Current deduction vs. capitalization of fees for shelf space - IRS circulates draft proposed coordinated issue paper.

• Author: Conjura, Carol

Food manufacturers that incur costs to obtain shelf space in retail outlets may have to capitalize these costs, based on a recently circulated IRS draft proposed coordinated issues paper. These expenditures, otherwise known as "slotting allowances," may be paid in the form of cash, product or product discounts.

Proposed IRS position

The Service concluded in its draft coordinated issues paper that slotting allowances are generally nondeductible capital expenditures, since they provide a benefit substantially beyond the tax year in which incurred. The IRS explained that INDOPCO, 112 Sup. Ct. 1039 (1992), gave more prominence to the presence of a significant future benefit as the predominant test for requiring capitalization of a business expenditure.

If the Service ultimately adopts this position, food manufacturers would be required to capitalize slotting allowances in all circumstances other than those in which the manufacturer is specifically required by contract to pay an annual fee to retain the right to shelf space for the following year. The manufacturer would be able to amortize amounts that are capitalized, but only to the extent that it can establish that the right to shelf space will expire after a limited time specified in the contract. in the absence of such an agreement, the expenditure would have an indeterminable useful life and no cost recovery would be allowed unless (and until) either the product fails or the shelf space is vacated.

Arguments against proposed IRS position

In many circumstances, the nature of any potential future benefit from an allotment of shelf space is comparable to that inherent in any other advertising expenditure. As such, the tax treatment of slotting allowances arguably should be governed by Rev. Rul. 92-80, which held that INDOPCO did not affect the current deductibility of ordinary product advertising expenses.

In Rev. Rul. 92-80, the IRS stated that "[o]nly in the unusual circumstance where advertising is directed towards obtaining future benefits significantly beyond those traditionally associated with ordinary product advertising or with institutional or goodwill advertising, must the costs of that advertising be capitalized." Arguably, slotting allowances that do not provide the manufacturer with a specific contractual right to an allotment of shelf space beyond the year immediately following the year of the expenditure would follow...