In field attorney advice memo 20121602F, the IRS determined that the “all-events test”, which determines when a liability is incurred and deductible, is met when a wholesaler sells products to a pharmaceutical company at prices below the wholesaler’s acquisition cost.
Under the terms of a chargeback program, the pharmaceutical company pays a discounted price that is less than the cost to the wholesaler. The discounts are initially absorbed by the wholesaler but the pharmaceutical company is later obligated to pay chargeback reimbursements when requested by the wholesaler. Before receipt of the chargeback reimbursement request, the pharmaceutical company is unable to determine the exact amount of the reimbursement. The pharmaceutical company, however, deducts an estimate of the chargeback reimbursement liability based on its historical pricing information and other data.
Under IRC section 461(h), a liability is incurred and deductible when the “all-events test” is met and economic performance has occurred. The “all-events” test requires that (1) the liability is fixed and (2) the liability can be determined with reasonable accuracy. Generally, the fact of taxpayer’s liability is established when (1) the event fixing liability, whether required performance or some other event occurs or (2) payment is unconditionally due. Rev. Rul. 2007-3.
Here, the IRS determined that the fixing event under the chargeback program occurs when the wholesaler sells to the pharmaceutical company at prices below cost because, at that time, the wholesaler’s right to demand a chargeback reimbursement is unconditional. According to the memo, the submission of a reimbursement form by the wholesaler appears to be a ministerial demand for payment and, therefore, a condition subsequent that does not affect the pharmaceutical company’s liability to reimburse the wholesaler. The IRS also said that an estimate of liability based on reliable inputs and reasonable methods is generally acceptable, and the pharmaceutical company is entitled to use the recurring item exception under Treas. Reg. section 1.461-5(b)(1).
Keep in mind that the memorandum is issued in response to a taxpayer request for assistance and may not be used or cited as precedent. To read the memo in its entirety, click here.