TAX COURT JUDGE HANDS VICTORY TO ADVERTISERS: IRS STOPPED FROM THWARTING RJR'S METHOD OF USING WRITE-OFF

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The Internal Revenue Service suffered a setback in U.S. Tax Court last week in a case that could have opened the door for a dramatic change in the tax treatment of ad and marketing costs.

Judge James S. Halpern, ruling in a dispute involving RJR Nabisco, rejected an IRS contention that immediate tax write-offs be denied for marketing expenditures that generate long-term "good will" benefits.

IRS said such marketing costs, now routinely deducted in the year in which they are incurred, should be expensed over a period of years to reflect their long-term value. That is the same type of tax treatment given to the cost of tangible goods, such as factory machinery, which are deducted, or amortized, over their useful lives.

$2.2 MIL IN COSTS CHALLENGED

In the RJR case, IRS specifically challenged $2.2 million in cigarette package redesign costs that RJR deducted from its 1982 taxes, contending they produced long-term benefits for RJR. IRS attorneys told Judge Halpern the same reasoning about long-term benefits ought to also bar immediate tax write-offs for the vastly larger sums marketers spend for media costs.

Ad groups have strongly resisted such a tax change. The proposal has surfaced from time to time in Congress but has never been approved by lawmakers.

In his action last week, Judge Halpern affirmed his initial decision in the RJR case, which was handed down in July. The IRS now has 90 days in which to decide whether it will appeal. An IRS spokesman said no decision had been made.

The IRS made a distinction between "advertising campaign" expenditures, such as the costs of media, and "advertising execution" expenditures, such as the costs for producing a TV commercial. Advertising execution costs could continue to be deducted in full in the year in which they were incurred, IRS said. "Campaign" expenditures would be amortized.

GENERATING `GOOD WILL'

Judge Halpern acknowledged that advertising campaigns can generate long-term "good will" for a brand, and that "at least in theory the proper time to give tax effect to the expenditure may be a period of time running beyond the taxable year of expenditure."

But the judge rejected the IRS approach. "To distinguish advertising campaign expenditures from advertising execution expenditures solely on the basis of the taxpayer's expectations regarding the duration of the expected benefits is insufficient to require capitalization of an advertising expenditure," he wrote.

ONLY A FIRST STEP

Wayne Kaplan, an attorney who handled the case for RJR, warns that the Tax Court judge's ruling is only the first step and the case still poses danger for marketers.

"Advertisers should have reason to be concerned," he said. "The worst case impact is if they [the IRS] obtain a reversal from the U.S. Circuit Court of Appeals for the 3rd District in New York, all of advertising would have to be capitalized."

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