## Facts

- Westpac Pacific Food was a grocery-industry purchasing syndicate that negotiated volume-purchase arrangements with suppliers.
- Suppliers paid Westpac cash advances upfront, labeled in the trade as “advance trade discounts,” in exchange for Westpac’s binding commitment to purchase a specified volume of inventory at stated list prices.
- Westpac received roughly $5 million per year under these arrangements.
- If Westpac met the agreed purchase volume, it kept the advance as the discount on those purchases.
- If Westpac fell short of the agreed volume, it had to repay the advance on a pro rata basis reflecting the shortfall.
- Westpac used accrual accounting and recorded the advances as liabilities upon receipt.
- As Westpac purchased covered goods, it applied the discount pro rata against the full purchase prices, reducing cost of goods sold and increasing taxable income over time.
- The Commissioner treated the advances as taxable gross income in the year received and issued deficiency notices.
- The Tax Court agreed with the Commissioner and held the advances includible in gross income upon receipt.
- Westpac appealed to the Ninth Circuit.

## Issues

1. Whether supplier cash advances paid to secure a retailer’s volume-purchase commitment are “gross income” under 26 U.S.C. § 61 in the year received.
2. Whether such advances are instead properly treated as contingent liabilities or purchase-price adjustments recognized through reduced cost of goods sold as purchases occur.

## Decision

- The Ninth Circuit reversed the Tax Court.
- The court held the cash advances were not gross income when received.
- The court characterized the payments as advance trade discounts (purchase-price reductions), not immediate accessions to wealth.
- Because Westpac had a binding obligation either to satisfy the purchase commitment or to repay the unearned portion, the cash was encumbered by a repayment obligation and functioned like a liability on receipt.
- The court approved recognizing the economic benefit over time through reduced cost of goods sold as covered purchases were made.

## Legal Principles

- A cash receipt is includible in gross income under § 61 only if it constitutes an accession to wealth that is clearly realized and not subject to a substantial obligation to repay.
- Amounts received subject to a repayment obligation conditioned on future performance are not income upon receipt and may be treated as liabilities until the obligation is satisfied.
- Trade discounts, including discounts delivered in cash form, are generally treated as reductions of purchase price and are reflected in taxable income through inventory accounting (e.g., reduced cost of goods sold), rather than as separate gross income items upon receipt.
- Tax characterization turns on the transaction’s economic substance; cash form alone does not convert a purchase-price adjustment into immediate gross income.

## Conclusion

The Ninth Circuit held that supplier cash advances tied to enforceable volume-purchase commitments, with pro rata repayment if the commitment is not met, are advance trade discounts rather than gross income when received, and are taken into account as purchase-price reductions through reduced cost of goods sold as purchases occur.


Westpac Pac. Food v. Comm'r, 451 F.3d 970 (9th Cir. 2006)