as corporations.   See Ravenscroft, “The
    Proposed Limitation on the Patronage Dividend Deduction”, 12 Tax
    L. Rev. 151, 152 (1957).   However, under administrative
    practices, judicially affirmed, they could exclude from gross
    income the amounts allocated to patrons as patronage dividends.
    E.g., Farmers Coop. Co. v. Birmingham, 
    86 F. Supp. 201
    , 219
    (N.D. Iowa 1949) (collecting administrative rulings).      Primarily,
    - 37 -
    two distinct theories were advanced as the reason for the
    exclusion of patronage dividends from the taxable income of
    cooperatives.     Certified Grocers, Inc. v. United States, 18 AFTR
    2d 5012, 66-2 USTC par. 9493 (M.D. Fla. 1966).     In that case, the
    District Court described those theories as follows:
    Under the so-called agency theory, the cooperative
    should never be taxed because it is conceived of as an
    agent, bailee, or trustee for the patrons, serving
    merely as a conduit for their income which it does not
    own. On the other hand, the so-called price adjustment
    theory excludes patronage dividends from income because
    it treats the dividends as minor adjustments in the
    costs of goods, analogous to discounts and rebates
    given by a seller at the time of sale or upon prompt
    payment. [Id. at 5,013, 66-2 USTC par. 9493, at
    86,547.]
    See also discussion and cases collected in Ravenscroft, supra at
    154-168; Reynolds, “What Then To Do With a Non-Cooperative
    Cooperative?” 56 Tax Law. 825, 831-832 (2003).
    The price adjustment theory appears to have been the more
    widely accepted theory.     Certified Grocers, Inc. v. United
    
    States, supra
    ; Ravenscroft, supra at 157, 160; Reynolds, supra at
    831.    Indeed, the U.S. Court of Appeals for the Fifth Circuit has
    said:
    The exclusion of patronage dividends for federal
    income tax purposes has not been placed upon the ground
    that cooperatives are special creatures of statute
    under the tax laws, but rather upon the theory that
    patronage dividends are in reality rebates on purchases
    or deferred payments on sales allocated or distributed
    pursuant to a pre-existing obligation of the
    cooperative, and thus do not constitute taxable income
    to the cooperative. * * *
    - 38 -
    United States v. Miss. Chem. 
    Co., 326 F.2d at 573
    (citing Midland
    Coop. Wholesale Oil Association v. Commissioner, 
    44 B.T.A. 824
    (1941), for the stated proposition).
    The legislative history of the 1962 Act indicates that, in
    providing a statutory deduction for patronage dividends, the tax-
    writing committees of Congress had in mind the price adjustment
    theory.   S. Rept. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B.
    707, 822 (“patronage dividends represent price adjustments”); H.
    Rept. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 405, 485-486
    (similar).
    d.   The Price Adjustment Theory Has Its Limits
    An examination of the limited caselaw on the subject and
    scholarly and other authoritative writings convinces us that,
    although the Federal income tax treatment of patronage dividends
    may rest substantially on the price adjustment theory, a price
    adjustment made by a cooperative may reduce its gross income even
    if the adjustment does not qualify as a patronage dividend.
    It has long been understood that the distinguishing
    characteristic of a cooperative enterprise is the obligation of
    the enterprise to distribute what may be called its “excess
    receipts” (or “net margins”) on a patronage basis.   See Packel,
    Law of Cooperatives 248–249 (3d ed. 1956).   While there is some
    question as to whether, with regard to a cooperative enterprise,
    the concept of profit is appropriate (since the enterprise is run
    - 39 -
    for the benefit of those who do business with it and not for the
    purpose of making a profit for the organizers), the idea is that,
    periodically, any surplus, or amount in excess of the break-even
    point from doing business with patrons, will be returned to the
    patrons on the basis of their dealings with the cooperative
    (i.e., on a patronage basis).    See 
    id. Indeed, today,
    for
    Federal income tax purposes, patronage dividends are determined
    by reference to the “net earnings” of the organization from
    business done with or for its patrons.     Sec. 1388(a)(3); sec.
    1.1388-1(a)(1), Income Tax Regs.    The regulations describe “net
    earnings” as including “the excess of amounts retained (or
    assessed) by the organization to cover expenses or other items
    over the amount of such expenses or other items.”     Sec. 1.1388-
    1(a)(1), Income Tax Regs.
    Notwithstanding the question of the appropriateness of the
    term “profit” with respect to a cooperative enterprise, both
    early administrative interpretations and judicial decisions
    conceived of a patronage dividend not as a simple price
    adjustment or immediate rebate but as a distribution of corporate
    profits or income.   In O.D. 64, 1 C.B. 208 (1919), the
    Commissioner ruled concerning an incorporated fruit grower’s
    association that conducted its business at a profit.     It ruled
    that the nonexempt corporation would not have to pay any income
    tax on its patronage dividends.    It authorized the corporation
    - 40 -
    to:   “deduct from gross income amounts periodically returned to
    members as a refund of profits on business transacted with them,
    and proportioned to the amount of such business.”   
    Id. (emphasis added).
      In United Coops., Inc. v. Commissioner, 
    4 T.C. 93
    , 107-
    108 (1944), we held that an agricultural cooperative was entitled
    to exclude from gross income as a patronage dividend the excess
    of its net income available for distribution to its patrons (and
    to which they had a right) over the amount of that income that
    the cooperative had discretion to pay as dividends on its common
    stock.    We said:
    These dividends, if paid, would be paid out of net
    income. If dividends were not paid, then the net
    income of petitioner available for distribution to its
    patrons would be accordingly greater. The choice of
    whether so much of its net income as equaled 8 percent
    of the par value of its common stock should be
    distributed to its stockholders as a dividend or to its
    patrons as rebates was in the corporation. * * * [Id.
    at 108; emphasis added.]
    It hardly seems disputable that, whether by administrative or
    judicial decision, or by act of Congress, the allowance of a
    deduction for patronage dividends was intended not to confirm
    that a trade discount is a proper adjustment to the price
    reported on a particular sale of a good or service to a patron
    (whether a shareholder or not) but was intended to allow a
    deduction for a patronage-based return made from the excess
    proceeds from many sales, to many patrons (i.e., from net
    earnings), over the course of time.
    - 41 -
    That patronage dividends are somehow different from
    transaction-specific price reductions was recognized well before
    Congress codified the definition of a patronage dividend in 1962.
    The difference was recognized by courts overseeing legislative
    price regulation in fields in which cooperatives operated.    In
    1950, the U.S. Court of Appeals for the Third Circuit held that a
    purchasing cooperative cannot use its cooperative status as a
    shield against State Fair Trade Laws prohibiting price reductions
    at the time of sale.   Sunbeam Corp. v. Civil Serv. Employees’
    Coop. Association, 
    187 F.2d 768
    (3d Cir. 1951).   Also in 1950,
    the California District Court of Appeals held that the provisions
    of the California Corporations Code that permit a cooperative
    corporation to distribute its earnings to its shareholder-patrons
    are paramount to the provisions of the California Alcoholic
    Beverage Control Act that prohibit sales of liquor at less than
    posted prices and secret rebates.   Certified Grocers v. State Bd.
    of Equalization, 
    223 P.2d 291
    (Cal. Dist. Ct. App. 1950).
    A categorical difference between patronage dividends and
    transaction-specific price reductions had been recognized by
    commentators.   See, e.g., Packel, supra at 217 (“It is important
    to distinguish a price reduction, given at the time of the
    transaction, from a true patronage dividend.”); Bunn, Consumers’
    Co-Operatives and Price Fixing Laws, 
    40 Mich. L
    . Rev. 165, 173
    (1941) (“The truth is that a patronage dividend is not a price
    - 42 -
    reduction on any given sale.”).   One commentator has explained
    the distinction as being based on the impracticability, if not
    the impossibility, of relating patronage dividends to gain or
    loss upon any particular transaction with any particular patron.
    Adcock, “Patronage Dividends: Income Distribution or Price
    Adjustment”, 13 Law & Contemp. Probs. 505 (1948).   As explained
    by Professor Bunn (who, in Sunbeam Corp. v. Civil Service
    Employees’ Cooperative 
    Assn., supra
    , was credited for his
    “scholarly discussion” that “greatly helped” the court):
    [A patronage dividend] cannot be allowed or promised
    when a sale is made, for it is made from earnings only,
    and no one can be sure there will be any earnings. Our
    business may sell at an eighty per cent mark-up and
    still go broke if overhead exceeds that spread. And we
    will not know our overhead per unit until we know our
    total volume. Neither will we know our bad debts, or
    other losses. We may make shrewd guesses, and quite
    close estimates of earnings if we know our business
    well, but we cannot be sure, and therefore we can never
    promise. * * *
    Bunn, supra at 173.   Professor Bunn concludes:
    True patronage dividends are divisions of net earnings.
    Net earnings are not made on any single sale. They
    result from the total operations of some accounting
    period, and become known only after the results for
    that period are in. A distribution of them, on
    whatever basis, is not a price reduction nor a rebate
    * * * .
    
    Id. (fn. ref.
    omitted).
    - 43 -
    e.   Conclusion
    We do not believe that Congress intended to subsume within
    the definition of the term “patronage dividend” transaction-
    specific price reductions such as are encompassed by the term
    “trade discount”.   While the term “rebate” may sometimes be used
    in explaining the allowance of the deduction for patronage
    dividends, see, e.g., Buckeye Countrymark, Inc. v. Commissioner,
    
    103 T.C. 558
    , we agree with the commentators that there is a
    categorical difference between a rebate in the nature of a trade
    discount and a patronage dividend.     A patronage dividend is paid
    under an obligation to distribute some or all of net earnings of
    the enterprise on the basis of patronage.11    Respondent puts his
    finger right on the difference when he argues that petitioner
    cannot show that the passed-on rebates he deems petitioner to
    have made “were calculated by reference to the net earnings of
    the cooperative from business done with or for its patrons.”
    They were not; they were calculated exclusively with reference to
    the rebates accorded to petitioner by the vendors on account of
    orders taken by petitioner from member stores at the food shows.
    If we were to agree with respondent that, for lack of a net
    11
    In theory, of course, a cooperative could set its prices
    so as to minimize its profit and reduce the amount available for
    patronage dividends. That has been referred to as the “pricing
    out” problem, which may exist more in theory than in practice.
    See Patterson, The Tax Exemption of Cooperatives 89-90 (2d rev.
    ed. 1961). In any event, it does not concern us here.
    - 44 -
    earnings connection, the passed-on rebates fail as price
    adjustments because they are defective patronage dividends, then
    what of other transaction-specific rebates, refunds, or price
    adjustments?   Are we to conclude that, if a purchasing
    cooperative has a buy-two-get-one-free sale, offers a loss-leader
    or a volume discount, or, indeed, sells any good or service for
    less than some hypothetical normal price, it has paid a defective
    patronage dividend unless, in some way, it can show that the
    price reduction is a distribution of net earnings?    Indeed, must
    any merchant offering a rebate, refund, or other price reduction
    consider whether it is operating on a cooperative basis,
    distributing defective patronage dividends?    We think not.
    We conclude that a transaction-specific price reduction,
    such as is encompassed by the term “trade discount”, is not
    generally determined with respect to the net earnings of the
    payer, and, for that reason, it is not a patronage dividend
    (defective or not).
    4.   Other Factors
    Respondent argues that petitioner “has virtually no records
    of the currency incentives used at the food shows.    It destroyed
    most of the relevant records.    * * *   This fact combined with the
    use of cash invites suspicion.”    While it is true that petitioner
    discarded most all of the tear strips after the relevant
    information was entered into its billing and accounting records,
    - 45 -
    petitioner had sufficient information to compute its margin on
    each sale.   There also is a stipulation as to the net amount of
    petitioner-delivered currency retained by the vendors.   There is
    no evidence confirming the actual payments of petitioner-
    delivered currency by vendors to member stores, but the deemed
    fact of those payments underlies respondent’s adjustments.    While
    cash payments to member stores might invite abuse by the member
    stores, there is no evidence of any such abuse here, and, to the
    extent that payments were actually made by the vendors to member
    stores, we assume that the vendors had adequate motivation to
    keep adequate records of those payments.   In short, whatever
    shortcomings exist in petitioner’s records, respondent has failed
    to convince us that those shortcomings justify denying petitioner
    a reduction in the amount of its gross receipts from sales to
    member stores on account of deemed rebates that respondent would
    charge against petitioner’s costs of goods sold and would treat
    as having been passed on as price reductions to the member
    stores.
    5.   Conclusion
    The deemed rebates that respondent charges petitioner with
    making are (if they are to be charged to petitioner) properly
    characterized as trade discounts.   They were not paid with
    reference to petitioner’s net earnings but merely passed along
    price adjustments that petitioner was entitled to on account of
    - 46 -
    the orders placed by the member stores at the food shows.     They
    reduce petitioner’s gross receipts and are not defective
    patronage dividends.12
    C.   Conclusion
    For the audit years, petitioner had no items of gross income
    on account of petitioner-delivered currency paid by vendors to
    member stores as show money.
    IV.   Conclusion
    In the light of the foregoing,
    Decision will be entered
    for petitioner.
    12
    Our conclusion is, of course, based on the assumption
    that the petitioner-delivered currency paid to member stores
    flowed through petitioner, as passed-on rebates, in the manner
    
    described supra
    in sec. III.B.1 of this report. We do not decide
    that manufacturers’ rebates paid directly to retail customers are
    necessarily deemed to pass through the retailer. Such a rebate
    was addressed by the Commissioner in Rev. Rul. 76-96, 1976-1 C.B.
    23, suspended in part by Rev. Rul. 2005-28, 2005-1 C.B. 997,
    which describes an automobile manufacturer’s rebate paid directly
    to qualifying retail customers and gives no indication that the
    rebate was considered to have flowed through the retailer.