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Food Industry Overview - Complete Version

LMSB-04-0207-018

"This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited, or relied upon as such."

Table of Contents

  1. Introduction
    A. Purpose of Industry Overview
    B. Use of the Intranet and Internet
    C. General History of Technical Advisor Program (TAP)
    D. History of Food TAP
    E. Industry Specialist Staffing (Technical Advisors in LB&I)
    F. LB&I Industry Staffing
    G. Description of the Food Industry
  2. Industry Operating Procedures
    A.   Restaurant Industry
    B.   Beverages (Alcoholic and Non-Alcoholic)
    C.   Food Manufacturers
  3. Government Regulatory Requirements
    A.   Federal Requirements
    B.   State Requirements
    C.   Local Requirements
  4. Significant Law and Important Issues
    A.   Coordinated Issues
    B.   Emerging or Other Significant Issues
    C.   Recent or Pending Legislation
    D.   Specific Industry Related Tax Law
    E.   Important Revenue Rulings or Revenue Procedures
    F.    Important Court Cases
    G.   Technical Advice Memorandums – Field Service Advices
  5. Industry Resources
    A.   WEB Sites
    B.   Trade Associations
    C.   IRS and Other Training Courses/Videotapes
    D.   Trade Magazines and Newsletters
    E.   Industry Books
    F.    Internal Revenue Manual Citations
    G.   AICPA Auditing Standards and Publications
    H.   Market Segment Specialization Program (MSSP)
A.   Complete Listing of Industry Overviews Available

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1. Introduction

A. Purpose of Industry Overview - This overview is designed to provide industry-related information to all Large Business & International (LB&I) Division.   This is a step in the effort of LB&I to develop a greater level of expertise in the industry or industries to which you will be assigned.   This overview is one of a series of industry specific overviews.  See the Appendix for a complete listing of available overviews.

B.  Use of the Intranet and Internet - Each Technical Advisor has established a web site on the LB&I Intranet.  These web sites contain more detailed information on each Technical Advisor area.  Topics that have been included in this Industry Guide are sometimes expanded upon and new topics may be added.  Each web site also has a “Hot Topics” section where Technical Advisors can highlight the latest developments such as new court cases, new technical advice memorandums, new revenue rulings, etc.  A section called “LB&I Forums” was also established.  Individuals will be able to write questions they have about various issues.  Others reading the question may be able to help you with your issue. 

C.  General History of Technical Advisor Program (TAP) formerly known as the Industry Specialization Forum (ISP)

 

 

Date

Event

1952 The Service was restructured in 1952 into a highly decentralized organization consisting of seven regions and 58 districts.  This reorganization was implemented in part to achieve greater sensitivity and responsiveness to pubic needs.  District Directors were given wide latitude and authority in administering the Service's policies, procedures and programs.  While decentralization of the Service proved to be a progressive action, communication between the regions and districts was made more difficult because of their quasi‑autonomy.  Positions taken by the Service on industry issues could differ significantly from one region to another on the same issues.
1971 The Service implemented the Industry Wide Examination Program to concurrently examine the major taxpayers in a given industry, coordinate selected issues common to that industry and to resolve those issues uniformly and consistently among all the industry taxpayers.  Under the direction of project coordinators (usually large case branch chiefs), the industry wide examinations were largely successful in achieving uniform and consistent treatment of issues.  Industry wide examinations were conducted in several industries between 1971 and 1979 and the ability to communicate freely across district and regional lines proved to be invaluable to the success of these examinations.
1977 The Industry wide Examination Program had one major drawback.  Since they existed for only two or three tax years and were then terminated, the program failed to provide continuity.  To correct this situation, a major study group was created in 1977 to review the Service's Coordinated Examination Program.  The study recommended that permanent positions be established for several Industry Specialists and a National Industry Coordinator.  In addition, the study group identified basic industries to which it recommended specialists be assigned.  The duties and responsibilities of the Specialists and the Coordinator were to be much broader than the former Project Coordinators whom they replaced.
1979 The recommendations of the study group were implemented greatly expanding the scope and depth of the Industry wide Examination Program.  The term, Industry Specialization Program, eventually evolved as a name that could encompass the varied concepts of Industry Specialists, National Industry Coordinator, Coordinated Issues, and the many refinements suggested by the study group.
2000 As part of the Internal Revenue Service’s restructuring, the Industry Specialists were assigned to Pre-Filing and Technical Guidance which is part of LMSB, Headquarters.  The “Industry Specialists” are now called Technical Advisors.  Each of them was placed in one of the five industry areas and is managed by a Technical Advisor Manager.

D.  History of Food ISP

 

 

Date

Event

1984 - 1986

Conducted study of food industry, 55 cases in 7 regions included in the program study. 

1986

Food industry approved for inclusion in ISP

1987 - 1992

Coordinated issue papers and appeals settlement guidelines developed.

E.  Industry Specialist Staffing (Technical Advisors in LB&I)

 

Name of Specialist

Telephone #

FAX #

Email Address

 

Philip Hofmann, Food

316-352-7434 316-352-7255 Philip.J.Hofmann@irs.gov
Eric Lacher, Gaming 702-868-5262 702-868-5442 Eric.A.Lacher@irs.gov

F.  LB&I Industry Staffing - The Industry Specialist is assigned to the Pre-Filing and Technical Guidance Division that is a part of LB&I Headquarters.  Each industry is assigned to one of the five Industry Functional Divisions.  Industry Specialists will be known as technical advisors in LB&I and will be supervised by a Manager, Technical Advisors.  Information relative to the management in the Industry Division that this industry is assigned as well as the Manager: of the Technical Advisor(s) of this industry is as follows:

 

Name

Title

Location

Sergio Arellano Industry Director, RFPH

 

Downers Grove, IL

Jim Roosey Field Operations Director West, RFPH

 

Downers Grove, IL

Lori Nichols Field Operations Director East, RFPH Louisville, KY
Greg Zielinski Manager, Technical Advisors, RFPH

 

Chesterfield, MO

Kathleen Follis Manager, Technical Advisors, CTM

 

King of Prussia, PA 

Paul Knap Industry Counsel

 

Milwaukee, WI

Jessica Yip Senior Program Analyst, RFPH

 

Downers Grove, IL

 

 

G.  Description of the Food Industry

The Food Industry program covers taxpayers involved in the manufacture and distribution of food, alcoholic beverages, non-alcoholic beverages and the restaurant industry.

The North American Industry Classification System (NAICS) has replaced the U.S. Standard Industrial Classification (SIC) system.    The major NAICS categories for the Food Industry are:

  • 311 Food Manufacturing
  • 312 Beverage Manufacturing
  • 445 Food and Beverage Stores
  • 722 Food Services and Drinking Places

This industry is also comprised of many sub-industries.  The following is a sample of the data for these sub-industries.   Information on each of these sub-industries is available on the Internet at:   http://www.census.gov/epcd/naics02/naicod02.htm

  • 31123 Breakfast Cereal Manufacturing
  • 31141 Frozen Food Manufacturing
  • 31151 Dairy Product (except Frozen) Manufacturing
  • 31181 Bread and Bakery Product Manufacturing
  • 31211 Soft Drink and Ice Manufacturing
  • 31212 Breweries
  • 31214 Distilleries
  • 44511 Supermarkets and Other Grocery (except Convenience) Stores
  • 72211 Full-Service Restaurants
  • 72221 Limited-Service Eating Places
  • 72241 Drinking Places (Alcoholic Beverages)

The Food ISP also covers food brokers.   Not all food products are sold by brokers but there is significant activity. Typically, many of the food brokers are in SB/SE.

 

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2. History of Food Industry

As it exists today, the domestic food and beverage industry is a very competitive and mature industry with little domestic growth. Increases in a company’s market share usually come at the expense of a competitor’s loss of market share (cannibalization). Overall most growth comes from international expansion.  With the passage of NAFTA and GATT, many domestic companies are either entering into alliances with foreign entities, or acquiring them.  There are many reasons for this.  For example, much domestic food and beverage companies want to take advantage of existing distribution systems, or underutilized plant capacity.  Some acquisitions may be motivated by Federal income tax considerations.

From the time that agriculture began about 7,000 years ago to the present there have been many important developments that are responsible for the state of the industry as it is today.  The following events have had a major impact on where the industry is today. 

 

 

Event

Explanation

IRRIGATION The use of some form of irrigation is well documented throughout the history of civilization. It has enabled food production to occur in areas previously too hostile for plants and to counter the effects of drought.
INDUSTRIAL REVOLUTION Resulted in mass production of food products at lower cost and consistent characteristics.
FOOD PRESERVATIVES Classified into two main groups, antioxidants that delay or prevent the deterioration of foods by oxidative materials and antimicrobial agents that inhibit the growth of spoilage and pathogenic microorganisms in food.
PACKAGING Tinned products came to America in 1822 and allowed food to be stored for long periods of time.  Some packaging processes were developed to enable Napoleon’s armies to carry war to distant areas and remain well fed.
PASTEURIZATION A partial sterilization accomplished by raising milk to a temperature high enough to destroy pathogenic bacteria.  This process allows milk to remain consumable for about 14 days if refrigerated in closed containers.
TRANSPORTATION First, railroads and barges, then trucks and air transportation have enabled many food products to be enjoyed in regions where food cannot be grown.  Many locally grown food products can be consumed globally (bananas, fish, fruit, etc.).
PESTICIDES Enabled farmers to significantly increase yield.
NUTRITION In the 1950’s and forward, nutrition became a major concern for production/consumption.  The emphasis on eating healthy has spawned a new market segment; for example organic foods, low-fat foods and healthy foods all enjoy healthy margins and increased demand.

All of the aforementioned technological developments have played a major role in the evolution of the food and beverage industry.  There have also been some business developments that have had an impact on the current state of the industry.

 

 

Event

Explanation

FUTURES MARKETS Many food manufacturers participate in the futures markets by entering into futures contracts to “hedge” against price fluctuations for their inventories of raw materials. 
GOVERNMENT AGENCIES OSHA and the FDA, have had a dramatic effect on the meat and food processing plants. They have helped ensure safety in production and consumption.
PRODUCT BRANDING Branding of products is accomplished by extensive advertising, in many instances this product advertising costs more than the cost of production.  Branding is partially responsible for the emergence of radio and television (soap operas).
FRANCHISING In the 1950’s and 1960’s, the concept of franchised restaurants was promoted.  This enabled franchisers to expand with limited capital investment.
MERGERS and ACQUISITIONS In the 1980’s there were many mergers and acquisitions of food and beverage companies.  This trend continues today.  Many companies are actively buying and selling brands like baseball teams trade players.

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3. Trends

Beginning in the early 1980’s, there has been extensive merger and acquisition activity in the food and beverage industry. Many companies are selling specific brands to competitors in an effort to get back to its “core business”. Several food and beverage manufacturers have spun off their restaurant businesses.

There is also a trend in the food and beverage industry to get to a paperless inventory system.  With the improvements in scanning equipment this is made possible.  In many instances ordering, delivery, payment and stocking is all initiated and accomplished by software prompted by information captured by scanning equipment with very little human involvement.

Franchising continues to flourish in the restaurant and food distribution segments.

 

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4. Industry Terms

 

 

Industry Term

Definition or Explanation

Account-specific marketing The practice of tailoring marketing programs to specific-customers.
Accrual The amount of funds earned through purchases over a stated period. Usually earned on the basis of so much per dollar or per item purchased.
Accrual period The period during which purchases accrue allowances.
Ad scrip A certificate entitling a retailer to a specified amount of co-op funding. Often used as a means to provide allowances to indirect customers.  Sometimes called “co-o in a box”
Advertising deadline The last date by which advertising may take place if it is to qualify for reimbursement.
Affidavit of performance A sworn statement that provides information about certain advertising.  Typically refers to a statement from a medium, such as a radio, cable, or television station or an outdoor supplier.
Audit A process by which a claim is analyzed and a determination made as to whether a claim falls within program guidelines and, if so, how much should be paid.
Automatic inventory replenishment An arrangement by which a retailer authorizes a manufacturer to monitor the retailer’s inventory of the manufacturer’s products and automatically ship additional products when inventory reaches certain levels.
Barter The trading of merchandise instead of paying cash for advertising.
Carryover period. A period after the end of a co-op program during which a retailer can spend funds left over from the program.
Category killers A relatively new class of exceptionally large retail stores that is devoted to one category of merchandise, examples are Home Depot, Best Buy.  Also called superstores.
Claim The invoice from a retailer or other intermediary for reimbursement of the cost of advertising or promotion of a supplier’s product or service.
Cooperative advertising Any arrangement by which a product or service is brought to public notice over the names of both the supplier and any intermediary who comes between that supplier and the ultimate purchaser.  The intermediary may be a retailer who buys a product for resale, a distributor who sells to retailers or other form of intermediaries.  This arrangement results in consumer advertising as well as other forms of promotion.  The cost of the promotion may be shared by the supplier and the intermediary, or the supplier may pay all costs.  The process commonly involves reimbursing retailers for advertising they create and place.
Credit memo An alternative to cash as reimbursement to customers for cooperative advertising.  The supplier issues a credit memo that authorizes the retailer to deduct that amount from the next payment to the supplier.
Deal/deal period A time frame during which a manufacturer offers products to its customers at unusually low prices and/or with other inducements, such as increased co-op accruals or volume rebates.  Most common in the packaged goods industry.  Some deals may induce a customer to buy more products than can be sold during the deal period, leading to diverting.
Deduction A retailer’s subtraction of co-op charges from the supplier’s invoice.
Direct customers Customers who buy directly from the manufacturer without going through a wholesaler.
Display allowances Payment by a manufacturer to a retailer for in-store displays or for preferential shelf space or positioning.
Diverting The practice of buying a product on deal in one area and reselling it in another area where it is not on deal.  Often done by retailers who resell to other retailers or to other divisions of their own company.
Efficient consumer response (ECR) A catch all term covering a variety of actions undertaken by many food and packaged goods manufacturers, distributors, and retailers to improve distribution practices and clean up abuses in the industry.  Trade allowance practices including deductions, are a major component of the process.
Electronic data interchange (EDI) A variety of techniques by which firms communicate with each other, generally through computers tied into dedicated networks using standardized formats.
Everyday low pricing (EDLP) Originally a retailing concept most often practiced by warehouses and clubs, in which there are no or few off-price promotions; any deals are averaged into the everyday price and products are offered at the same price consistently.  Has now spread into manufacturing, where some companies call it  “value pricing”
Failure fees Payments made to retailers when a product is discontinued due to lack of movement.
FTC Guides Federal Trade Commission Guides for Advertising Allowances and Other Merchandising Payments and Services.  The Guides present the FTC’s view of how suppliers, retailers, media, and others can comply with the terms of the Robinson-Patman Act as it relates to promotional allowances.  Issued in 1960 and reissued with major modifications in 1969 after a Supreme Court decision in the case of FTC v. Fred Meyer, Inc.
Just-In-Time The concept of cutting inventory costs by ordering supplies only as needed.  Pioneered in manufacturing by the Japanese, now increasingly popular among retailers.
Key market funds Funds over and above the normal co-op allowances made available by suppliers for use only in certain markets in which they have a strong interest.
Market development funds (MDF) Extra funding given to specific retailers for specific purposes, such as a major seasonal promotion, by the manufacturer’s sales and/or marketing management.  These funds generally are not given out on a proportional basis, when this is the case; they are of questionable legality (Robinson-Patman Act).
Multi-vendor programs Programs in which two or more manufacturers jointly offer a promotion to their retailers.
Off-invoice The practice of taking an allowance directly off the price of the product, rather than submitting a claim for payment of the allowance.
Overbill A practice among some retail buyers who ask suppliers to bill in excess of the regular price and hold the excess funds at the buyer’s disposal to be used for promotional or other purposes.  Sometimes stimulated by management pressure on the buyer to seek money over and above the supplier’s regular allowance.  In other cases, buyers use this approach when they want to promote an item for which no store funds are available.  In some industries, called “price loading”
Pay for performance. Programs offering to pay retailers a specified amount for each unit of the manufacturer’s product sold during a specified period usually based on scanner data.
Push money The practice by which a manufacturer offers cash or other inducements to retailer’s salespeople to encourage them to recommend its products to potential buyers.  Most common format is to offer the salesperson a certain amount per unit sold during s specified time period.  A common variant is to offer points, which the salesperson can sue to buy various merchandise from a manufacturer-supplied catalog.  Also known as “spiffs”
Robinson-Patman Act Federal legislation requiring that all competing customers of a supplier who offers promotional help to those customers must be treated on an equal basis.
Sales contest A form of push money in which, instead of offering cash incentives, the manufacturer offers participating retail salespeople the opportunity to win some kind of prize, either through a drawing or by achieving defined levels of sales.
Slotting/slotting allowances Payments by a manufacturer to a retailer for the retailer’s shelf space.  Sometimes also used incorrectly to refer to payments for displays or preferential shelf space.
Soft dollars Promotional allowances. 
Stock-keeping unit (SKU) Each item inventoried by a retailer. For example,  “Widget” might represent several SKUs for typical grocery store, one SKU for each size, style, etc.  The more shelf space required, the more inventory cost.
Trade loading The practice of inducing retailers or distributors to take on unusually large amounts of merchandise, generally by offering exceptional prices or terms.  Often done at the end of a quarter or other financial reporting period in order to reach quotas.
Vendor support programs Requests by retailers for extra funding for specified promotional efforts.  Such programs are often illegal.
Vendors Name typically used by retailers to refer to manufacturers.

 

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5. Accounting Principles

There are not any industry specific special accounting requirements for companies in the food and beverage industry. Companies in the food and beverage industry have significant marketing activities and make large year end accruals for outstanding liabilities incurred as a result of promotional activities with brokers and retailers. A thorough understanding of IRC Section 461 especially relating to the recurring item provisions of this code section is necessary.

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6. Information Systems

Point of Sale systems are used extensively in the retail restaurant industry.  Store cash registers are linked up with computerized systems that prepare perpetual accounting functions and facilitate inventory replenishment, and internal controls over ordering and sales.

Many food manufacturers and brokers use outside firms to account for their promotional activities with their retailers.  These systems contain information about customers ordering habits, promotional activities, promotional results, cooperative advertising, etc.  The Food and Beverage Industry Technical Advisor has information about these systems.  

 

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7.  Industry Operating Procedures

 

A.  Restaurant Industry

As a general rule full service restaurants are for the most part company owned with very little franchising.  Fast food restaurants are heavily involved in franchising activities.  Franchisees will pay a fixed per-cent of receipts to a franchiser for advertising and royalties.  Some fast food franchisers will lease the structure to the franchisee for a monthly rate or a percentage of sales.

Suppliers will help restaurant chains with marketing and advertising funds.  It is not unusual for major suppliers to offer rebates or provide upfront payments to obtain exclusive supplier status.

The internal controls of these chain restaurants are extensive; conversely individual independent restaurants do not always enjoy these controls over operations.

Normally restaurants purchase from foodservice companies or they may purchase their inventory from a national chain commissary.  Perishable goods are usually purchased from a local vendor.

Four tip reporting programs are available for these taxpayers to enter into with the Service.  Two of these pro forma documents are titled Tip Reporting Alternative Commitment (TRAC) and Tip Rate Determination Agreements (TRDA).  The IRS developed the Employer Designed Tip Reporting Alternative Commitment (EmTRAC) Agreement program in response to employers in the food and beverage industry who expressed an interest in designing their own TRAC programs.  Attributed Tip Income Program (ATIP) is a new three-year pilot program for food and beverage employers.  The first annual basis begins January 1, 2007.  Details and requirements for participation for employers and employees are available in Revenue Procedure 2006-30.

The agreements serve a dual purpose: improving compliance of tipped employees and avoiding tip examinations.  The TRAC agreement is by far the more popular with large and midsized taxpayers.  It can be obtained at:http://www.irs.gov/businesses/small/industries/article/0,,id=98367,00.html

B.  Beverages

Normally manufacturers of alcoholic and non-alcoholic beverages sell to distributors who own a franchise to sell in a given geographic area.  There is extensive government oversight over the liquor industry and individual states and local jurisdictions usually have rules and regulations affecting the sale of these beverages within their jurisdictions.

These beverage companies are very competitive and are focusing a lot of their activities in expanding internationally.

 

C.  Food Manufacturers

It is not uncommon for food manufacturers to spend more money advertising its products than making the product.  Most of these companies have to pay a fee to get a retailer to provide shelf space for the manufacturer’s products (slotting payments).  Some of the largest national advertising budgets are those of food and beverage companies.

Manufacturers (vendors) provide various discounts and promotional funds to retailers, (volume, price, early payment, seasonal, rebates, cooperative advertising funds, market development funds, slotting, etc.)

ECR (Efficient Consumer Response) is a concept that has been around since the late 1980’s and is an initiative undertaken jointly by the manufacturers, distributors and retailers to improve distribution practices and clean up abuses in the industry.  Trade allowance practices, including deductions are a major component of the process.    The scanning features on cash registers provide data to all parties to make this process more efficient.

The use of coupons is extensive; many manufacturers have set up web-sites that provide coupons on-line.  These coupons are also available in the stores, magazines, newspapers and through the mail.

Most manufacturers of food products have adopted just in time manufacturing processes.

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8. Government Regulatory Requirements

A. Federal Requirements

The Federal Trade Commission (FTC) publishes the rulebook for promotional allowance marketing, titled Guides for Advertising Allowances and Other Merchandising Payments and Services, these guides are usually referred to as “The Guides”, “the FTC Guides” or the “Fred Meyer Guides”.

The Robinson-Patman Act (1936) passed as an amendment to the Cayton Act, Robinson-Patman was the result of small grocery retailers’ complaints to the Federal government that they could not compete with the large chain supermarkets that had begun to spring up around the time of the Great Depression.  The primary intent was to outlaw discriminatory allowances that amounted to discriminatory pricing in favor of larger retailers.

There are significant Federal controls on the sale and resale of alcoholic beverages; publications are available from the Bureau of Alcohol, Tobacco, and Firearms at the ATF Website shown in Section 11 of this outline.

There are labeling and packaging regulations along with controls on the manufacture of food and beverage products.  (Food and Drug Administration)

B.  State Requirements - Each state has their own specific requirements and regulations regarding the manufacture, sale, resale, and consumption of alcoholic beverages.

C.  Local Requirements - Many localities have control over the purchase, sale, resale and consumption of food and beverages.

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9. Significant Law and Important Issues

A. Coordinated Issues

 

 

Issue

Brief Summary of Issue

Package Design Costs

Food and beverage companies incur significant costs in developing package designs for their products.  Package design costs are costs incurred to develop the shape, size, graphics, etc. on a product package.  The Internal Revenue Service has issued guidance in the form of a coordinated issue paper and several Revenue Procedures (Revenue Procedures 90-63, 97-35, 97-37, 98-39) and Revenue Ruling 89-23 stating that these costs are capital in nature and depending upon the election a taxpayer makes, are recoverable over four or five years.

The issue was litigated (RJR Nabisco, Inc., et al., v. Commissioner. T.C. Memo. 1998-252). The taxpayer convinced the court that package design costs are merely a form of advertising (point of purchase advertising), and as such are currently deductible.  The Internal Revenue Service argued that although there are some advertising characteristics present, the fact that there is a long term benefit dictates that these costs are capital in nature and therefore must be capitalized.

Note: This issue has been recommended for de-coordination.  The reason for the de-coordination is based on the December 22, 2003 release of the final regulations on capitalization of intangibles (Treas. Reg. § 1.263(a)-4).  The final regulations provide that an amount paid to create a package design, computer software or an income stream from the performance of services under a contract is not treated as an amount that creates a separate and distinct intangible asset. 

Charitable Contributions of Food Inventory

IRC Section 170(e)(3) allows an enhanced deduction for qualifying contributions of food inventory.  Basically this deduction is equal to the basis of the property contributed plus one half of the appreciation, not to exceed twice the basis.  This amount would be treated as a contribution and cost of goods sold would be reduced by the basis of the property contributed. 

The Congressional intent of this code section is to encourage charitable contributions of excess inventory.  Some of the problems encountered during examinations are as follows:

-Taxpayer took enhanced deduction but did not reduce cost of goods sold by the basis of the property.

-Contribution made to an organization that is not a qualifying organization.

-Fair market value (this is the area where most disputes between the taxpayer and the revenue agent occur).

Settlement guidelines have been developed.

Investment Credit on Refrigerated Structures

Although investment tax credit no longer exists, the definition of Section 38 property is used to help make determinations about the characterization of property as either Section 1245 or Section 1250 property.  This coordinated issue paper discusses whether or not investment tax credit is allowed for refrigerated structures.  The coordinated issue paper is a summary of relevant Revenue Rulings and Letter Rulings discussing various fact patterns.

Settlement guidelines have been developed.

B.  Emerging or Other Significant Issues

 

Issue

Brief Summary of Issue

Depreciable Life of a Restaurant’s Smallwares Asset Account and Treatment of Replacements When a full service restaurant opens a location, they will purchase $40,000 to $70,000 worth of smallwares (glassware, china, silverware, linen and small kitchen tools).  An issue had been identified relating to the recovery period of these assets and how to treat the replacement costs of these items.  This issue was considered under the new Industry Issue Resolution (IIR) program.  On January 7, 2002, the Service issued guidance (Rev. Proc. 2002-12) on a safe harbor method of accounting for the cost of smallwares.   The IRS will now allow for the cost of certain smallwares as current year deductible expenses.  For more information see:    http://www.irs.gov/pub/irs-drop/rp-02-12.pdf
Gift Cards/Certificates Deferral of Income The Food & Beverage TA has observed inconsistent tax accounting treatment for gift cards/certificates involving both revenue and expense recognition.  This is a Tier II issue and an IDD will be issued in 2007.
Losses Incurred When a Restaurant is Closed Is a taxpayer entitled to deduct the difference between the adjusted basis of the property and its appraised value when a location is closed but not disposed of?  In the restaurant industry approximately 80 percent of all new restaurants go out of business within 2-3 years.  Conversely, franchised restaurants and national chain restaurants have an 80-90 percent success rate.  Some taxpayers are taking the position that when the building is owned, they are entitled to a loss in the form of added depreciation equal to the difference between the adjusted basis and the appraised value of the building, when a decision is made to close an unprofitable location.  Members of the National Restaurant Association have been working with the Food TA to determine what the correct tax position is, given this fact pattern.   The Food TA has taken the position that a loss on the Section 1250 property is not allowed until an actual disposition (sale or abandonment) has occurred.  The mere closing of the store is not an actual disposition. 
Treatment of Upfront Payments to Restaurant Owners From Suppliers under Supplier Agreements

It is common in the restaurant industry for suppliers to enter into supplier arrangements with restaurants; typically these arrangements extend beyond the taxable year.  For example, suppose that Supplier A enters into an agreement with a restaurant chain to supply soft drink concentrate.  The contract states that the supplier will advance $5,000,000 to the restaurant chain immediately and in return the restaurant chain agrees to purchase all of its soft drinks from Supplier A for the next five years.  Technical Advice Memorandum 9719005 discusses the treatment of upfront payments received under supplier agreements and states that upfront payments are income upon receipt.  Many taxpayers will recognize this income ratably over the life of the contract.      

Some taxpayers are treating the upfront payments as loans.  The IRS does not agree with that treatment.

Several court cases discuss the issue including:

  • Westpac Pac. Food v. Commissioner, 2006 U.S. App. Lexis 15160 (9th Cir., June 21, 2006)
  • Karns Prime & Fancy Foods Ltd. v. Commissioner, T.C. Memo 2005-233 Colombo v. Commissioner, T.C. Memo 1975-162
  • Erickson Post Acquisition, Inc. v. Commissioner, T.C. Memo 2003-218

Contact the Technical Advisor if you have questions in this area.                     

C.  Recent or Pending Legislation

 

 

Effective Date

Title

Summary and Impact of Legislation

2006 & 2007

H.R. 990 &

S. 37  Good Samaritan Hunger Relief Tax Incentive Act

The Pension Protection Act of 2006 expands the enhanced deduction available for food contributions now contained in section 170(e)(3) to all taxpayers (currently enhanced deduction only applies to C Corps).  The provisions expire on 12-31-2007
Pending H.R. 2 Minimum Wage/Small Business Tax Package The American Jobs Creation Act of 2004 established that restaurants could depreciate qualified restaurant building improvement costs over 15 years through the end of 2005. The Tax Relief and Health Care Act of 2006 extended the existing improvement provision for costs incurred through the end of 2007. The Minimum Wage/Small Business Tax Relief bill (H.R. 2) that passed the Senate on February 1, 2007 contains two provisions which would extend the improvement piece through March 31, 2008 and add new construction depreciation from the date of enactment through March 31, 2008 as well.
Pending S. 419; H.R. 920 Restaurant Depreciation Recently, bill were introduced to enact a permanent 15-year depreciation schedule for restaurant building improvements and new construction.
Pending H.R. 2 Minimum Wage/Small Business Tax Package As part of the Tax Relief and Health Care Act of 2006, WOTC and the Welfare-to-Work tax credit were each extended through 2006, and then combined through 2007. In addition, the bill extended the paperwork filing deadline from 21 days to 28 days. The Minimum Wage/Small Business Tax Relief bill (H.R. 2) that passed the Senate on February 1, 2007 contains a five year extension of WOTC through 2012.

D.  Specific Industry Related Tax Law

 

Effective Date

Code Section

Summary and Impact of Law

Current Section 170(e)(3) Allows C Corporations an enhanced deduction for qualified contributions of food inventory to qualified organizations.
10/22/04 to 12-31-07 168(e)(3)(E) 15 year deprecation for “qualified leasehold improvement property” and “qualified restaurant property.” 
1-1-05 199(c)(4)(B) Congress generally excluded the restaurant industry from the scope of § 199, Domestic Production Deduction, by including this phrase as an excluded activity:  “The sale of food or beverages prepared by the taxpayer at a retail establishment.” 

E.  Important Revenue Rulings or Revenue Procedures

 

 

Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

Retroactive Revenue Ruling 92-80 States that INDOPCO does not affect the deductibility of advertising.  The ruling further states that advertising must be capitalized in the unusual circumstances where it is directed towards obtaining future benefits significantly beyond those traditionally associated with ordinary product advertising or with institutional or goodwill advertising.
1983 Revenue Ruling    85-8 Ruling discusses the amount of a taxpayer’s charitable contribution deduction under various circumstances.  Supersedes Revenue Ruling 83-29.
Retroactive Revenue Ruling    98-39 Ruling discusses year end accruals relating to outstanding liability a manufacturer has under cooperative advertising arrangements with retailers, specifically the ruling states that the fact of liability is established when a retailer conducts qualified advertising vs. when a claim for reimbursement is received from the retailer.  Revenue Ruling 98-39 was the desirable method of announcing that the Service has changed its position on the issues addressed in TAM’s, 9320001, 9343006, 9204003 and 9416004.
2002 Revenue Procedure 2002-12 On January 7, 2002, the Service issued guidance (Rev. Proc. 2002-12) on a safe harbor method of accounting for the cost of smallwares.   The IRS will now allow for the cost of certain smallwares as current year deductible expenses.
2003 Revenue Ruling  2003-112 This provides guidance on whether an individual meets the family membership requirements permitting certification for the WOTC and WTW tax credits.  Many taxpayers are filing claims using the revenue ruling as justification.  The service position is that the only amounts claimed that have state certificates are allowable.  See IRS Announcement 2006-49:  http://www.irs.gov/irb/2006-29_IRB/ar12.html
2004 Revenue Procedure 2004-34

This revenue procedure allows taxpayers a limited deferral beyond the taxable year of receipt for certain advance payments. Qualifying taxpayers generally may defer to the next succeeding taxable year the inclusion in gross income for federal income tax purposes of certain advance payments to the extent the advance payments are not recognized in revenues (or, in certain cases, are not earned) in the taxable year of receipt.

See full Rev. Proc. at:http://www.irs.gov/irb/2004-22_IRB/ar16.html

F.  Important Court Cases

 

 

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

1995 Lucky Stores, Inc. and Subs v. Commissioner 105 T.C. 480 (1995) Adverse decision relating to the valuation of bread contributed to charitable organization.  No appeal was taken due to the factual nature of the case.  Many taxpayers will cite this as authority for their valuation of contributed inventory.  Unless the fact pattern is similar to the facts in the case, the decision will not be relevant.
1998 RJR Nabisco, Inc., et al., v. Commissioner, T.C. Memo 1998-252 Adverse decision relating to package design costs.  Decision states that package design costs are a form of advertising and as such are currently deductible.  Action on Decision issued recommending nonacquiescence.
1990 Jefferson Pilot Corp. v. Comm.  98 T.C. 435 (1992), affd. 995 F2d 530 (4th Cir. 1993)

The court determined that a license is a franchise as defined in IRC Section 1253(b)(1).  The Courts looked to the legislative history of IRC Section 1253 and found that it does not limit the application of IRC Section 1253 to private commercial franchises.  This has resulted in taxpayers filing Forms 3115 to change their method of accounting for the cost of liquor licenses.  Previously the Service’s position was that a liquor license had an indeterminate life and therefore costs were not recoverable through depreciation or amortization.  As a result of this decision, taxpayers can amortize the cost of their liquor license. See also

Tele-Communications Inc. (TCI) v. Comm. 95 T.C. 495 (1990)

Affd. 12F 3d 1005 (10th Cir. 1993)

1990 Fox Photo, T.C. Memo 1900-348 This decision allowed a small structure to be treated as 5-year property for depreciation purposes.
2001 WestPac Pacific Foods, et. Al. V. Commissioner, T.C. Memo 2001-175

The Tax Court has held that a partnership that distributed goods to related grocery chains wasn’t entitled to defer recognition of upfront cash payments as income from various manufacturers beyond the year of receipt.

Caution see appeal below

2005 Karns Prime & Fancy Foods Ltd. v. Commissioner, T.C. Memo 2005-233 The Tax Court held that the $1.5 million from the retailer’s principal supplier under a supply agreement was income, not a loan, because the company was under no unconditional obligation to repay and because it had some guarantee that it could keep a portion of the funds.
2006 Westpac Pac. Food v. Commissioner, 2006 U.S. App. Lexis 15160 (9th Cir., June 21, 2006). The 9th Circuit, reversing the Tax Court, held that cash advances a wholesaler made to a retailer for volume commitments were not income when received because the advances were similar to a loan, which is not an "accession to wealth." The 9th Circuit found the advances were made solely in consideration of Westpac’s purchase commitment, and thus, were advances given in lieu of periodic volume discounts.  Note: To the extent a taxpayer is outside the 9th Circuit Court of Appeal’s jurisdiction, the Tax Court’s Westpac decision, supporting the IRS position, remains the law.

G.  Technical Advice Memorandums - Field Service Advices

PLRs AND TAMs ARE ADDRESSED ONLY TO THE TAXPAYERS WHO  REQUESTED THEM.  FSAs ARE NOT BINDING ON EXAMINATION OR  APPEALS, NOR ARE THEY FINAL DETERMINATIONS.  FURTHERMORE,  SECTION 6110(k)(3) PROVIDES THAT PLRs, TAMs, AND FSAs MAY NOT  BE USED OR CITED AS PRECEDENT.

 

 

 

Number

Description

November 26, 2001 FSA 200147035 Concludes that graphic and/or package design costs are distinguishable from business advertising costs either because the benefits associated with advertising costs do not extend beyond the tax year or because these costs are recurring in nature.  Similarly, we must acknowledge the treatment or short-term promotional designs as advertising rather than package design.  Therefore, graphic and package design costs should generally be capitalized.
June 12, 1995 LTR 9522001 Discussion on whether food products development activities may qualify for research credit.
May 4, 1998 LTR-9834003 Concludes that promotional funds advanced to food brokers from manufacturers are income to the broker under certain circumstances.
May 12, 1998 LTR 9719005 Payments a purchaser receives from manufacturers in exchange for entering into supplier agreements are income upon receipt v. being reported over the life of the contract.

 

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10. Alternative Issue Resolution Considerations

 

 

Cost Segregation Studies relating to restaurant structures Members of the National Restaurant Association have expressed an interest in developing an industry wide agreement on the treatment of the costs of a building used as a restaurant or it may be a good pre-filing candidate. There have been 5 restaurant PFA’s on this topic.

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11. Industry Resources

A. Websites

 

Name of Site

Summary and Available Information

FASB Summaries

FASB Summaries

AICPA Home Page

Information from the AICPA

Rutgers Resources

Information from business library

Association for Accounting Administration

Self-explanatory

CPA Journal Home Page

Self-explanatory

Wall Street Journal Home Page

Self-explanatory

Internal Auditing Web Page

Self-explanatory

Stock History

Self-explanatory

Company Profiles

Self-explanatory

Tax and Accounting Sites

Links to CPA Sites

Search SEC documents

Self-explanatory

SEC home page

Self-explanatory

Thomas Legislative Research

Self-explanatory

TCU Professor - Tax Links

Provides links to various tax sites

News Articles

Self-explanatory

News Articles

Self-explanatory

Tax Gateway

Provides links to various sites

Nations Restaurant News

Information on the restaurant industry

Grocery Manufacturers of America Association

Largest grocery manufacturers association

National Restaurant Association

Activities and other information relating to the restaurant industry

Prepared Foods

Information about the prepared foods industry

Wall Street Research Net

Information on publicly traded restaurants

Corporate Information

Information on companies

Restaurant Seminars

Restaurant Seminars

Restaurant Industry Info

Information on Restaurant and Institutions

Restaurant Directory

Restaurant Directory

B. Trade Associations

 

Name

Address

Purpose, Goals, Objectives, etc.

Grocery Manufacturers of America

1010 Wisconsin Avenue NW
Suite 900
Washington DC 20007

To forcefully advance the public policy and trade relations interests of grocery manufacturers through aggressive, strategic government relations, communications, legal, regulatory, scientific and education advocacy and by forging cooperative industry alliances to improve the productivity and distributional efficiencies of the industry.

National Restaurant Association

1200 17th Street. NW
Washington, DC 20036

Serves its members by providing representation, education, and promotion of the restaurant industry.

Food Marketing Institute

800 Connecticut Avenue, NW,
Suite 500
Washington DC 20006

A non-profit association conducting programs in research, education and public affairs on behalf of retailers, wholesalers and their customers.

Tax Executive Institute

1200 G. St.
Suite 300
Washington, DC 20005-3814

A professional organization of business executives who are responsible for taxation matters on an administrative or policymaking level, or whose work is otherwise primarily concerned with the problems of business taxation.

C. IRS and Other Training Courses/Videotapes

 

Name of Course

Course Number

Delivery Method

Developer of Course and Procedures to Secure Material

No formal courses

 

 

 

D. Trade Magazines and Newsletters

 

Title

Frequency of Publishing

Summary of Purpose/Information Included/Availability

Beverage Aisle

Monthly

Subscription rate is $65.00/yr. Contains information about the beverage industry.

Frozen Food Age

Monthly

Subscription rate is $115.00/yr. Contains information about the various frozen food products.

Food & Beverage Marketing

Monthly

Subscription rate is $85.00/yr. Contains information about the food and beverage industry, new developments, marketing and education information.

Advertising Age

Weekly

Subscription rate is $109.00/yr. Contains information about corporate advertising strategies, new products, etc.

E. Industry Books

 

Date of Latest Edition

Title

Summary of Contents

1995

Co-Op Advertising by Bob Houk, available from the Association of National Advertisers

The book describes marketing activities, development of marketing budgets, cost controls, marketing jargon, legal considerations for price structures, etc. Helps the reader understand the motivations and internal procedures relative to marketing strategies.

1993

Great Advertising Campaigns

Discusses successful marketing strategies, brand building, etc.

Annual

Thomas Food Registry

Lists companies and their products and brands, d/b/a names and other statistical information.

F. Internal Revenue Manual Citations

IRM Section

Title

Summary of Information Included

None

 

 

G. AICPA Auditing Standards and Publications

 

Date of Issuance

Title

Summary of Information Included

1981

S45 – Accounting for Franchise Fee Revenue

Discusses treatment of franchise fee revenue. Since many national restaurant chains are franchisers, this statement provides guidance.

1999

S121- Leases

Accounting for leases: Sale-Leaseback Transaction, Involves R/E, Sales-Type Leases of Real Estate- Definition of the lease term and Initial direct costs of direct financing leases-an amendment of FASB ‘s #13, 66, 91

1993

SOP 93-7

Discusses the treatment of advertising costs for financial accounting purposes.

1999

SAB 101

Provides the SEC’s views in applying generally accepted accounting principles to selected revenue recognition issues.

2001

FASB 144

FASB 144 is effective for fiscal years beginning after December 15, 2001. It provides for asset impairment losses to be recognized for financial accounting purposes

H. Market Segment Specialization Program (MSSP)

 

Guide Name

Retail Industry ATG - Chapter 4: Examination Techniques for the Food and Beverages Industries

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Page Last Reviewed or Updated: 18-Apr-2014