                       128 T.C. No. 7



                UNITED STATES TAX COURT



 AFFILIATED FOODS, INC., A CORPORATION, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 12846-04.                Filed March 29, 2007.



     P, a wholesale food purchasing cooperative, holds
one or more food shows a year at which member stores
and vendors selling to P meet. The vendors offer
special show discounts to member stores placing orders
with P for the vendors’ products at the food shows.
The special discount sometimes takes the form of a cash
payment from the vendor to the member store based on
the quantity of the vendor’s products ordered. Vendors
not bringing currency to the shows obtain cash for
those payments from promotional allowance accounts
established by the vendors with P or from checks given
to P and cashed by P. R treats such P-delivered
currency as, first, being received by P as a vendor
rebate, second, being returned by P to the vendor, and,
third, being paid by the vendor to the member store. R
considers the first step to result in a reduction in
P’s cost of goods sold and the third step to be the
payment by P of a defective (nondeductible) patronage
dividend. According to R, the defect is that the
payment is not out of P’s net earnings. The net result
                               - 2 -

     of R’s adjustments is an increase in P’s gross income
     for each of the years in question in the amount of P-
     delivered currency paid by vendors to member stores.

          1. Held: P is not collaterally estopped from
     challenging R’s adjustments by our report in Affiliated
     Foods, Inc. v. Commissioner, T.C. Memo. 1996-505, affd.
     in part, revd. in part and remanded 154 F.3d 527 (5th
     Cir. 1998).

          2. Held, further, the payments that R charges P
     with making to member stores are properly characterized
     as trade discounts. They were not paid with reference
     to P’s net earnings but merely passed along the price
     adjustments that P was entitled to on account of the
     orders placed by the member stores at the food shows.
     They reduce P’s gross sales and are not defective
     patronage dividends.


     William A. Hoy, for petitioner.

     George E. Gaspar and Mark E. O’Leary, for respondent.



     HALPERN, Judge:   By notice of deficiency dated April 22,

2004, respondent determined deficiencies in petitioner’s Federal

income tax of $143,978, $166,493, and $11,101 for petitioner’s

taxable (fiscal) years ended September 30, 1991, October 2, 1992,

and October 1, 1993, respectively (the audit years).   Petitioner

is a corporation operating on a cooperative basis (a purchasing

cooperative), whose shareholder-patrons operate retail grocery

stores.   The issues for decision concern the proper treatment of

certain payments made to petitioner’s shareholder-patrons at food

shows petitioner conducted during the audit years.
                               - 3 -

     Respondent increased petitioner’s gross income for each of

the audit years on account of those payments and denied

petitioner any offsetting deductions on the ground that the

payments are nondeductible patronage dividends.   In part,

respondent defends against petitioner’s assignments of error by

claiming that petitioner is precluded from challenging

respondent’s adjustments on the basis of the outcome in

Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505,

affd. in part, revd. in part and remanded 154 F.3d 527 (5th Cir.

1998); on remand T.C. Memo. 1999-136.   Petitioner denies that it

is precluded from challenging the adjustments and claims that it

did not receive the payments, but, if it did, the payments either

did not increase its gross income because of offsetting

adjustments or, if they did increase its gross income, it was

entitled to offsetting deductions.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code as in effect for the audit years.    The

references to subchapter T are to that subchapter (sections 1381

through 1388) of chapter 1 of subtitle A of the Internal Revenue

Code.   Subchapter T deals with cooperatives and their patrons.
                                 - 4 -

                           FINDINGS OF FACT

     Some facts are stipulated and are so found.     The stipulation

of facts, with accompanying exhibits, is incorporated herein by

this reference.

Petitioner

     Petitioner is a wholesale food purchasing cooperative that

resells a variety of products to retail grocery stores in Texas,

New Mexico, Oklahoma, Kansas, Colorado, and Arizona.     At the time

the petition was filed, petitioner maintained its principal place

of business in Amarillo, Texas.     Petitioner was incorporated in

1946 under the cooperative laws of the State of Texas to increase

the bargaining power of member stores in their dealings with

vendors.1    As of the time of the trial, petitioner had more than

239 shareholder-patrons, who operated approximately 715 member

stores.     Petitioner does not own any interest in any member

store.

     Petitioner computes its taxable income using an accrual

method of accounting and pursuant to the provisions of part I


     1
        The parties have stipulated that the term “member stores”
refers to retail grocery stores that individually or as a group
of related and associated retail grocery stores purchase food and
other consumer products from or through petitioner and that are
members of, or shareholders in, petitioner’s cooperative system.
They have further stipulated that the term “vendor” refers to
manufacturers or other producers of food and other products sold
to petitioner and member stores. We shall adopt those locutions
for purposes of this report.
                                 - 5 -

(sections 1381 through 1383) of subchapter T, which addresses the

tax treatment of cooperatives.

     At the end of its fiscal year, petitioner returns the

profits from its wholesale grocery purchasing business to its

shareholder-patrons as patronage dividends.

Member Stores

     Member stores determine independently of petitioner the

types, brands, and quantities of the commodities that they

purchase for resale to customers.

Promotional Allowance Accounts

     From time to time, petitioner receives from some vendors and

vendor representatives (without distinction, vendors)2 funds to

be spent in promoting the sale of products offered by those

vendors.   Petitioner deposits the funds in its own bank account

and, on its books, treats the deposits as liabilities owed to the

contributing vendors.   Petitioner identifies the balance on hand

for each contributing vendor in a set of accounts that it has

designated the “promotional allowance accounts” (promotional

allowance accounts).


     2
        The parties have stipulated that the term “vendor
representative” refers to an individual or entity who solicits
and concludes sales of food and food products to petitioner and
member stores on behalf of vendors, including all independent
distributors, brokers, sales representatives, and agents of
vendors. We shall adopt that locution for purposes of this
report.
                                 - 6 -

Discounts and Allowances

     Petitioner negotiates with individual vendors to obtain

discounts and allowances (without distinction, discounts) from

the list prices advertised by the vendors.   Thus, for example,

for a limited time, a vendor of canned goods may offer $1 off on

each case of its 16-oz. cans of peaches ordered.

     Except with respect to certain special price discounts

offered by vendors only at the food shows and described in the

next paragraph, vendor discounts on merchandise purchased by

petitioner reduce the price paid by (invoiced to) petitioner and

are referred to by petitioner as “off-invoice” (off-invoice)

discounts.   Petitioner passes on to member stores off-invoice

discounts it obtains from vendors unless the associated

administrative costs exceed the amount of the discount.

Hereafter, we shall use the term “usual discount” to describe any

vendor discount other than the special price discounts offered

only at the food shows.

Food Shows-–General

     Beginning in 1984 and extending at least through the audit

years, petitioner held one or more food shows a year at which

vendors and member stores met.    One purpose of those shows was to

encourage member stores to place orders with petitioner for the

products that vendors promoted at the shows.   The food shows held

during the audit years were held in Amarillo, Texas.
                               - 7 -

     Several weeks before each food show, petitioner sent

invitations to member stores and vendors.   Attendance at the

shows by members, and participation in the shows by vendors, was

voluntary.   A vendor wishing to participate in a food show

entered into an agreement with petitioner under which the vendor

agreed to pay a participation fee, rent and decorate a booth at

the show, and offer to member stores discounts on the products

that the vendor offered at the show.   Those discounts, although

negotiable, were subject to petitioner’s approval and had to be

greater than the usual discounts.   The special show discounts,

although limited to orders placed at the food shows, were, like

the usual discounts, based on the quantity of merchandise

ordered.

     Also, in preparation for each food show, each participating

vendor provided petitioner with a “deal data sheet”, which, among

other things, showed the products the vendor was promoting and

the per-unit show discount (referred to by petitioner as “show

money” (show money)) offered for each product.    Petitioner had

the right to reject individual product items.    Vendors had

discretion to make show money available to member stores in one

of two ways: (1) a credit against the purchase price of the

product to be reflected on the invoice to be issued to the member

store by petitioner on fulfillment of the order after the food

show (i.e., an off-invoice discount), or (2) an immediate payment
                               - 8 -

at the food show, in currency or by check, from the vendor to the

member store.   In the case of an off-invoice discount, petitioner

stood as an intermediary between the vendor and the member store,

reducing the price it charged the member store to reflect the

off-invoice discount and receiving an equal reduction from the

vendor in the price it charged petitioner.   Petitioner made no

explicit price reduction if the vendor agreed to pay show money

directly to the member at the food show.

     Vendors exercised their discretion with respect to show

money by indicating their choices on the deal data sheets they

submitted.   Information from deal data sheets was transferred by

petitioner to individual sheets for each vendor.   Those sheets

were then reproduced and bound into books (show books) for

distribution to members attending the food show.

     Each sheet in the show book had attached to it a perforated

strip (tear strip) that the member store could detach and use to

order from petitioner an item (or items) described on the

associated sheet.   The member store delivered the tear strip to

the appropriate vendor, who, if an immediate payment of show

money was called for, made that payment and then delivered the

tear strip to petitioner for fulfillment of the order.

Petitioner entered the necessary information from the tear strip

into its billing and accounting records and, in most cases, then

discarded the tear strips.   Petitioner ordered additional
                               - 9 -

merchandise from the vendor, if necessary, and filled the order

on the date requested by the member store.   Petitioner invoiced

the member store for the shipment, reflecting on the invoice

credit for the appropriate amount of show money if, and only if,

that amount had not already been paid by the vendor to the member

store.

     A member store had discretion not to receive show money in

currency or by check from a vendor who had elected to offer show

money that way.   A member store had no discretion, however, to

demand a payment from a vendor if the vendor had elected the off-

invoice method of offering show money.

Petitioner’s Profit on Sales to Member Stores

     Petitioner profits on sales to member stores by marking up

the prices it charges member stores from the prices it pays

vendors.   Except with respect to off-invoice discounts resulting

from show money offered at the food shows, petitioner applies its

customary markup to the price it charges a member store; i.e.,

the markup is applied to the vendor’s list price less the usual

discount obtained by petitioner.   With respect to show money,

petitioner applies any off-invoice discount only after adding its

own markup.   Thus, petitioner calculates that its margin (the

difference between the cost and selling price) and its markup on

food show orders are the same if a member store receives show
                                - 10 -

money in currency or check or if the member store elects an off-

invoice credit.3




     3
        The following table is based on a table prepared by
Tammie Coffee, petitioner’s chief financial officer, to
illustrate the point in the text.

Consolidated Foods, Inc.
Comparison of gross profit on AFI’s ledger of off-invoice/at-show
payment:

Item #27024

                                             Off invoice    At show

Sale to AFI customer:
  List price                                   $76.20       $76.20
  Less: usual discount                           1.20         1.20
    Subtotal: Price before markup               75.00        75.00
  Add Markup: 7.5%                               5.25         5.25
    Subtotal                                    80.25        80.25
  Less: Off-invoice show money discount           .75          n/a
    Total amount billed to member store         79.50        80.25

AFI purchase price from vendor:
  List cost                                     76.20         76.20
  Less:
    Usual discount                               1.20          1.20
    Off-invoice show money discount               .75           n/a
      Total cost of goods sold                  74.25         75.00

Gross profit on AFI general
  ledger (margin):
                                                            1
Amount billed to member store                   79.50         80.25
Less: cost of goods sold                        74.25         75.00
  Total margin                                   5.25          5.25
     1
        We note that,   if it is assumed that the member store
receives a payment of   $0.75 at the food show, it would have to
subtract that receipt   ($0.75) from the amount it pays petitioner
($80.25) to determine   its cost for the goods it purchased
($79.50).
                              - 11 -

Food Shows; Currency

     The currency used by vendors to pay show money had three

possible sources: (1) the vendor’s promotional allowance account,

if the vendor gave petitioner written instructions to charge a

specific amount against the account and to deliver currency in

that amount to the vendor at the food show, (2) a vendor’s check,

given by the vendor to petitioner for the specific purpose of

providing currency to the vendor at the food show, and (3)

currency brought to the food show by the vendor and taken from an

account of the vendor unknown to petitioner.   In the first two

cases, petitioner obtained the necessary currency from the

Amarillo National Bank (the bank).

     Petitioner obtained currency from the bank in denominations

sufficient to meet the individual vendors’ requests for currency

in specific denominations.   Petitioner placed the currency in

locked bank bags identified with numbers unique to each vendor.

Immediately before a food show began, vendors retrieved their

bags from petitioner at a central location after, first,

verifying that the bag’s contents were as expected and, second,

signing a receipt.

     At the conclusion of the food show, vendors who had received

bank bags from petitioner returned to petitioner those bags and

any currency they wanted to deliver to petitioner.   Petitioner

issued written receipts for the bank bags and currency returned.
                              - 12 -

Respondent’s Adjustments

      Respondent attached to the notice of deficiency an

explanation of his adjustments to petitioner’s tax liabilities

for the audit years.   The explanation states that respondent has

determined that “the food show distributions” to petitioner’s

shareholders are both income to petitioner and nondeductible

patronage dividends paid by it to its members.   Therefore, the

explanation continues, petitioner’s taxable income is increased

by $421,973, $489,685, and $144,122, for 1991, 1992, and 1993,

respectively.

                              OPINION

I.   Introduction

      During the audit years, petitioner, a wholesale food

purchasing cooperative, conducted one or more food shows a year

at which member stores met with vendors.   Among other things, the

food shows were designed to encourage member stores to order from

petitioner the vendors’ products offered at the shows.     Pursuant

to an agreement with petitioner, each vendor attending a show was

required to offer member stores special show discounts on the

vendor’s products offered at the show.   Petitioner referred to

those special show discounts as “show money”.    Vendors could make

show money available to member stores in one of two ways.    First,

a vendor could offer a member store a discount on an order placed

with petitioner at the show, petitioner having agreed to honor
                              - 13 -

the discount (referred to by petitioner as an “off-invoice”

discount) when it invoiced the member store upon fulfillment of

the order after the show.   Petitioner would receive an identical

discount from the vendor.   Second, instead, the vendor could

offer to pay the member an amount equal to the off-invoice

discount immediately upon its executing an order to be placed

with petitioner.   In that case, no invoice either from petitioner

to the member store or from the vendor to petitioner would

reflect the payment.

     We are concerned here only with show money made available to

member stores in the second way; i.e., by an immediate payment by

a vendor to a member store.   Moreover, we are concerned with

those payments only if they were made in currency (i.e., not by

check), and then only if the currency was delivered by petitioner

to the vendor at the start of the food show.   We are not,

therefore, concerned with payments out of currency brought to a

food show by a vendor.   The currency delivered by petitioner to a

vendor at the start of a food show (which we shall refer to as

petitioner-delivered currency) had one or perhaps both of two

sources: (1) a charge against the vendor’s promotional allowance

account, at the direction of the vendor, for the specific purpose

of providing the vendor with currency at the food show, and, (2)

checks received from the vendor and cashed by petitioner for the

same purpose.   We shall use the terms “promotional-allowance
                               - 14 -

currency” and “vendor-check currency” to refer to petitioner-

delivered currency attributable to the former and the latter of

those sources, respectively.

     While, in the notice of deficiency, respondent explained

that his adjustments to petitioner’s Federal income tax for the

audit years were based on his determination that petitioner’s

“food show distributions” to its shareholders are income to

petitioner (and nondeductible patronage dividends paid to its

members), respondent did not explain how he computed those

adjustments.   The parties have stipulated respondent’s method of

computation:

          Respondent increased Petitioner’s taxable income
     in each of the years in issue by an amount equal to the
     difference between: (a) the sum of (i) the cash amounts
     withdrawn from the Promotional Allowance Accounts and
     (ii) the checks delivered to Petitioner by Vendors
     * * * in anticipation of the Food Shows, over (b) the
     cash returned to the Petitioner at the conclusion of
     the Food Shows by the same Vendors * * * .[4]

     We shall first address respondent’s claim that petitioner is

precluded from challenging respondent’s adjustments.   Since we

believe that petitioner is not so precluded, we shall then

address the parties’ other claims.




     4
        The parties’ stipulation repeats the explanation as
follows: “Respondent’s adjustment to Petitioner’s income for the
years in issue is, therefore, the difference between the checks
and withdrawals from the Promotional Allowance Accounts provided
by Vendors * * * to Petitioner reduced by the cash returned by
the Vendors * * * at the conclusion of the Food Shows.”
                               - 15 -

II.   Issue Preclusion

      A.   Introduction

      Respondent asserts that the Court in Affiliated Foods, Inc.

v. Commissioner, T.C. Memo. 1996-505, found that payments by

vendors to member stores of petitioner-delivered currency during

petitioner’s 1989 and 1990 tax years were both gross income to

petitioner and nondeductible payments of patronage dividends by

petitioner to its shareholders.    Relying on the doctrine of issue

preclusion (or collateral estoppel), respondent argues that

petitioner is precluded from relitigating those issues.   Since,

during the audit years, vendors also made payments of petitioner-

delivered currency to member stores, respondent argues that those

payments are items of gross income to petitioner for those years

and nondeductible payments of patronage dividends.

      B.   The Doctrine of Issue Preclusion

      In Monahan v. Commissioner, 109 T.C. 235, 240 (1997), we

said:

           The doctrine of issue preclusion, or collateral
      estoppel, provides that, once an issue of fact or law
      is “actually and necessarily determined by a court of
      competent jurisdiction, that determination is
      conclusive in subsequent suits based on a different
      cause of action involving a party to the prior
      litigation.” Montana v. United States, 440 U.S. 147,
      153 (1979) (citing Parklane Hosiery Co. v. Shore, 439
      U.S. 322, 326 n.5 (1979)). Issue preclusion is a
      judicially created equitable doctrine whose purposes
      are to protect parties from unnecessary and redundant
      litigation, to conserve judicial resources, and to
      foster certainty in and reliance on judicial action.
      See, e.g., id. at 153-154; United States v. ITT
                               - 16 -

     Rayonier, Inc., 627 F.2d 996, 1000 (9th Cir. 1980).
     This Court in Peck v. Commissioner, 90 T.C. 162,
     166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990), set
     forth the following five conditions that must be
     satisfied prior to application of issue preclusion in
     the context of a factual dispute * * * :

          “(1) The issue in the second suit must be
     identical in all respects with the one decided in the
     first suit.
          (2) There must be a final judgment rendered by a
     court of competent jurisdiction.
          (3) Collateral estoppel may be invoked against
     parties and their privies to the prior judgment.
          (4) The parties must actually have litigated the
     issues and the resolution of these issues must have
     been essential to the prior decision.
          (5) The controlling facts and applicable legal
     rules must remain unchanged from those in the prior
     litigation. * * * ”

     C.   Discussion

           1.   Petitioner’s Argument

     Petitioner concedes that the first three conditions are

satisfied.   Petitioner argues that the fourth condition is not

satisfied since, by assigning error to respondent’s failure to

allow it offsetting deductions or adjustments to gross income

from sales--if we should decide in the first place that

petitioner received anything on account of the vendors’ payments

to members of petitioner-delivered currency--petitioner has

raised issues that were neither litigated nor resolved in the

prior litigation.   Petitioner argues that the fifth condition is

not satisfied since the controlling facts in this case are not

the same as in the prior case.
                              - 17 -

          2.   Points Not at Issue in the Prior Litigation

     “Collateral estoppel applies only to an issue that was

actually litigated and determined in a prior action, not to an

issue that might have been litigated.”     Anderson, Clayton & Co.

v. United States, 562 F.2d 972, 992 (5th Cir. 1977); see also

Commissioner v. Sunnen, 333 U.S. 591, 597-598 (1948).     As put by

the Supreme Court in Commissioner v. Sunnen, supra at 598:

“Since the cause of action involved in the second proceeding is

not swallowed by the judgment in the prior suit, the parties are

free to litigate points which were not at issue in the first

proceeding, even though such points might have tendered and

decided at that time.”   Moreover, it is well settled that each

taxable year is the origin of a new liability and of a separate

cause of action.   Id.; see also Estate of Hunt v. United States,

309 F.2d 146, 148 (5th Cir. 1962).     In Cloud v. Commissioner,

T.C. Memo. 1976-27, we held that the taxpayers were not

collaterally estopped from challenging the Commissioner’s

disallowance of their deductions of certain expenses under a

theory different from the losing theory they had advanced in

litigation concerning the same types of expenses for prior years.

     Petitioner’s assignments of error to respondent’s failure to

allow it offsetting deductions or adjustments to gross income

from sales do raise issues that were neither litigated nor

resolved in the prior litigation.    Although petitioner did raise
                              - 18 -

the issue of an offsetting deduction in Affiliated Foods, Inc. v.

Commissioner, supra, and was sustained on that issue with respect

to petitioner-delivered currency given to one vendor, petitioner

failed on brief to argue the issue with respect to vendors

generally and, on account of that failure, was deemed to have

conceded the issue.   Id. n.11.   The issue of offsetting

deductions was not fully litigated in the prior litigation, and

petitioner is not precluded from raising it here. See Coors v.

Commissioner, 60 T.C. 368, 392 (1973) (Commissioner not barred

from litigating capitalization issue that, in prior litigation

between parties, he had abandoned, where no findings had been

made by Court with regard to issue, and it was not necessary to

result reached), affd. 519 F.2d 1280 (10th Cir. 1975).      Nor is

petitioner precluded from arguing for an offsetting adjustment to

gross income from sales, because that issue was not raised in the

prior litigation.   See Monahan v. Commissioner, supra at 240.

          3.   Difference in Controlling Facts

     The fact that petitioner is free to argue for offsetting

deductions or adjustments does not mean that it is free to argue

that it has no gross income (or no gross receipts) on account of

vendor payments to member stores of petitioner-delivered currency

if that issue was settled in the prior litigation.   See Jaggard

v. Commissioner, 76 T.C. 222, 224 (1981) (issue-by-issue

determination of whether collateral estoppel applies).
                               - 19 -

Nevertheless, petitioner claims that it is free to so argue since

the facts controlling the issue here are different from those in

Affiliated Foods, Inc. v. Commissioner, T.C. Memo. 1996-505.      In

that case, we found facts that, in much the same terms we use

today, describe food shows petitioner put on during its 1989 and

1990 taxable years (1989 and 1990, respectively).    We described

show money (although we did not use that term) much as we

describe it today, although we included no specific description

of off-invoice discounts.    We described the order forms (deal

data sheets) submitted by vendors and said “there was no

negotiating” after the order forms were submitted.    We described

the procedures for supplying petitioner-delivered currency much

as we describe them today.    We also said:

     In both instances [i.e., in the case of both
     promotional-allowance currency and vendor-check
     currency], petitioner required the vendors to sign for
     the cash received, and, most importantly, it also
     required any unused cash to be returned to it at the
     end of the food show. This was not a check-cashing
     service. Unlike a check-cashing service, petitioner
     ensured that the check proceeds were either paid to its
     shareholders or returned to it. [Emphasis added.]

We ended our discussion of petitioner-delivered currency by

concluding:

     Petitioner was not a nontaxable intermediary with
     respect to the food show cash disbursements arising
     from the promotional accounts. * * * Similarly, as
     for the food show cash disbursements arising from the
     check-cashing transactions, petitioner exercised
     dominion and control over these funds, as evidenced by
     the return of any “unused” cash. Thus, these amounts
                                - 20 -

     must also be included in petitioner’s income.   * * *
     [Emphasis added.]

     Petitioner argues that the important facts we relied on in

Affiliated Foods, Inc. v. Commissioner, supra, to support our

conclusion that it exercised dominion and control over the

petitioner-delivered currency are not present in this case.

Petitioner claims that, unlike what we found for 1989 and 1990,

during the audit years, (1) it did not require vendors to return

to it any remaining petitioner-delivered currency not paid to

member stores, and (2) although it had the final say, it did

negotiate with vendors the amounts of show money the vendor would

give.    It also claims that, with respect to its 1993 food shows,

vendors gave it no checks.    While we are not certain about

petitioner’s third claim, we have made findings consistent with

its first two claims.    With respect to its first claim, we have

found:    “At the conclusion of the food show, vendors who had

received bank bags from petitioner returned to petitioner those

bags and any currency they wanted to deliver to petitioner.”     See

supra p. 11 (emphasis added).    Our finding is almost a verbatim

recitation of a stipulated fact.    From that stipulation, we draw

the inference that vendors had discretion to, but were not

required to, return to petitioner at the end of a food show any

undistributed petitioner-delivered currency, and we so find.

     Whatever limited power vendors had to negotiate food show

money and, more importantly, their right to retain any
                              - 21 -

undistributed petitioner-delivered currency distinguish the facts

before us from the facts we relied on in Affiliated Foods, Inc.

v. Commissioner, supra.   In the prior litigation, we found “most”

important the requirement that undistributed petitioner-delivered

currency be returned; that requirement evidenced to us

petitioner’s exercise of dominion and control over petitioner-

delivered currency.5   The return requirement ensured that

petitioner-delivered currency would either be paid to member

stores or returned to petitioner.   In the present litigation, we

cannot be equally confident that petitioner-delivered currency

not returned to petitioner was paid to member stores, since




     5
        In Affiliated Foods, Inc. v. Commissioner, T.C. Memo.
1996-505, affd. in part, revd. in part and remanded 154 F.3d 527
(5th Cir. 1998), we found that amounts received from vendors and
credited to the vendors’ promotional allowance accounts were
items of gross income to petitioner when received. We were
reversed on that point by the Court of Appeals for the Fifth
Circuit. Affiliated Foods, Inc. v. Commissioner, 154 F.3d 527
(5th Cir. 1998). Respondent has made no adjustments for amounts
similarly received during the audit years, and we assume that, at
least for purposes of this case, respondent accepts the Court of
Appeals’ conclusion that vendors retained control of funds
credited to the promotional allowance accounts and receipt of
those funds did not give rise to gross income to petitioner.
Id. at 533. We assume further that an amount equal to any
petitioner-delivered currency that a vendor chose to return to
petitioner following a food show during the audit years was
either returned to the vendor or credited to its promotional
allowance account (and, therefore, petitioner retained no control
over any currency returned to it). We make those assumptions
because, for the audit years, respondent has increased
petitioner’s income by only the excess of the petitioner-
delivered currency over the amount of cash returned by vendors to
petitioner at the conclusion of the food show.
                                 - 22 -

vendors were under no obligation to return to petitioner any

petitioner-delivered currency not paid to member stores or to

account to petitioner for their disposition of petitioner-

delivered currency.      Petitioner’s dominion and control over

petitioner-delivered currency was different in the audit years

than it was in the years subject to the prior litigation.

Denying a party the right to litigate an issue is a matter that

requires circumspection.      Monahan v. Commissioner, 109 T.C. at

242.    On balance, we think that the interests of justice are

better served by allowing petitioner to litigate the control

issue afresh, in the light of the difference in facts from the

prior litigation.     See, e.g., Alexander v. Commissioner, 224 F.2d

788, 793 (5th Cir. 1955) (interests of justice not served by

holding barring taxpayer from showing change in facts concerning

partnership agreement subject to prior proceeding), affg. in

part, revg. in part and remanding 22 T.C. 318 (1954).

Affiliated Foods, Inc. v. Commissioner, supra, does not preclude

petitioner from litigating the inclusion in gross income of

petitioner-delivered currency.

       D.   Conclusion

       Respondent’s affirmative defense of issue preclusion fails.
                                  - 23 -

III.       Discussion

       A.     Arguments of the Parties

       Respondent argues that, for each of the audit years,

petitioner has an item of gross income on account of petitioner-

delivered currency because petitioner “asserted control over

those funds and used the vendor representatives as conduits to

make ‘disguised patronage dividends’ to its member stores at the

food shows.”       Respondent lists the following as among the

important operative facts:6

            Petitioner negotiated for the food show rebates
       and thereby provided for the direct payment of monies
       from vendors to members that would otherwise have
       accrued to Affiliated as earnings, i.e., rebates from
       vendors to Affiliated for product purchased by
       Affiliated.

            A member received food show rebates based on the
       amount of product purchased at the show. The greater
       the product purchases meant more food show rebates.

            Members committed to make purchases at the food
       show and subsequently bought the product through
       Affiliated.

            In this manner, a member received rebates based on
       the amount of product purchased through Affiliated, and

            Affiliated was able to provide a patronage dividend
       without complying with the statutory requirements.

       While petitioner disagrees that it paid any patronage

dividends or asserted control over the petitioner-delivered

currency (petitioner argues that it was only delivering to


       6
        Paragraph numbers and citations of respondent’s proposed
findings of fact are omitted.
                              - 24 -

vendors their own money, either reducing the balance of a

vendor’s promotional allowance account or delivering the proceeds

of a vendor’s check), its description of the facts does not

differ markedly from respondent’s:

     The payments in question were simply price rebates; no
     different than the price discounts and rebates afforded
     Member Stores on a day-to-day basis throughout the
     year. The day-to-day rebates and price discounts also
     represented value passing from Petitioner, who granted
     them, to the Member Stores, who purchased the goods to
     which the rebates and discounts attached. * * *

     If we should find that petitioner exercised sufficient

control over the petitioner-delivered currency to cause us to

conclude that petitioner had a receipt in an equal amount,

petitioner argues that either the receipt did not increase its

gross income because of an offsetting adjustment (either an

increase in petitioner’s cost of goods sold or a reduction in the

amount of its receipts from sales to member stores) or, if the

receipt did increase its gross income, it had an offsetting

deduction.

     B.   Discussion

             1.   Control

     Petitioner organized the food shows and required vendors

wishing to participate to offer special deals (show money) on

their products offered and ordered at the show.   In the case of

an off-invoice discount, petitioner accorded the member store the

discount and, in turn, was accorded an equal discount by the
                               - 25 -

vendor.    A vendor could choose, however, to make an immediate

payment of show money to a member store, either in currency or by

check.    If the vendor chose currency, the currency either had

come from petitioner (i.e., petitioner-delivered currency) or was

provided by the vendor itself (vendor-provided currency).    If

payment was of petitioner-delivered currency, respondent’s

argument is that the vendor was not using its own money to pay

show money:    The vendor was using petitioner’s money to pay show

money.    As respondent sees it, simultaneously with the vendor’s

making a payment of petitioner-delivered currency to a member

store, the vendor rebated an equal amount to petitioner, which

petitioner returned to the vendor under an earlier direction that

the vendor pay the amount to the member store on petitioner’s

behalf.

     Respondent justifies such indirection on the ground that

petitioner asserted sufficient control over the circumstances

surrounding the vendors’ receipts of petitioner-delivered

currency that the vendors should be viewed as nothing more than

petitioner’s agents engaged to pay to the member stores rebates

from moneys (rebates) first received by petitioner.    Respondent

does not pin down the nature of that control, however, and the

fact that respondent does not similarly treat the vendors as

petitioner’s agents in the case of vendor-provided currency or

checks (hereafter, without distinction, vendor-provided currency)
                              - 26 -

paid to member stores leaves us less than clear as to the

substance of respondent’s argument concerning control.

     As set forth supra in section III.A., respondent claims as a

fact:   “Petitioner negotiated for the food show rebates and

thereby provided for the direct payment of moneys from vendors to

members that would otherwise have accrued to Affiliated as

earnings, i.e., rebated from vendors to Affiliated for product

purchased for sale by Affiliated.”     While it is true that

petitioner negotiated with respect to show money and had the

right to final approval and, therefore, exercised some control

over show money, petitioner’s authority and rights were the same

irrespective of whether the vendor chose to use petitioner-

delivered or vendor-provided currency to pay show money to member

stores.   Yet respondent’s adjustments increasing petitioner’s

income on account of rebates petitioner is deemed to have

received is made only with regard to petitioner-delivered

currency (and without regard to vendor-provided currency).     If

negotiation and approval with respect to show money signify

control, then we do not see why those factors do not equally

signify control with respect to vendor-delivered currency.     The

singular distinction between petitioner-delivered and vendor-

provided currency is that the former came to vendors from

petitioner’s hands.   As explained in the next two paragraphs, we

do not see that distinction as justifying different treatment.
                              - 27 -

     With respect to each vendor receiving petitioner-delivered

currency, the delivery was of either, or both of, promotional-

allowance currency or vendor-check currency.   A vendor retained

control of its promotional allowance account,7 and only upon its

specific instruction was petitioner authorized to charge the

account and deliver a specified amount of currency to the vendor

at the food show.   Petitioner had no discretion in the matter.

Petitioner likewise lacked discretion with respect to the

proceeds of a vendor’s check that it delivered to the vendor at

the food show.   In N. Am. Oil Consol. v. Burnet, 286 U.S. 417,

424 (1932), the Supreme Court announced what has been termed the

“claim-of-right” doctrine:

     If a taxpayer receives earnings under a claim of right
     and without restriction as to its disposition, he has
     received income which he is required to return, even
     though it may still be claimed that he is not entitled
     to retain the money, and even though he may still be
     adjudged liable to restore its equivalent. * * *

The doctrine does not apply to amounts a taxpayer receives as a

mere conduit or agent for transmittal to another.    E.g.,

Apothaker v. Commissioner, T.C. Memo. 1985-445.     Indeed, in a

case predating subchapter T and upholding the payer corporation’s

exclusion from gross income of patronage based refunds, the Court

of Appeals for the Fifth Circuit grounded its analysis in part on

the following proposition:   “‘[I]n order for receipts to



     7
         See supra note 5.
                              - 28 -

constitute taxable income to a taxpayer there must be (1) the

presence of a claim * * * [of] right to such receipts, and (2)

the absence of a definite, unconditional obligation to pay the

same to another.’”   United States v. Miss. Chem. Co., 326 F.2d

569, 573 (5th Cir. 1964) (quoting Farmers Coop. Co. v.

Birmingham, 86 F. Supp. 201, 214 (N.D. Iowa 1949) (citing

Commissioner v. Wilcox, 327 U.S. 404 (1946))).

     Petitioner-delivered currency came into petitioner’s hands

on the understanding that petitioner would in short order deliver

the currency to the vendors whose promotional allowance accounts

had been debited, or whose checks had been cashed, to provide the

currency.   Petitioner lacked meaningful control over petitioner-

delivered currency, and neither its receipt of checks from

vendors, its withdrawal of currency from the bank, nor its

delivery of that currency to vendors can, alone or together,

serve as the basis for charging petitioner with having received

rebates from vendors.   With respect to this narrow aspect of the

show money operation, petitioner merely served as a conduit,

providing the vendors with liquidity from their own funds.    We do

not see that petitioner effectively exercised any more control

over petitioner-delivered currency than it did over vendor-

provided currency.

     We end our discussion of control inconclusively because, so

far as we understand respondent’s control argument, it is
                              - 29 -

unpersuasive:   We do not see a sufficient difference between

petitioner’s control over petitioner-delivered and vendor-

provided currency that they should be treated differently, yet

that is what respondent has done.   Nevertheless, we are mindful

that in affirming our prior treatment of show money in Affiliated

Foods, Inc. v. Commissioner, 154 F.3d at 533, the Court of

Appeals remarked that, by negotiating the terms of show money

payments, petitioner provided for the direct payment of moneys

from vendors to member stores that otherwise would have accrued

to petitioner as earnings.   Even were we to ignore respondent’s

failure to treat petitioner-delivered and vendor-provided

currency equivalently, however, and to credit petitioner with

control over petitioner-delivered currency, we believe that

petitioner prevails for the reasons stated below.

           2.   Rebates

     Both petitioner and the member stores are merchants.    A

merchant computes its gross income from sales during a year by

subtracting from its revenue from sales the cost of the goods

sold.   See sec. 1.61-3(a), Income Tax Regs.   A purchase price

adjustment or a price rebate that a taxpayer receives with

respect to goods that it has purchased for resale is not, itself,

an item of gross income but, instead, is treated as a reduction

in the cost of the goods sold.   See, e.g., Dixie Dairies Corp. v.

Commissioner, 74 T.C. 476, 492 (1980).
                               - 30 -

     In his reply brief, respondent describes how petitioner

should have accounted for the rebates that respondent deems

petitioner received on account of the vendors’ currency payments

to member stores.   Without distinguishing between petitioner-

delivered and vendor-provided currency, respondent states:

“Affiliated should have reduced its cost of goods sold to reflect

these currency rebates and thereby increased its income.   This is

what happened, for example, with those rebates that took the form

for a reduction in the invoice price (i.e., ‘off invoice’).”

That, however, is not what happened with respect to off-invoice

discounts.   Petitioner’s chief financial officer, Tammie Coffee,

gave uncontradicted and convincing testimony that, in the case of

show money paid by way of an off-invoice discount, the discount

reduced both the cost of the goods sold and petitioner’s receipt

from the sale of the goods (its gross receipt).   The net effect,

of course, is that any off-invoice discount had no effect on

petitioner’s gross income.8   Nor did any payment of show money

from vendor-provided currency have any effect on gross income,

since petitioner ignored it in determining both the cost of the




     8
        Because petitioner had a fixed right to reimbursement at
the time it accorded an off-invoice discount to a member store,
there should be no difference between the time it accrued the
receipt from the sale and the time it reduced its cost for the
goods sold. See Rev. Rul. 84-41, 1984-1 C.B. 130 (citing Wolfors
v. Commissioner, 69 T.C. 975, 983-985 (1978)).
                              - 31 -

goods sold and the gross receipt from the sale, and respondent

has not challenged that treatment.

     While he has misunderstood how petitioner accounted for the

off-invoice discounts, we assume that respondent would agree

that, as between petitioner and the vendors, any off-invoice

discounts or deemed rebates were trade discounts, which reduced

the cost to petitioner of merchandise purchased from the vendors.

See sec. 1.471-3(b), Income Tax Regs. (cost of merchandise

purchased during taxable year is invoice price less “trade” and

certain other discounts); Rev. Rul. 84-41, 1984-1 C.B. 130, 130

(“Trade discounts represent adjustments to the purchase price

granted by a vendor.”).   Putting aside for the moment

petitioner’s status as a cooperative corporation, it is difficult

to see why the rebates that respondent deems petitioner received

from vendors and passed on without alteration to member stores on

sales made to those stores should not also be deemed to reduce

petitioner’s receipts from those sales.    We have found that the

special show discounts were based on the quantity of merchandise

member stores ordered from petitioner at the food shows.   The

discounts were an inducement to greater sales.   If petitioner is

deemed to have paid any show money, its purpose was to increase

sales (and profits9) by reducing prices.   Those deemed payments,



     9
        Petitioner ignored special show discounts in applying its
markup to food show sales. See supra note 3.
                              - 32 -

therefore, should be considered as reducing its receipts from

sales.

     We cannot improve on the Commissioner’s explanation in Rev.

Rul. 2005-28, 2005-1 C.B. 997, as to why any deemed payments

should be considered as reducing petitioner’s receipts from

sales.   In that revenue ruling, the Commissioner holds that

Medicaid rebates incurred by a pharmaceutical manufacturer are

purchase price adjustments that are subtracted from gross

receipts in determining gross income.   The Commissioner states:

     In Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707
     (1956), * * * the Tax Court addressed whether
     allowances, discounts, or rebates paid by a milk
     producer to certain purchasers of its milk, in willful
     violation of state law, are adjustments to the purchase
     price of the milk resulting in a reduced sales price,
     or ordinary and necessary business expenses under § 162
     (in which case no deduction would be allowed under the
     rules of § 162(c)). The court reasoned that for income
     derived from the sale of property, in determining gain,
     the amount realized must be based on the actual price
     or consideration for which the property was sold and
     not on some greater price for which it possibly should
     have been, but was not, sold. The court focused on the
     facts and circumstances of the transaction, what the
     parties intended, and the purpose or consideration for
     which the allowance was made. The court found that the
     allowances were part of the sales transaction and
     concluded that gross income must be computed with
     respect to the agreed net prices for which the milk was
     actually sold. Thus, under Pittsburgh Milk, where a
     payment is made from a seller to a purchaser, and the
     purpose and intent of the parties is to reach an agreed
     upon net selling price, the payment is properly viewed
     as an adjustment to the purchase price that reduces
     gross sales. [Id., 2005-1 C.B. at 997; emphasis
     added.]
                                - 33 -

     We must, therefore, consider whether petitioner’s status as

a cooperative requires a different result.

            3.   Cooperative Status

            a.   Introduction

     Section 1382 addresses the taxable income of cooperatives,

such as petitioner, to which section 1381 applies (individually,

a subchapter T cooperative).     Section 1382(a) addresses the gross

income of subchapter T cooperatives.     In pertinent part, it

provides:

          SEC. 1382(a). Gross Income.–-Except as provided
     in subsection (b), the gross income of any organization
     to which this part applies shall be determined without
     any adjustment (as a reduction in gross receipts, an
     increase in cost of goods sold, or otherwise) by reason
     of any allocation or distribution to a patron out of
     the net earnings of such organization * * * .

Subsection (b)(1) of section 1382 provides an exception that, in

effect, allows a deduction from gross income for the payment of

“patronage dividends”.    That term, in pertinent part, is defined

in section 1388(a) to mean amounts paid by a subchapter T

cooperative:

          (1) on the basis of quantity or value of business
     done with or for such patron,

          (2) under an obligation of such organization to
     pay such amount, which obligation existed before the
     organization received the amount so paid, and

          (3) which is determined by reference to the net
     earnings of the organization from business done with or
     for its patrons.
                                - 34 -

            b.   Respondent’s Argument:   Defective Patronage
                 Dividends

     As we understand respondent’s argument, it is that the trade

discounts that respondent deems petitioner to have received from

the vendors and to have passed on without alteration to member

stores on sales made to those stores do not reduce petitioner’s

gross receipts from those sales because those passed-on rebates

were defective patronage dividends.

     According to respondent, the passed-on rebates resembled

patronage dividends in two respects.      First, they were patronage

based.   Indeed, respondent proposes that we find that the deemed

rebates “were based on the amount of product purchased, or

business done, by [petitioner’s shareholder-patrons]”.      Second,

they were prearranged, at least in the sense that they were part

of the negotiated sale price of merchandise ordered by member

stores at the trade shows and were consistent with petitioner’s

policy of passing on to member stores discounts obtained from

vendors.    Respondent argues, however: “[P]etitoner cannot show

that the dividends were calculated by reference to the net

earnings of the cooperative from business done with or for its

patrons.”    Therefore, respondent concludes:    “The amounts in

question do not qualify for the patronage dividend deductions.”

Respondent adds:    “Once it has been determined that the amounts

at issue were disguised [we would say “defective”] patronage

dividends the analysis should stop.”
                                   - 35 -

     But if the analysis stops there, then respondent may well

lose.        If the passed-on rebates are defective patronage dividends

because petitioner cannot show that they were calculated with

reference to its patronage-based net earnings, then, perhaps,

they were not calculated with reference to those earnings.       If

not, then it would appear that section 1382(a) imposes no

restriction on petitioner’s reducing its gross receipts from

sales to member stores to reflect what respondent must concede

are price adjustments (i.e., trade discounts).10       Nor has

respondent advanced an argument separate from his defective

patronage dividend argument that any provision of subchapter T

prevents a subchapter T cooperative from subtracting trade




        10
        Moreover, in Pittsburgh Milk Co. v. Commissioner, 26
T.C. 707 (1956), and cases following that decision, the Tax Court
has held that when, as added consideration for a sale, a seller
rebates part of a customer’s purchase price or pays that customer
cash from a separate account, the amount of the rebate is not a
business expense, potentially deductible under sec. 162, but,
rather, a reduction of selling price. Regardless of whether the
rebate is legal (viz, whether sec. 162(c) would disallow
deduction of such an illegal rebate by that seller/taxpayer), the
seller is treated as if it never received more than the net
selling price (i.e., the stated selling price, less the rebate);
the amount of the rebate is excluded from the seller’s gross
income. See generally Max Sobel Wholesale Liquors v.
Commissioner, 630 F.2d 670, 671-672 (9th Cir. 1980), affg. 69
T.C. 477 (1977). In Max Sobel, 630 F.2d at 672, the Court of
Appeals for the Ninth Circuit further observed: “The Pittsburgh
Milk doctrine has the obvious merit of reflecting economic
reality.” The Commissioner has acquiesced to the Tax Court’s
holdings in Max Sobel and Pittsburgh Milk. See 1982-2 C.B. 2, 4;
see also Rev. Rul. 82-149, 1982-2 C.B. 56.
                               - 36 -

discounts accorded patrons from the purchase price it charges

those patrons in determining gross receipts.

     We shall consider further the nature of patronage dividends.

          c.   Patronage Dividends Considered Price Adjusments

     We have said:   “Patronage dividends are considered rebates

on purchases or deferred payments on sales, allocated or

distributed pursuant to a preexisting obligation of the

cooperative, and, as such, do not constitute taxable income to

the cooperative.”    Buckeye Countrymark, Inc. v. Commissioner, 103

T.C. 547, 558 (1994).

     The notion that a cooperative should not be taxed on

patronage-based payments because those payments amount to nothing

more than price adjustments is a longstanding rationale

underlying the Federal income tax treatment of patronage

dividends.   Subchapter T was added to the Internal Revenue Code

by the Revenue Act of 1962 (the 1962 Act), Pub. L. 87-834,

section 17, 76 Stat. 1045.   Before the 1962 Act, non-tax-exempt

cooperatives were taxed as corporations.   See Ravenscroft, “The

Proposed Limitation on the Patronage Dividend Deduction”, 12 Tax

L. Rev. 151, 152 (1957).   However, under administrative

practices, judicially affirmed, they could exclude from gross

income the amounts allocated to patrons as patronage dividends.

E.g., Farmers Coop. Co. v. Birmingham, 86 F. Supp. 201, 219

(N.D. Iowa 1949) (collecting administrative rulings).      Primarily,
                                - 37 -

two distinct theories were advanced as the reason for the

exclusion of patronage dividends from the taxable income of

cooperatives.     Certified Grocers, Inc. v. United States, 18 AFTR

2d 5012, 66-2 USTC par. 9493 (M.D. Fla. 1966).     In that case, the

District Court described those theories as follows:

        Under the so-called agency theory, the cooperative
        should never be taxed because it is conceived of as an
        agent, bailee, or trustee for the patrons, serving
        merely as a conduit for their income which it does not
        own. On the other hand, the so-called price adjustment
        theory excludes patronage dividends from income because
        it treats the dividends as minor adjustments in the
        costs of goods, analogous to discounts and rebates
        given by a seller at the time of sale or upon prompt
        payment. [Id. at 5,013, 66-2 USTC par. 9493, at
        86,547.]

See also discussion and cases collected in Ravenscroft, supra at

154-168; Reynolds, “What Then To Do With a Non-Cooperative

Cooperative?” 56 Tax Law. 825, 831-832 (2003).

        The price adjustment theory appears to have been the more

widely accepted theory.     Certified Grocers, Inc. v. United

States, supra; Ravenscroft, supra at 157, 160; Reynolds, supra at

831.    Indeed, the U.S. Court of Appeals for the Fifth Circuit has

said:

            The exclusion of patronage dividends for federal
       income tax purposes has not been placed upon the ground
       that cooperatives are special creatures of statute
       under the tax laws, but rather upon the theory that
       patronage dividends are in reality rebates on purchases
       or deferred payments on sales allocated or distributed
       pursuant to a pre-existing obligation of the
       cooperative, and thus do not constitute taxable income
       to the cooperative. * * *
                              - 38 -

United States v. Miss. Chem. Co., 326 F.2d at 573 (citing Midland

Coop. Wholesale Oil Association v. Commissioner, 44 B.T.A. 824

(1941), for the stated proposition).

     The legislative history of the 1962 Act indicates that, in

providing a statutory deduction for patronage dividends, the tax-

writing committees of Congress had in mind the price adjustment

theory.   S. Rept. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B.

707, 822 (“patronage dividends represent price adjustments”); H.

Rept. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 405, 485-486

(similar).

          d.   The Price Adjustment Theory Has Its Limits

     An examination of the limited caselaw on the subject and

scholarly and other authoritative writings convinces us that,

although the Federal income tax treatment of patronage dividends

may rest substantially on the price adjustment theory, a price

adjustment made by a cooperative may reduce its gross income even

if the adjustment does not qualify as a patronage dividend.

     It has long been understood that the distinguishing

characteristic of a cooperative enterprise is the obligation of

the enterprise to distribute what may be called its “excess

receipts” (or “net margins”) on a patronage basis.   See Packel,

Law of Cooperatives 248–249 (3d ed. 1956).   While there is some

question as to whether, with regard to a cooperative enterprise,

the concept of profit is appropriate (since the enterprise is run
                                - 39 -

for the benefit of those who do business with it and not for the

purpose of making a profit for the organizers), the idea is that,

periodically, any surplus, or amount in excess of the break-even

point from doing business with patrons, will be returned to the

patrons on the basis of their dealings with the cooperative

(i.e., on a patronage basis).    See id.   Indeed, today, for

Federal income tax purposes, patronage dividends are determined

by reference to the “net earnings” of the organization from

business done with or for its patrons.     Sec. 1388(a)(3); sec.

1.1388-1(a)(1), Income Tax Regs.    The regulations describe “net

earnings” as including “the excess of amounts retained (or

assessed) by the organization to cover expenses or other items

over the amount of such expenses or other items.”     Sec. 1.1388-

1(a)(1), Income Tax Regs.

     Notwithstanding the question of the appropriateness of the

term “profit” with respect to a cooperative enterprise, both

early administrative interpretations and judicial decisions

conceived of a patronage dividend not as a simple price

adjustment or immediate rebate but as a distribution of corporate

profits or income.   In O.D. 64, 1 C.B. 208 (1919), the

Commissioner ruled concerning an incorporated fruit grower’s

association that conducted its business at a profit.     It ruled

that the nonexempt corporation would not have to pay any income

tax on its patronage dividends.    It authorized the corporation
                              - 40 -

to:   “deduct from gross income amounts periodically returned to

members as a refund of profits on business transacted with them,

and proportioned to the amount of such business.”   Id. (emphasis

added).   In United Coops., Inc. v. Commissioner, 4 T.C. 93, 107-

108 (1944), we held that an agricultural cooperative was entitled

to exclude from gross income as a patronage dividend the excess

of its net income available for distribution to its patrons (and

to which they had a right) over the amount of that income that

the cooperative had discretion to pay as dividends on its common

stock.    We said:

      These dividends, if paid, would be paid out of net
      income. If dividends were not paid, then the net
      income of petitioner available for distribution to its
      patrons would be accordingly greater. The choice of
      whether so much of its net income as equaled 8 percent
      of the par value of its common stock should be
      distributed to its stockholders as a dividend or to its
      patrons as rebates was in the corporation. * * * [Id.
      at 108; emphasis added.]

It hardly seems disputable that, whether by administrative or

judicial decision, or by act of Congress, the allowance of a

deduction for patronage dividends was intended not to confirm

that a trade discount is a proper adjustment to the price

reported on a particular sale of a good or service to a patron

(whether a shareholder or not) but was intended to allow a

deduction for a patronage-based return made from the excess

proceeds from many sales, to many patrons (i.e., from net

earnings), over the course of time.
                              - 41 -

     That patronage dividends are somehow different from

transaction-specific price reductions was recognized well before

Congress codified the definition of a patronage dividend in 1962.

The difference was recognized by courts overseeing legislative

price regulation in fields in which cooperatives operated.    In

1950, the U.S. Court of Appeals for the Third Circuit held that a

purchasing cooperative cannot use its cooperative status as a

shield against State Fair Trade Laws prohibiting price reductions

at the time of sale.   Sunbeam Corp. v. Civil Serv. Employees’

Coop. Association, 187 F.2d 768 (3d Cir. 1951).   Also in 1950,

the California District Court of Appeals held that the provisions

of the California Corporations Code that permit a cooperative

corporation to distribute its earnings to its shareholder-patrons

are paramount to the provisions of the California Alcoholic

Beverage Control Act that prohibit sales of liquor at less than

posted prices and secret rebates.   Certified Grocers v. State Bd.

of Equalization, 223 P.2d 291 (Cal. Dist. Ct. App. 1950).

     A categorical difference between patronage dividends and

transaction-specific price reductions had been recognized by

commentators.   See, e.g., Packel, supra at 217 (“It is important

to distinguish a price reduction, given at the time of the

transaction, from a true patronage dividend.”); Bunn, Consumers’

Co-Operatives and Price Fixing Laws, 40 Mich. L. Rev. 165, 173

(1941) (“The truth is that a patronage dividend is not a price
                              - 42 -

reduction on any given sale.”).   One commentator has explained

the distinction as being based on the impracticability, if not

the impossibility, of relating patronage dividends to gain or

loss upon any particular transaction with any particular patron.

Adcock, “Patronage Dividends: Income Distribution or Price

Adjustment”, 13 Law & Contemp. Probs. 505 (1948).   As explained

by Professor Bunn (who, in Sunbeam Corp. v. Civil Service

Employees’ Cooperative Assn., supra, was credited for his

“scholarly discussion” that “greatly helped” the court):

     [A patronage dividend] cannot be allowed or promised
     when a sale is made, for it is made from earnings only,
     and no one can be sure there will be any earnings. Our
     business may sell at an eighty per cent mark-up and
     still go broke if overhead exceeds that spread. And we
     will not know our overhead per unit until we know our
     total volume. Neither will we know our bad debts, or
     other losses. We may make shrewd guesses, and quite
     close estimates of earnings if we know our business
     well, but we cannot be sure, and therefore we can never
     promise. * * *

Bunn, supra at 173.   Professor Bunn concludes:

     True patronage dividends are divisions of net earnings.
     Net earnings are not made on any single sale. They
     result from the total operations of some accounting
     period, and become known only after the results for
     that period are in. A distribution of them, on
     whatever basis, is not a price reduction nor a rebate
     * * * .

Id. (fn. ref. omitted).
                              - 43 -

          e.   Conclusion

     We do not believe that Congress intended to subsume within

the definition of the term “patronage dividend” transaction-

specific price reductions such as are encompassed by the term

“trade discount”.   While the term “rebate” may sometimes be used

in explaining the allowance of the deduction for patronage

dividends, see, e.g., Buckeye Countrymark, Inc. v. Commissioner,

103 T.C. at 558, we agree with the commentators that there is a

categorical difference between a rebate in the nature of a trade

discount and a patronage dividend.     A patronage dividend is paid

under an obligation to distribute some or all of net earnings of

the enterprise on the basis of patronage.11    Respondent puts his

finger right on the difference when he argues that petitioner

cannot show that the passed-on rebates he deems petitioner to

have made “were calculated by reference to the net earnings of

the cooperative from business done with or for its patrons.”

They were not; they were calculated exclusively with reference to

the rebates accorded to petitioner by the vendors on account of

orders taken by petitioner from member stores at the food shows.

If we were to agree with respondent that, for lack of a net



     11
        In theory, of course, a cooperative could set its prices
so as to minimize its profit and reduce the amount available for
patronage dividends. That has been referred to as the “pricing
out” problem, which may exist more in theory than in practice.
See Patterson, The Tax Exemption of Cooperatives 89-90 (2d rev.
ed. 1961). In any event, it does not concern us here.
                                - 44 -

earnings connection, the passed-on rebates fail as price

adjustments because they are defective patronage dividends, then

what of other transaction-specific rebates, refunds, or price

adjustments?   Are we to conclude that, if a purchasing

cooperative has a buy-two-get-one-free sale, offers a loss-leader

or a volume discount, or, indeed, sells any good or service for

less than some hypothetical normal price, it has paid a defective

patronage dividend unless, in some way, it can show that the

price reduction is a distribution of net earnings?    Indeed, must

any merchant offering a rebate, refund, or other price reduction

consider whether it is operating on a cooperative basis,

distributing defective patronage dividends?    We think not.

     We conclude that a transaction-specific price reduction,

such as is encompassed by the term “trade discount”, is not

generally determined with respect to the net earnings of the

payer, and, for that reason, it is not a patronage dividend

(defective or not).

          4.   Other Factors

     Respondent argues that petitioner “has virtually no records

of the currency incentives used at the food shows.    It destroyed

most of the relevant records.    * * *   This fact combined with the

use of cash invites suspicion.”    While it is true that petitioner

discarded most all of the tear strips after the relevant

information was entered into its billing and accounting records,
                              - 45 -

petitioner had sufficient information to compute its margin on

each sale.   There also is a stipulation as to the net amount of

petitioner-delivered currency retained by the vendors.   There is

no evidence confirming the actual payments of petitioner-

delivered currency by vendors to member stores, but the deemed

fact of those payments underlies respondent’s adjustments.    While

cash payments to member stores might invite abuse by the member

stores, there is no evidence of any such abuse here, and, to the

extent that payments were actually made by the vendors to member

stores, we assume that the vendors had adequate motivation to

keep adequate records of those payments.   In short, whatever

shortcomings exist in petitioner’s records, respondent has failed

to convince us that those shortcomings justify denying petitioner

a reduction in the amount of its gross receipts from sales to

member stores on account of deemed rebates that respondent would

charge against petitioner’s costs of goods sold and would treat

as having been passed on as price reductions to the member

stores.

          5.   Conclusion

     The deemed rebates that respondent charges petitioner with

making are (if they are to be charged to petitioner) properly

characterized as trade discounts.   They were not paid with

reference to petitioner’s net earnings but merely passed along

price adjustments that petitioner was entitled to on account of
                               - 46 -

the orders placed by the member stores at the food shows.     They

reduce petitioner’s gross receipts and are not defective

patronage dividends.12

      C.   Conclusion

      For the audit years, petitioner had no items of gross income

on account of petitioner-delivered currency paid by vendors to

member stores as show money.

IV.   Conclusion

      In the light of the foregoing,

                                            Decision will be entered

                                       for petitioner.




      12
        Our conclusion is, of course, based on the assumption
that the petitioner-delivered currency paid to member stores
flowed through petitioner, as passed-on rebates, in the manner
described supra in sec. III.B.1 of this report. We do not decide
that manufacturers’ rebates paid directly to retail customers are
necessarily deemed to pass through the retailer. Such a rebate
was addressed by the Commissioner in Rev. Rul. 76-96, 1976-1 C.B.
23, suspended in part by Rev. Rul. 2005-28, 2005-1 C.B. 997,
which describes an automobile manufacturer’s rebate paid directly
to qualifying retail customers and gives no indication that the
rebate was considered to have flowed through the retailer.
