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Petitioner's income taxes for fiscal years 1991 and 1992 were
substantially understated as a result of (1) giving rebates to its
related entities for which it has shown no economic justification
other than to avoid taxation, and (2) writing down its ending
inventory in the respective amounts of $160,000 and $415,000 in
fiscal years 1991 and 1992. Our discussion in Issue 1 leaves no
doubt that petitioner had no reasonable basis or substantial
authority for its position of giving the rebates. We will
hereinafter discuss whether petitioner was justified in writing
down its ending inventory.
Petitioner maintained a perpetual inventory system. On a
daily basis, purchase invoice amounts were plugged into
petitioner's computer and sales were taken off on a daily sales
sheet, leaving an inventory balance. Each month, if amounts sold
were greater than purchases, ending inventory would be lower than
the previous month. If amounts sold were less than purchases,
ending inventory would be higher than the previous month. At
yearend, petitioner relied on its perpetual inventory system and
took no physical inventory of goods on hand. As new inventory was
purchased, petitioner updated its book inventory cost per unit on
the basis of the most recent invoice price from suppliers.
Petitioner had no significant amounts of obsolete inventory in
stock in the years at issue. If inventory became obsolete,
petitioner's suppliers would normally accept the inventory in
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