DEALER'S INVENTORY COST REDUCTION FOR AUTOMOBILE MANUFACTURER'S REBATE

Rev. Rul. 84-41

ISSUE

Is it proper for an automobile dealer to record the cost of new automobiles in inventory (and cost of goods sold) without reduction of a manufacturer's rebate under the circumstances described below?

FACTS

X, an automobile dealer, uses an accrual method of accounting and files its federal income tax returns on a calendar year basis. X is entitled to a 2 percent rebate (the "rebate") from the automobile manufacturer, which is based on the cost to X of new automobiles purchased during the taxable year. The rebate is based solely on the total cost of dealer purchases, and does not relate to sales volume, length of time that the dealer holds the automobile in inventory, or other incentives that the manufacturer may offer. Pursuant to the agreement with the manufacturer, X is entitled to the rebate in the taxable year of purchase; however, the rebate is actually received by X in the taxable year subsequent to the year of purchase.

Under X's method of accounting at the time new vehicles are purchased from the manufacturer the purchases are recorded in inventory at X's cost with no reduction for the 2 percent rebate. As vehicles are sold, the inventory is reduced by the cost of the vehicles (which becomes the cost of goods sold), without any recognition of the 2 percent rebate that will be received. With respect to automobiles on hand at the end of X's taxable year, such automobiles are valued at cost with no reduction for the rebate. When X actually receives its 2 percent rebate on new vehicle purchases in the following year, the cost of goods sold for that year is reduced by an amount equal to the rebate received. That is, the 2 percent rebate is recorded on a cash basis in the year of receipt, even though it relates to and is derived from new vehicle purchases made in the prior taxable year.

LAW AND ANALYSIS

Section 1012 of the Internal Revenue Code provides, generally, that the basis of property shall be its cost. Section 1.1012-1(a) of the Income Tax Regulations provides that cost is the amount paid for such property in cash or other property.

Section 471 of the Code provides that whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting income.

Section 1.471-3(b) of the regulations provides that cost means, in the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed.

Generally, there are two types of discounts available: trade (or quantity) discounts and cash discounts. Trade discounts represent adjustments to the purchase price granted by a vendor. The discount may vary depending upon volume or quantity purchases, or other factors established by the vendor. If a discount is always allowed irrespective of time of payment, it is considered to be a trade discount. See Thomas Shoe Co., 1. B.T.A. 124 (1924), acq., IV-1 C.B. 3 (1925). The amount that a dealer will pay for an item is the net price after the trade discount. Cash discounts, on the other hand, represent a reduction in the invoice or purchase price attributable to payment within a prescribed time period. The discount is only available if the purchaser makes payment within such time period.

Rev. Rul. 76-96, 1976-1 C.B. 23, concerns the federal income tax treatment of rebates paid by an automobile manufacturer to qualifying retail customers who purchased its automobiles. Rev. Rul. 76-96 holds that the receipt of the rebate by a qualifying retail customer does not result in the receipt of gross income. However, Rev. Rul. 76-96 holds that the rebate represents a reduction in the purchase price of the automobile, requiring a downward adjustment to the basis of the automobiles in the hands of the purchasers under section 1012 of the code.

Although the present case involves rebates to an automobile dealer rather than to retail purchasers, the rationale expressed in Rev. Rul. 76-96 is applicable to the instant case. It supports a conclusion that a cash rebate paid to an automobile dealer should be treated as a reduction in the cost of the automobile purchased, and not as an item of gross income. This result is consistent with section 1.471-3(b) of the regulations.

In the present situation, X has a fixed right to reimbursement in the taxable year of purchase with respect to the amount of the rebate. Income is distorted in cases in which the rebate is not subtracted in calculating cost of goods sold. That is, under X's present method of reporting rebates, cost of goods sold is overstated and income is understated where X sells an automobile in the same taxable year in which it is purchased. X cannot deduct the rebate in a later year (through an adjustment to cost of goods sold) when it has fixed right to reimbursement from the manufacturer in the year a car is purchased. See Wolfers v. Commissioner, 69 T.C. 975, 983-985 (1978). That is, X's cost of new automobiles is the amount paid to the manufacturer, less the amount of the rebate for which it has a fixed right to reimbursement.

HOLDING

It is not proper for an automobile dealer to record the cost of new automobiles in inventory (and cost of goods sold) without reduction of manufacturer's rebate. In this case, the manufacturer's rebate received by an automobile dealer represents a trade discount and, therefore, must be treated as a reduction in the cost of the automobile in the year of purchase.

Any change in a taxpayer's method of accounting, from recording the cost of new vehicles in inventory at cost with no reduction for the 2 percent manufacturer's rebate, to the method described in this revenue ruling is a change in method of accounting to which the provisions of sections 446 and 481 of the Code apply.

This ruling is identified as a designated ruling pursuant to section 5.12 of Rev. Proc. 80-51, 1980-2 C.B. 818.