rr-98-39.pdf

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# Part I

Section 461. -- General Rule for Taxable Year of Deduction

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

## Rev. Rul. 98-39

### ISSUE

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

FACTS

X, an accrual method taxpayer using a calendar year as its
taxable year, manufactures various consumer products, including
product M. Retailers engaged in the business of selling
merchandise to consumers purchase product M from X for resale.
In August of Year 1, X made a written offer to pay each of these
retailers $1 for each case of product M that the retailer
purchased from X during September, October, and November of Year
1, provided that the retailer advertised X's product M during
October or November of Year 1. To qualify for X's payment, the
advertising provided by the retailer had to satisfy the
requirements set forth in X's offer regarding the format and
content of the advertising (including the offering of a discount

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on product M), and the time for performance of the advertising.
X's offer further required that, to obtain payment, the retailer
☒
had to submit a claim form and proofs of performance within 90
days after the date that the advertising was performed, verifying
that the advertising was performed in accordance with the terms
of X's offer.
☒

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

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

LAW AND ANALYSIS

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

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

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

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

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

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

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

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

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

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that did not postpone accrual of income otherwise earned) . See
also Continental Tie & Lumber Co. v. United States, 286 U. S. 290
(1932) .

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

In the cooperative advertising agreement between X and Y,
the performance required under the agreement is the provision of
advertising services. Y's submission of a claim form and proofs
of performance substantiating that it has performed the
advertising according to X's specifications is merely the
mechanism by which Y requests payment for advertising services
already performed. Thus, similar to Dally and Frank's Casing,
Y's submission of the claim form and proofs of performance is a
ministerial act, much like the submission of an invoice. These
facts distinguish the cooperative advertising agreement between X

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and Y from General Dynamics and demonstrate that Y's submission
to X of the claim form and proofs of performance is a mere
technicality, not a condition precedent that is necessary to
establish X's liability for § 461 purposes.

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

HOLDING

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

Any change in a taxpayer's method of accounting to conform
with this revenue ruling is a change in method of accounting to
which the provisions of $$ 446 and 481 and the regulations
thereunder apply. A taxpayer wanting to change its method of
accounting for its payments for cooperative advertising services

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

EFFECT ON OTHER DOCUMENTS

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

DRAFTING INFORMATION

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