Retail cash advances: loans or income?

• Author: Shevak, Richard

Often, a retailer will enter into an agreement with a supplier under which it receives a large cash payment and commits to purchase a certain volume of goods. The supplier may require the retailer to sign a note obligating it to repay the advanced funds unless certain volume goals are met, and may require a security interest in inventory or other property. The question is how the retailer should treat the payment received.

In light of two recent Tax Court decisions, and the IRS's response thereto, the answer is not clear. A review of these cases may lead one to conclude that whether the cash advance is a loan may be in the eye of the beholder. Unfortunately, if the Service is viewing the transaction, the result may not be good for the taxpayer.

Erickson Post

In Erickson Post Acquisitions, TC Memo 2003-218, a retail gas station operator received $175,000 from Amoco (its supplier) in exchange for a promise to purchase and sell only Amoco products for a five-year period. The taxpayer executed an interest-bearing promissory note providing for the repayment of the cash advance in annual installments. The note provided that the amounts due would be deemed paid if the supply agreement remained in full force and effect. Neither party breached or terminated the supply agreement. Consequently, Amoco forgave the annual loan payments, as the taxpayer met its obligations under the agreement.

The taxpayer treated the $175,000 as unearned revenue and recorded it as a liability prorated over 10 years (the note's length). The taxpayer did not characterize the $175,000 payment as a loan, nor did it deduct accrued interest payments. On audit, the IRS determined that the $175,000 advanced by Amoco was income to the taxpayer in the year received.

The taxpayer contended that the $175,000 was a loan forgiven incrementally on the due date of each annual installment; the Tax Court agreed. In support of its conclusion, it pointed to the following: (1) the existence of a promissory note calling for fixed annual payments; (2) the debt was secured by the taxpayer's real property and a mortgage was recorded in the local county recorder's office; and (3) Amoco routinely enforced the collection of promissory notes in the event retailers defaulted. According to the court,"[t]he focus is on the obligation created at the time of the transaction"

The Service, on the other hand, argued that the taxpayer's obligation was subject to a condition precedent and, thus, was not a...