Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 78-97

1978-1 C.B. 139

Sec. 451

IRS Headnote

Merchandise coupons; additions to reserve for redemptions. An accrual method taxpayer engaged in a retail service business that upon completion of a referral sale delivers merchandise coupons to a former customer who referred a sales prospect may not use the method of currently subtracting from gross receipts the net addition to a reserve for future redemptions of the coupons as provided by section 1.451-4(a) of the regulations.

Full Text

Rev. Rul. 78-97

Advice has been requested whether the method of currently subtracting from gross receipts the net addition to a reserve for future redemptions of trading stamps and coupons provided by section 1.451-4(a) of the Income Tax Regulations is permissible under the circumstances described below.

The taxpayer is engaged in a retail service business and computes its taxable income under an accrual method of accounting on a calendar year basis. The taxpayer delivers merchandise coupons to any former customer that furnishes a sales prospect with whom the taxpayer succeeds in completing a sale. The coupons, which are delivered when the referred sale is completed, can be used immediately or can be accumulated for more valuable merchandise. The taxpayer maintains a stock of merchandise consisting of items such as calculators, cameras, and binoculars from which coupon holders may select. These coupons have no time limit within which they must be used.

The taxpayer plans to establish and make additions to a reserve for future redemptions of the coupons. Taxpayer intends to subtract from gross receipts the additions to the reserve account in computing gross income from sales.

Section 1.451-4(a) of the regulations, provides, in part, that a taxpayer using the accrual method of accounting and issuing trading stamps or premium coupons with sales should, in computing gross income from such sales, subtract from gross receipts an amount equal to the cost to the taxpayer of merchandise, cash, and other property used for redemption in the taxable year, plus the net addition to a reserve for future redemptions during the taxable year.

The general rule is that a reserve for contingent liabilities, such as estimated expenses, is not deductible. Brown v. Helvering, 291 U.S. 193 (1934), XIII-1 C.B. 223 (1934); Lucas v. American Code Company, Inc., 280 U.S. 445 (1930), IX-1 C.B. 314 (1930). Section 1.451-4 of the regulations is an exception that provides relief from this general rule. When the construction of a term granting relief from the general rule of nondeductibility requires interpretation, as with provisions concerning exemption from taxation, it is preferable to construe that term narrowly. Senft v. United States, F.2d 642 (3rd Cir. 1963); Zillmer v. United States, 233 F.2d 912 (7th Cir. 1956).

Thus, the requirement that coupons be issued "with sales" in section 1.451-4 of the regulations means that the coupons must be issued to the purchaser as part of a sale, that is, the issuance of the coupon must be conditioned on and solely in consideration for the purchase of goods or services.

In this case, the coupon is neither issued as part of the sale to the former purchaser (the person making the sales referral) nor as part of the sale resulting from such referral. The coupon is issued to the former purchaser for a separate consideration, that is compensation for a lead that results in a sale.

Accordingly, the taxpayer is not permitted to use the method of currently subtracting from gross receipts the net addition to a reserve for future redemptions of trading stamps and coupons as provided by section 1.451-4(a) of the regulations. With respect to coupons redeemed for merchandise, the costs of the merchandise are deductible by the taxpayer when the coupons are presented for redemption.

Any change by the taxpayer from its present method of accounting for the redemption of its coupons is a change in method of accounting subject to the provisions of section 446 of the Code and regulations thereunder.