                         T.C. Memo. 2001-100



                       UNITED STATES TAX COURT



         DANIEL E. AND KAREN A. HARKINS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15623-99.                      Filed April 26, 2001.


     Tim A. Tarter, for petitioners.

     John W. Duncan and Ann M. Welhaf, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:    Respondent determined a deficiency of

$111,311 in petitioners' 1996 Federal income tax.    After various

concessions,1 the issues presented to us are (1) whether


     1
        We summarily describe certain concessions not discussed
in the Findings of Fact. Petitioners stipulate that they must
include in income $8,658 for fringe benefits received from
Harkins Amusement Enterprises, Inc. (in the form of paid medical
insurance premiums), while respondent allows a partially
offsetting health insurance deduction of $2,597 for self-employed
                                                   (continued...)
                                 - 2 -

petitioners must report as income in 1996 amounts paid during

1996 by Pepsi-Cola Co. (Pepsi) to Daniel E. Harkins' (Mr.

Harkins') solely owned S corporation and (2) whether petitioners

must report as income in 1996 amounts paid in 1997 by Pepsi which

are associated with the S corporation's activities in 1996.

Because the S corporation reports its income on the accrual

method of accounting, we evaluate the above issues within the

context of sections 446 and 451 and the regulations thereunder.2

                           FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.     At the time they filed

their petition, petitioners' residence was in Paradise Valley,

Arizona.

         Mr. Harkins operates various motion picture theaters

throughout the State of Arizona, most of which are located in the

greater Phoenix area.     He conducts his movie theater business

through Harkins Amusement Enterprises, Inc. (the theater


     1
      (...continued)
individuals. As to certain Schedule E, Supplemental Income and
Loss, income determined and deductions disallowed by respondent,
petitioners concede that they have additional income of $5,195
and that they are not entitled to deductions of $55,744 for rent
and $46,478 for repair and maintenance. Respondent concedes that
$7,941 in interest income is not subject to taxation.
     2
        Section references are to the Internal Revenue Code in
effect for 1996, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                               - 3 -

company), a corporate entity incorporated under the laws of

Arizona and classified for tax purposes as an S corporation.     See

secs. 1361-1363.   During the year in issue, the theater company

used the accrual method of accounting to report its income and

expenses.   Because the theater company is classified as an S

corporation for Federal income tax purposes, the income and

expenses reported by the theater company flow through to

petitioners' personal tax return.   See sec. 1366.

     At the time of trial, the theater company operated 19 movie

theaters with a total of 198 movie screens.   Along with providing

motion picture entertainment, the theater company sells food and

beverages at snack bars located inside its movie theaters.     In

order to generate significant and consistent revenues from its

food services, Mr. Harkins, as president of the theater company,

entered into an agreement with Pepsi to purchase postmix products

for use in preparing Pepsi brand soft drinks.3   Among other

requirements, the theater company agreed to purchase Pepsi paper

cups, Pepsi compressed CO2, and certain equipment used in the

preparation of fountain soft drinks.   The term of the agreement




     3
        The theater company did not generally sell any premixed
and prepackaged Pepsi products (i.e., Pepsi-brand bottles or cans
generally available to the public at stores and supermarkets).
There is an indication in the record, however, that the theater
company sold Aquafina, Pepsi-brand bottled water.
                                      - 4 -

commenced on January 1, 1995, and extended through January 1,

2000.4

     As part of the agreement, Pepsi agreed to provide certain

monetary support to the theater company based upon its purchases

of Pepsi products.       Pepsi agreed to pay 65 cents for each gallon

of postmix product purchased by the theater company.         The parties

designated this type of incentive as flex funds.          The agreement

provided:

         NATIONAL ACCOUNT PRICES AND FLEX FUND ALLOWANCES

                     *      *     *      *    *   *   *

     All standard flex funds will accrue on a semi-annual
     basis and will be paid to the Customer accordingly.
     The Customer will receive all $.65 per gallon under the
     flex fund program, which will be deemed earned by the
     Customer upon payment by Pepsi-Cola of the Flex Funds
     to the Customer.

Pepsi also provided marketing support to the theater company at

the rate of $2.05 for each gallon of postmix product purchased.

The parties designated these funds as marketing funds and

provided as follows:

                                MARKETING FUND

     During each year for the Term of this Agreement, Pepsi-
     Cola will accrue a marketing fund (“the Marketing
     Funds”) at the rate of $2.05 per gallon on all Postmix
     Products purchased by the Customer during each year.
     Pepsi-Cola will pay these Funds to the Customer each
     year within 60 days after the completion of each 6-
     month period, starting from the anniversary date and


     4
        At the time of trial, Mr. Harkins was negotiating a new
agreement with Pepsi.
                              - 5 -

     continuing through the end of the Term. The intent of
     this support is to provide financial support to aid in
     the development of marketing programs that provide
     mutual benefit to both the Customer and Pepsi-Cola, and
     to support the costs associated with the Customer's
     compliance with marketing requirements outlined in the
     Performance paragraph below.

     The Marketing Funds will be deemed to be earned only if
     the Customer is in full compliance with all of the
     requirements set forth in the Performance Paragraph
     below for that entire Year. Should the Customer fail
     to comply with any of the Performance Requirements
     during the Term, the Customer agrees that in addition
     to the forfeiture of any funding for the second 6-month
     period, the Customer shall immediately repay to Pepsi-
     Cola all of the funds paid to the Customer, by Pepsi-
     Cola, for the first 6-month period of that Year.
     [Emphasis added.]

In exchange for the right to receive the flex and marketing

funds, the theater company agreed to the following performance

criteria (which dealt with obligations to exclusively purchase,

sell, and advertise Pepsi-brand products):

                           PERFORMANCE

     This Agreement, including all of Pepsi-Cola's support
     to the Customer as described above [the flex funds and
     the marketing funds], is contingent upon the Customer's
     complying with all of the following performance
     criteria, with which the Customer hereby agrees to
     comply with as follows:

     1.   The Customer agrees that exclusively Pepsi-Cola
          supplied Soft Drink Products shall be served
          throughout the Term of this Agreement in each of
          the Customer's outlets: Pepsi-Cola, Diet Pepsi-
          Cola, Caffeine Free Diet Pepsi, Mountain Dew,
          Lemon Lime Slice, Mandarin Orange Slice, Wild
          Cherry Pepsi and Dr. Slice.

     2.   The Customer shall purchase only Pepsi-Cola
          supplied, Pepsi brand identified paper cups. If
          the Customer chooses to design a custom cup, at
                                - 6 -

          least one full vertical panel (or equivalent
          thereof, subject to the prior written consent of
          Pepsi-Cola) shall contain the Pepsi-Cola logo.
          All incremental costs to include artwork, art
          changes and custom cup development, will be the
          responsibility of the Customer.

    3.    Beginning in 1996, and each subsequent Year
          thereafter, for the Term of this Agreement, at
          least one full vertical panel on the Customer's
          32oz plastic refill cup (or equivalent thereof,
          subject to the prior written consent of Pepsi-
          Cola) shall contain the Pepsi-Cola logo. Should
          the Customer elect to trade out or sell a panel to
          another partner/vendor/supplier, the Customer
          agrees that production of said cup must be with
          the mutual approval of the Customer and Pepsi-
          Cola.

                  *    *    *      *    *   *   *

    10.   The Customer shall provide to Pepsi-Cola upon the
          execution of this Agreement a list of all outlets
          in the Customer's system. The Customer agrees
          that it shall promptly notify Pepsi-Cola in
          writing of each new outlet in the Customer's
          system which is opened or acquired during the
          Term, as well as any outlet which is closed, sold
          or otherwise disposed of during the Term.

    Finally, in a closing section of the agreement, the parties

agreed:

                       CLOSING PARAGRAPHS

    If for any reason the Customer fails to comply with any
    of the terms of this Agreement, the Customer agrees
    that, in addition to any other remedies to which Pepsi-
    Cola may be entitled by reason of such breach, the
    Customer shall immediately repay to Pepsi-Cola all
    funding previously paid by Pepsi-Cola but not earned by
    the Customer pursuant to the terms of this Agreement.
                               - 7 -

     Pepsi paid the flex and marketing funds associated with the

first half of 1996 (generally, January 1 to June 30) in 1996.5

The flex and marketing funds relating to the last half of 1996

(generally, July 1 to December 31) were paid by Pepsi in 1997.

On its 1996 tax return, the theater company reported in income

only the flex and marketing funds paid in 1996.

     Respondent determined that the flex and marketing funds paid

in 1997, which related to the latter half of 1996, should have

been accrued by the theater company in 1996 as income and

included on its 1996 tax return.   In their petition, petitioners

averred that the theater company did not have to accrue for 1996

any of the payments made in 1997 or 1996.   Respondent now

concedes that petitioners did not have to report as income the

flex funds for the last half of 1996 which were paid in 1997.

Respondent still contends that the marketing funds for the latter

half of 1996 which were paid in 1997 should have been accrued by

the theater company in 1996 and included in petitioners' 1996 tax

return.   Respondent maintains that the payments made in 1996 with

respect to the first half of that year were properly reported on

the theater company's and petitioners' 1996 tax returns.




     5
        The parties stipulate that the flex funds for the first
half of 1996 accounted for the period beginning Jan. 4, 1996, and
ending June 14, 1996. The parties do not provide any explanation
for this departure from the agreement.
                                - 8 -

                               OPINION

I.     Evidentiary Issue

       At trial, respondent objected generally to the proposed

testimony of Ron Goodson, a general manager from the Pepsi-Cola

Bottling Group of Arizona.    Petitioners presented his testimony

for the purpose of addressing and interpreting certain terms in

the agreement.    Respondent argued that Mr. Goodson's testimony

was an attempt by petitioners to vary or contradict the written

terms of the agreement in violation of Arizona's parol evidence

rule.    Petitioners, on the other hand, contended that Mr. Goodson

was to testify in a manner consistent with the agreement, and

therefore the introduction of parol evidence for the purpose of

interpreting the intent of the parties was proper under Arizona

law.

       The Court allowed Mr. Goodson to testify conditionally for

the purpose of evaluating whether his testimony would be in

conflict with Arizona's parol evidence rule and reserved ruling

on respondent's objection.    We briefly describe Mr. Goodson's

relevant testimony.

       Mr. Goodson testified that during the 60-day period

following the end of each 6-month period of the agreement, Pepsi

investigated whether the theater company was in compliance with

the agreement.    He, however, described only the investigation
                                - 9 -

undertaken by Pepsi at the end of each calendar year.6    Mr.

Goodson explained that only if Pepsi, after conducting the

investigation, considered the theater company to be in compliance

with the agreement would Pepsi then pay the flex and marketing

funds to the theater company.   He also explained that Pepsi

believed that it could recover any flex or marketing funds

previously paid if Pepsi considered the theater company to have

breached the agreement.   We now rule on respondent's objection.

     Under Arizona's parol evidence rule, a judge “first

considers the offered evidence and, if he or she finds that the

contract language is ‘reasonably susceptible’ to the

interpretation asserted by its proponent, the evidence is

admissible to determine the meaning intended by the parties.”

Taylor v. State Farm Mut. Auto. Ins. Co., 854 P.2d 1134, 1140

(Ariz. 1993).   The judge, however, must still exclude extrinsic

evidence which would vary or contradict the meaning of the

written agreement.   See id.

     We believe that certain parts of Mr. Goodson's testimony are

properly admissible for the purpose of interpreting the rights

and obligations of the parties under the agreement.    We also

believe that other parts of Mr. Goodson's testimony are

inadmissible as they contradict or vary the parties' agreement as



     6
        Mr. Goodson testified that the investigation could take
up to 180 days.
                               - 10 -

written.    We therefore do not consider the parts of Mr. Goodson's

testimony which are inadmissible in deciding the issues before

us.    For simplicity, we set out and refer to Mr. Goodson's

admissible and nonadmissible testimony below as we evaluate the

written language of the agreement.

II.    The All Events Test

       A taxpayer may use the accrual method of accounting to

report income.    See secs. 446(a), (c), 451(a).   If the taxpayer

elects to report its income in that manner, the taxpayer must

report income in the year in which “all the events have occurred

which fix the right to receive such income and the amount thereof

can be determined with reasonable accuracy.”    Sec. 1.451-1(a),

Income Tax Regs.; see also sec. 1.446–1(c)(1)(ii)(A), Income Tax

Regs.    Generally, all the events that fix the right to receive

income occur on the earliest of the following:     (1) The date

payment is received; (2) the date payment is due; or (3) the date

of performance.    See Schlude v. Commissioner, 372 U.S. 128

(1963); Johnson v. Commissioner, 108 T.C. 448, 459 (1997), affd.

in part, revd. in part and remanded on another ground 184 F.3d

786 (8th Cir. 1999); Firetag v. Commissioner, T.C. Memo. 1999-

355.

       In addition, when applying the all events test, we consider

conditions precedent, which are required to be met before a fixed

right to receive income exists, but disregard conditions
                               - 11 -

subsequent, which may terminate an existing right to income but

the presence of which does not preclude the accrual of income.

See Keith v. Commissioner, 115 T.C. 605, 617 (2000); Charles

Schwab Corp. & Subs. v. Commissioner, 107 T.C. 282, 293 (1996),

affd. 161 F.3d 1231 (9th Cir. 1998).    Having stated the

boundaries of the all events test, we now turn to the parties'

contentions.

III.    The Parties' Contentions

       As to the flex and marketing funds paid by Pepsi during 1996

(for the first half of 1996) and which the theater company

reported as income on its 1996 tax return, petitioners now argue

that those payments were refundable deposits not subject to

accrual in 1996.    Petitioners cite Commissioner v. Indianapolis

Power & Light Co., 493 U.S. 203 (1990), for the proposition that

a taxpayer does not have to accrue payments over which he does

not have complete dominion and that complete dominion occurs only

when the taxpayer has some guaranty of retaining the funds at

issue.    Petitioners argue that because the theater company was

obligated to repay the payments for the flex and marketing funds

in the event of a breach by the theater company occurring as late

as “after year end (e.g., March 1997)”, the theater company did

not enjoy complete dominion over the payments during 1996 and

therefore did not have to accrue them.    Petitioners contend that

the theater company enjoyed complete dominion over the funds
                                 - 12 -

received in 1996 only after Pepsi performed its investigation in

1997 (i.e., only after Pepsi decided to approve payment).

      With regard to the marketing funds payment in 1997 for the

last half of 1996, petitioners reiterate that under the

agreement, Pepsi had 60 days from the end of 1996 to determine

whether the theater company had complied with the performance

criteria of the agreement.    Petitioners therefore implicitly

argue that only after Pepsi had conducted its review and

established for itself that the theater company was entitled to

the funds did the theater company have a fixed right to receive

that income.

      Respondent disagrees with petitioners that the flex and

marketing funds paid in 1996 constitute refundable deposits and

instead considers the payments as advances subject to accrual in

1996.    As to petitioners' other contentions, respondent counters

that by the close of 1996, the theater company had performed all

outstanding obligations required under the agreement to accrue

the marketing funds paid in 1997.     Specifically, respondent

argues that the agreement did not call for a review or

investigation by Pepsi–-it called only for the theater company's

performance.

IV.   Deposits Versus Advances

        In Commissioner v. Indianapolis Power & Light Co., supra,

the Supreme Court dealt with the issue of whether certain
                              - 13 -

payments constituted refundable deposits not subject to inclusion

in income versus advance payments subject to accrual.    As to

petitioners' argument that the theater company did not have

complete dominion over the payments made in 1996 until sometime

in 1997, the test of whether a taxpayer has “complete dominion”

over payments centers on “whether the taxpayer has some guarantee

that he will be allowed to keep the money.”    Id. at 210.   Indeed,

the Supreme Court remarked that the “individual who makes an

advance payment retains no right to insist upon the return of the

funds; so long as the recipient fulfills the terms of the

bargain, the money is its to keep.”    Id. at 212.   In evaluating

whether a taxpayer enjoys complete dominion, we look to “the

parties' rights and obligations at the time the payments are

made.”   Id. at 211.

     Petitioners ignore that when the 1996 payments for the flex

and marketing funds were made, the theater company, under the

agreement, had in essence a guaranty that it could retain the

funds as long as it performed according to the agreement.    For

purposes of the accrual method, the theater company's right to

the flex and marketing funds was not contingent on Pepsi's

investigating the theater company's compliance with the agreement

or approving the funds.   Therefore, the theater company's

obligation (if any) to repay the funds as a result of not

performing according to the agreement did not convert the funds
                              - 14 -

into refundable deposits or preclude their accrual as income.

     Pursuant to Arizona's parol evidence rule and Mr. Goodson's

testimony, we accept petitioners' argument that Pepsi generally

conducted an investigation during the 60-day period following the

end of each calendar year.   This part of Mr. Goodson's testimony

is consistent with the agreement in which Pepsi had 60 days to

pay the marketing funds following the end of each 6-month

period.7

     We, however, reject petitioners' contention that the theater

company's right to the funds was dependent on Pepsi's approving

the funds, for it would require us to read a provision into the

agreement.   The agreement simply states that the flex and

marketing funds were “contingent upon the Customer's complying

with * * * the * * * performance criteria”.   Because the theater

company had a guaranty of retaining the flex and marketing funds

as long as it performed under the agreement, we do not consider

the flex and marketing funds paid in 1996 to be refundable

deposits as suggested by petitioners.8


     7
        The agreement did not explicitly provide that Pepsi had
60 days at the end of each 6-month period to pay the flex funds.
     8
        As to respondent's argument that the flex funds paid in
1996 for the first half of that year constituted advance
receipts, we note that the agreement provided that flex funds
were “earned” when paid; that provision could lead to the
conclusion that at the time the flex funds were received in 1996,
they were receipts on account of actual rather than expected
performance. See infra note 9 for our interpretation of the word
                                                   (continued...)
                               - 15 -

V.   Marketing Funds Paid in 1997

     We now turn to the issue of whether the marketing funds paid

in 1997 (for the last half of 1996) were subject to accrual under

the all events test in 1996.   As to this payment, petitioners

contend that the theater company did not have a fixed right to

the marketing funds until Pepsi performed its review of whether

the theater company had complied with the agreement (i.e.,

sometime during the 60 days after the end of 1996).

     With respect to every calendar year during the term of the

agreement, Pepsi agreed to provide the theater company marketing

funds based upon the amount of Pepsi products purchased during

each respective year.   The marketing funds, however, were paid

semiannually and due from Pepsi within 60 days after the

completion of every 6-month period of each year.   The marketing

funds related to each year were considered earned under the

agreement only if the theater company was in full compliance with

the performance requirements listed in the agreement during the

entire year.9   Entitlement to the marketing funds, we have

already concluded above, was not contingent on Pepsi's approving

the marketing funds, even though Pepsi had 60 days from the close


     8
      (...continued)
“earned”.
     9
        We interpret the parties' usage of the word “earned” as
addressing when the theater company was entitled to those funds
under the agreement and not as a technical term addressing the
accrual of income for Federal tax purposes.
                              - 16 -

of the calendar year to make the payment related to the marketing

funds for the last half of the calendar year.     The right to the

marketing funds simply depended on the theater company's

performing as provided in the agreement during 1996.

     There is no evidence in the record indicating that the

theater company did not perform as called for in the agreement

during the 1996 tax year.   Mr. Harkins, as president of the

theater company, was in the best position to know the state of

his business by the end of 1996.     He had control of all the

records and information related to the theater company.     At

trial, he did not indicate any circumstances occurring by the end

of 1996 inconsistent with the theater company's performance

obligations under the agreement.10    Therefore, because the

theater company had performed in 1996 as provided for in the

agreement, the payment made in 1997 for the marketing funds for

the last half of 1996 should have been accrued in 1996.

     Petitioners additionally argue that if the theater company

had failed to perform on the agreement during the 60-day period



     10
        Mr. Harkins did testify that on one occasion, the
machine used to produce fountain soft drinks at one of his movie
theaters had stopped working. In order to provide customers with
soft drinks, a movie theater manager had purchased “Coke” bottles
(by accident) at a local store. When Mr. Harkins arrived at the
movie theater, he immediately told the manager to remove the
“Coke” bottles from the movie theater. Mr. Harkins did not
indicate whether this incident occurred in 1996, and petitioners
do not cite this incident as a basis for nonperformance on the
agreement.
                              - 17 -

after the close of the 1996 taxable year, the period reserved to

Pepsi for making payment of the marketing funds for the second

half of 1996, the theater company would have been forced to

forfeit the marketing funds for the last half of 1996 and to

repay the marketing funds for the first half of 1996.

Petitioners therefore contend that the theater company's right to

the marketing funds remained contingent even after the close of

the taxable year.   Petitioners base their contention on the

provision in the agreement labeled “Marketing Fund”:

     Should the Customer fail to comply with any of the
     Performance Requirements during the Term, the Customer
     agrees that in addition to the forfeiture of any
     funding for the second 6-month period, the Customer
     shall immediately repay to Pepsi-Cola all of the funds
     paid to the Customer, by Pepsi-Cola, for the first 6-
     month period of that Year. [Emphasis added.]

     As previously stated, however, we do not look to conditions

subsequent in applying the all events test.   See Keith v.

Commissioner, 115 T.C. at 617.   We therefore sustain respondent's

determination that the marketing funds paid in 1997 should have

been accrued in 1996.

     To the extent not herein discussed, we have considered the

parties' other arguments but found them to be moot, irrelevant,

or unconvincing.
                        - 18 -

To reflect the foregoing,

                                  Decision will be entered

                             under Rule 155.
