Flash Inventory? Thoughts on the FLIS Enterprises Withdrawals from Stock Analysis

While the Arkansas Supreme Court's recent decision in Walther v. FLIS Enterprises, Inc., 2018 Ark. 64 was mostly watched for its ruling that sovereign immunity is not jurisdictional, it went on the grapple with the substantive tax question: whether the tax base for gross receipts tax on a Burger King franchisee's free meals given to employees is the cost of the ingredients or the menu price of the meals.

Arkansas Code Annotated section 26-52-322 specifies imposition of tax on withdrawals from stock based on the value of the goods withdrawn. It authorizes the Department of Finance and Administration (DFA) to promulgate regulations, which DFA has done with Rule GR-18(D). In essence, that rule provides for tax based on the purchase price for raw materials and based on the ordinary sales price for manufactured or processed goods created by the taxpayer. The parties disputed whether a hamburger was a processed good subject to tax based on the notional sales price instead of the cost of the ingredients. The taxpayer had prevailed in the circuit (trial) court.

The Supreme Court reversed and ruled in favor of DFA. The court found that a hamburger or other meal item was within the meaning of a processed or produced good subject to the higher price. The impracticality of assessing tax on a few cents worth of each ingredient also supported taxing the menu price instead of the ingredients.

One can think about the case as a question of when the withdrawal from stock occurred for the taxpayer. (Compare the majority opinion with the dissent by Justice Womack.) Was the taxable exent when the ingredients were withdrawn, or was it when the completed prepared food was ready? Since a restaurant generally does not maintain inventory of menu items, you have a kind of "flash inventory" where the menu item was notionally in inventory and then immediately withdrawn.

This decision is likely of little import to most taxpayers. Perhaps the most relevance is to manufacturers: conceivably DFA would have an easier time imposing tax on goods that are produced and then immediately consumed or destroyed, if the taxpayer also sells such goods.

Perhaps the biggest upside for taxpayers was the court's dismissal of an argument by the taxpayer that it could have planned around this by selling meals to employees for pennies instead of giving them away. The court recognized and ratified this situation. Hypothetically, that recognition could be used to support Arkansas sales and use tax planning against DFA challenges.

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