In Suriel v. Comm’r, 141 T.C. No. 16 (Dec. 4, 2013), the Tax Court ruled that, under the specific facts in this case, the economic performance rules under IRC Section 461(h), permitting a tax deduction for certain liabilities when a liability is fixed and before the liability is actually paid, did not trump the qualified settlement fund economic performance rules under Treas. Reg. section 1.468B-3(c)(1), which require actual payment to occur in order to claim a tax deduction.
In Suriel, the taxpayer, a distributor, but not a manufacturer, of tobacco products in the US, made payments to the qualified settlement fund established under the Tobacco Master Settlement Agreement, which provides liability protection for manufacturers of tobacco products. The settlement resolved claims by 46 states, DC, Puerto Rico and 4 US territories which had commenced or were expected to commence litigation in order to assert claims for monetary, equitable, and injunctive relief against tobacco product manufacturers under consumer protection and antitrust laws. Although the taxpayer was not a manufacturer of tobacco products, the taxpayer was able to join in the settlement under a special provision provided for distributors of tobacco products. The taxpayer joined in the Tobacco Master Settlement Agreement in order to ease its ability to sell cigarettes it purchased from Protabaco, a Columbian cigarette manufacturer, which was not a party to the Tobacco Master Settlement Agreement. The taxpayer took a tax deduction for the amount it owed, but had not paid, to the qualified settlement fund. The taxpayer argued that it was not liable to make payments to the qualified settlement fund, but rather that it had assumed a liability of Protabaco, who was a manufacturer of tobacco products, and therefore the year of deduction was determined pursuant to the economic performance rules under IRC Section 461(h).
The Tax Court determined that, under the terms of the operative documents, the taxpayer obligated itself as if it were a manufacturer of tobacco products and therefore, the taxpayer was paying its own liability to the qualified settlement fund, not a liability it had assumed on behalf of Protabaco, because Protabaco had chosen not to enter into the Tobacco Master Settlement Agreement. As a result, there was no Protabaco liability for the taxpayer to assume. Rather, the liability to make payments to the qualified settlement fund was binding on the taxpayer and was not a result of the taxpayer’s obligations to Protabaco in exchange for cigarettes. Accordingly, the economic performance rules under IRC Section 468B requiring payment in order to claim a tax deduction determined the year of the deduction. The court also held that the qualified settlement fund rules control the timing of economic performance for all obligations to a qualified settlement fund, including interest payments.