ONE B. & W. COUPON

4. The coupons issued by petitioner with its three brands of cigarettes were identical. They were redeemable for cash at all times until February 1951 U.S. Tax Ct. LEXIS 269">*274 28, 1946. They were redeemable for merchandise until about December 1, 1943. In 1941 and subsequent years they were also redeemable for defense stamps, war savings stamps and bonds. Beginning April 1, 1944 all cigarette coupons were redeemed 16 T.C. 432">*435 for cash, war stamps, or beginning November 1, 1944 for cigarettes. The coupons were given a cash redemption value of 3/4 of one cent per coupon to comply with the laws of certain states and to appeal to customers who preferred cash to premiums. Cash redemption of bonus coupons increased the retail dealer's profit on each purchase of less than a carton.

5. The expiration date printed on each coupon fixed a time limit on petitioner's liability on the outstanding coupon and fixed a date when petitioner could terminate its over-all liability if for any reason it discontinued its coupon redemption plan. From time to time petitioner changed the expiration date on the coupons being issued but generally speaking the coupons expired within 36 months from the date of issue. Prior to February 28, 1946, petitioner ignored the various expiration dates and redeemed all coupons presented regardless of the date of issue. The only expiration 1951 U.S. Tax Ct. LEXIS 269">*275 date ever enforced was that of February 28, 1946. This expiration date appeared on coupons issued during the months of March to October 1943, which were the last coupons issued under this coupon redemption plan.

6. Initially, petitioner contracted with United Profit-Sharing Corporation, a wholly owned subsidiary of the United Cigar Stores Company of America to service its coupon redemption plan. This contract was canceled when petitioner decided to service its own coupon redemptions so that it could exercise complete control of the plan in all its phases. In operating its own plan petitioner felt that the plan could be advertised and promoted more effectively, consumer good will could be protected, and substantially better values could be offered to its consumers.

7. In 1932 in pursuance of the plan adopted petitioner established a premium department which it staffed with a manager and his secretary. Additional employees were added, as required, until eventually 175 persons were employed therein. During the fall months of each year the premium department expanded its facilities in all directions to take care of the increased load from redemptions in November and December. In 1951 U.S. Tax Ct. LEXIS 269">*276 servicing the coupon redemption plan the premium department was responsible for clerical work, the correspondence, the redemption of coupons, the shipment of premiums, store employees, stock men in the warehouses, and the supervision of the different groups and subdivisions that were required and functioned under the plan. The premium department's personnel shopped for and selected merchandise suitable for use as premiums, fixed the number of coupons necessary to acquire each premium, secured approval of the premium from petitioner's executive committee, catalogued each premium, and purchased a sufficient quantity to provide an inventory to fill redemption orders by customers. Premiums were shipped prepaid and every effort was made to ship the premium within 24 to 48 hours of the receipt of the customer's order. No substitute premiums were shipped. If a premium was not immediately available, or too many coupons were received for the premium ordered, or if, for any reason, the customer had a surplus of coupons, the premium department sent back a credit certificate to the customer. Premiums damaged in transit or defective in manufacture were immediately replaced. Normally the premium1951 U.S. Tax Ct. LEXIS 269">*277 department carried a 30 days' supply of premiums on hand, a 30 days' supply in transit or readily available for shipment, and an additional 30 days' supply on order with the supplier or manufacturer. Complaints from customers were very infrequent.

8. The first premium offered by petitioner to its customers was playing cards, then a card table cover, a score pad, and in 1934 a card table. In June 1934 the first premium catalog was distributed offering coupon holders a dozen or 16 T.C. 432">*436 more different premiums in redemption of their coupons. Subsequent premium catalogs were distributed usually in the spring and fall of each year. The catalogs reflected changes in the merchandise offered by the addition of new premiums and the discontinuance of premiums with less popular appeal. The premium department constantly strove to improve the attractiveness of the catalog, the quality of the premiums, and to publicize the coupon redemption plan. From June 1934 through 1943 petitioner's distribution of premium catalogs was as follows:

1951 U.S. Tax Ct. LEXIS 269">*278 9. To facilitate the redemption of its coupons petitioner opened premium stores in the following cities:

These stores, which remained open until the cigarette coupon plan was discontinued in the fall of 1943, were handsomely appointed, well located, and had facilities and surroundings comparable to the finest retail stores. The merchandise offered as premiums for coupons was attractively displayed but no merchandise was offered for sale.

10. The premiums offered by petitioner were, generally speaking, luxury items of high quality that appealed to men, women and children. The current retail price on most of its premiums exceeded two dollars and many were made by nationally known manufacturers. The number of items shipped as premiums, the amount of cash, defense and war stamps used to redeem coupons during some of the taxable years, and the percentage of the latter of the total coupons redeemed, were as follows: 1951 U.S. Tax Ct. LEXIS 269">*279

16 T.C. 432">*437 During 1940 the most popular premiums, next to stamps and cash, based upon the coupons redeemed in that year, with the name of the manufacturer of the premium as shown by the 1940 catalog, were as follows:

11. Petitioner purchased its premiums direct from the manufacturer. It bought many items in carload or multiple carload lots. It took almost the entire output of two factories to supply petitioner with card tables. It was Westinghouse's1951 U.S. Tax Ct. LEXIS 269">*280 largest customer for electric irons. It was able to purchase quality merchandise at maximum discounts. It computed its delivered-to-the-customer cost by adding together the cost of the premium, handling expenses, and all transportation charges. It then converted delivered-to-the-customer cost to redemption value in terms of coupons necessary to redeem by a mathematical formula. The petitioner did not mark up its premiums, and realized no profit upon the redemption of its coupons.

12. During the taxable years petitioner's coupons were worth from one cent to two and one-half cents per coupon when redeemed for merchandise. When coupons were redeemed for card tables the coupon holder realized two and one-half cents per coupon based on the retail selling price of comparable card tables. For certain premiums the purchasing power of each coupon was as low as one cent, but the average was about one and one-half cents or twice the cash redemption value of each coupon. Petitioner's premium department constantly checked the market costs and the retail prices of various types of merchandise in order to determine which articles offered the most value as premiums to its customers. The value1951 U.S. Tax Ct. LEXIS 269">*281 of petitioner's coupons whether redeemed for merchandise or cash was one of the highest if not the highest of any coupon plan.

13. The petitioner used all kinds of advertising media to promote the sale of its coupon bearing cigarettes and to acquaint the public with its coupon redemption plan. It advertised its products and its plan over the radio by sponsoring nation wide evening programs, such as Baron Munchausen, Tommy Dorsey's Band, Paul Sullivan, Plantation Parties, Red Skelton, Hildegarde-in-the-Raleigh Room, and People Are Funny. It advertised with full page ads in color, as well as smaller ads in black and white, in magazines, such as Life, Colliers, Liberty, The Saturday Evening Post, Army & Navy Journal, and others. Newspaper advertisements along the same line were carried in many papers. Posters, billboards, window displays, the premium stores, and the catalogs urged the public to save "B. & W." coupons and acquire the premiums offered. The coupon redemption plan and some of the premiums were featured in many of its advertisements. 16 T.C. 432">*438 Petitioner's advertising expenditures made with respect to its coupon bearing cigarettes during the period for which they bore1951 U.S. Tax Ct. LEXIS 269">*282 coupons were as follows:

14. The annual domestic sales in thousands of petitioner's coupon brands, the annual United States consumption of cigarettes, and the ratio of petitioner's sales to total U. S. consumption, the latter being based on tax-paid withdrawals as officially reported by the Commissioner of Internal Revenue and the United States Department of Commerce were as follows:

1951 U.S. Tax Ct. LEXIS 269">*283 15. The following table shows domestic sales for certain months, in thousands, of Raleigh and Kool cigarettes, United States consumption of cigarettes for the same months, and the ratio of petitioner's sales to total U. S. consumption, the latter being based on tax-paid withdrawals as officially reported by the Commissioner of Internal Revenue and the United States Department of Commerce. In the case of Raleighs, the period covered is the six months preceding and following the initial issuance of coupons in connection with that brand. In the case of Kools, the period begins with the introduction of the brand on the market and includes the six months following the initial issuance of coupons thereon.

1951 U.S. Tax Ct. LEXIS 269">*284 16 T.C. 432">*439 16. The following table shows the cigarette coupons issued, the number going to Alaska and Hawaii, the coupons contained in cartons of cigarettes, the number of coupons redeemed, and percentage figures as indicated:

16 T.C. 432">*440 17. The annual cost of redeeming petitioner's cigarette coupons, September 1932-February 1946, including1951 U.S. Tax Ct. LEXIS 269">*286 both domestic and export issue, was as follows:

18. In October 1936, Sir Hugo Cunliffe-Owen of England was Chairman of the board of both petitioner and its parent corporation, the British-American Tobacco Company, Limited. By that time petitioner's coupon redemption plan had become a large operation and the whole plan was discussed and reviewed by the responsible officers of the two companies at a conference on October 9, 1936. The conference was called by Sir Hugo to impress upon the management of the petitioner the importance of setting up ample provision to take care of the redemption of the coupons that were being issued. Sir Hugo had had world-wide experience with the coupon plans of British-American subsidiaries and suggested the desirability of making provisions for and maintaining an amount which would enable petitioner1951 U.S. Tax Ct. LEXIS 269">*287 to redeem 95 per cent of its outstanding unredeemed coupons. The failure of the Imperial Tobacco Company of Canada, Limited, a British-American subsidiary, to provide an adequate amount for redeeming its coupons, with the resulting necessity of providing an additional reserve in 1935, was discussed at this conference. The possible tax consequences of a policy providing for an amount sufficient for redemption of 90 per cent or more of outstanding coupons was recognized and considered but, nevertheless, it was decided that an amount would be set aside each year on the books sufficient to redeem 90 per cent of the coupons issued during the year.

19. In May, 1939, another conference was held between officials of the petitioner and the British-American Tobacco Company, Limited, relative to the amounts to be provided for redemption of petitioner's outstanding coupons. The policy adopted at the meeting on October 9, 1936, had not been followed, and it was decided that effective April 1, 1939, the provision for redemption of petitioner's cigarette coupons should be at the rate of $ 0.00684 per coupon, an increase of $ 0.00018 per coupon. The new rate represented 90 per cent of $ 0.0076, 1951 U.S. Tax Ct. LEXIS 269">*288 which was the then average cost of redemption per coupon. During the taxable years petitioner provided for the redemption of cigarette coupons at the end of each month upon the basis that 90 per cent of the coupons issued during the month would ultimately be redeemed. This policy was followed until the issuance of cigarette coupons was discontinued in November, 1943. During part of the taxable year 1940 petitioner provided for the redemption of coupons at the rate of 100 per cent of the anticipated cost of redemption in order to build up the credit balance of its provision account. This additional amount was not claimed as a deduction on its 1940 Federal income tax return.

20. The following table sets forth the credit balance in petitioner's book account captioned, "Provision for Redemption of Cigarette Coupons" as of 16 T.C. 432">*441 December 31, 1932-1945, inclusive, and at February 28, 1946, "Per Books" and "For Federal Income Tax Purposes":

After discontinuing the issuance of coupons in November 1943, no further amounts were credited to the above account. All entries in the account thereafter were debit entries. The cost of redeeming coupons was charged to the account, and amounts were transferred therefrom to surplus. In December 1944, petitioner transferred $ 1,752,000 from this account to its surplus account. On its corporate income tax return for 1946 petitioner reported the sum of $ 4,122,441.97 as taxable income by reason of the closing of this account. Due to a mathematical error, the amount returned to income in 1946 on said return was overstated by $ 86,258.80.

21. The redemption cost to petitioner of cigarette coupons to be used in determining the amount of subtraction from gross sales for each of the years involved herein is as follows:

22. Petitioner first encountered minor difficulties in buying suitable premiums in 1941. Its difficulties became progressively worse during 1942 and 1943 as1951 U.S. Tax Ct. LEXIS 269">*290 materials became critical in the war period. The premiums containing metals were the first affected, and petitioner's last premium catalog, number 22, effective until September 1, 1943, omitted silverware, fishing tackle, and all electrical appliances. Petitioner substituted for these premiums defense and war stamps, and chinaware, glass ware, furniture, textiles, and other top quality, nationally advertised merchandise.

23. By October 1943, acute shortages had developed in household domestic goods. Petitioner found it impossible to secure the kind of premiums it needed to successfully operate its coupon redemption plan. It decided that the plan would not serve its purpose of promoting sales without such premiums, and, accordingly, petitioner ceased issuing coupons with its Raleigh cigarettes on November 11, 1943. Prior thereto, it had ceased issuing coupons with its specialty 16 T.C. 432">*442 cigarettes, Viceroy and Kools, because the management thought that the market would absorb petitioner's production without a sales promotion plan.

24. Petitioner announced that it had discontinued issuing coupons with its Raleigh cigarettes by inserts placed in each package and each carton of 1951 U.S. Tax Ct. LEXIS 269">*291 cigarettes, which read as follows:

SPECIAL NOTICE: We regret that conditions beyond our control compel us to discontinue packing coupons with Raleigh plain and tipped cigarettes, effective November 20, 1943.

All merchandise offers are hereby withdrawn but we shall continue to redeem all B. & W. Coupons outstanding in accordance with the terms of their issue for War Stamps and Bonds or cash at the rate of 3/4 cents per coupon until FEBRUARY 28, 1946, the last expiry date.

Our primary aim of blending Raleighs from the choicest Turkish and Domestic Tobaccos that money can buy will be maintained and you will continue to find Raleigh "the finest cigarette you ever smoked."

Remember you have until February 28, 1946 to redeem your coupons.

BROWN & WILLIAMSON TOBACCO CORP., P. O. BOX 599, LOUISVILLE, KY., U. S. A.

25. After November 1943, petitioner's executives became concerned about the company's ability to redeem the expected upsurge in coupon redemptions. The petitioner was then heavily in debt. It entered into negotiations with its parent company, British-American Tobacco Company, Ltd., seeking funds from it. The parent company could transfer funds out of England only upon authorization1951 U.S. Tax Ct. LEXIS 269">*292 of the British Treasury. Permission was received therefrom and British-American transferred $ 2,500,000 to petitioner during 1944 to assist in the redemption of its outstanding coupons.

26. During the years 1920 to 1928, inclusive, the United Cigar Stores of America operated retail tobacco stores throughout the United States. Its wholly-owned subsidiary, United Profit Sharing Corporation, conducted a coupon plan during these years which was used by United Cigar Stores and William Wrigley Company in merchandising their products. One coupon was issued for each five cent retail purchase. The coupons were redeemable for cash or premiums at premium stores and redemption stations and by mail. The only advertising in connection with the United coupon plan was by the display of premiums on counters and the distribution of catalogs at the premium stores and redemption stations. The cash value of one United coupon was one-tenth of a cent, but when exchanged for premiums it was worth about three-tenths of a cent. United offered its coupon holders many of the same types of premiums as petitioner, e. g., card tables, bathroom scales, electric irons, electric toasters, and glassware. Considering1951 U.S. Tax Ct. LEXIS 269">*293 the difference in the time and spending power the premiums offered by United during the years 1920 to 1928, inclusive, were comparable to the premiums offered by petitioner during the taxable years. During the nine-year period United issued 2,570,000,000 coupons. During the same period it redeemed 2,170,000,000 coupons or 84.44 per cent of the coupons issued.

27. Imperial Tobacco Company of Canada, Limited, like many other subsidiaries of the British-American Tobacco Company, Ltd., operated a coupon redemption scheme. Its plan was known as the "Poker Hand Premium Scheme." The coupons or "inserts" were in the form of poker hands packed with Imperial's tobacco products, approximately 75 per cent of which were packed with cigarettes. The inserts were redeemable for premiums and had no cash value. 16 T.C. 432">*443 Premium redemptions were made only for complete sets of 52 cards. Most of the inserts had no expiration dates. The expiration dates printed on the early inserts were never enforced. Inserts could be redeemed at premium stores in the principal cities in Canada or by mail, premium prepaid. Premium catalogs were distributed at the premium stores and the redemption plan was mentioned1951 U.S. Tax Ct. LEXIS 269">*294 in advertisements of Imperial's products. During the period August 1925 to December 31, 1935, Imperial issued 2,804,888,592 inserts. Inserts redeemed until the beginning of World War II totaled 2,417,150,579, or an overall redemption of 86.18 per cent of the inserts issued. Prior to 1932 Imperial provided on its books for redemption of inserts upon the assumption that approximately 60 per cent of the inserts would be redeemed. In 1932 it had to make a special appropriation to provide additional funds for redemption.

28. Beginning in October 1938 and continuing quarterly until December 1943, petitioner conducted a series of test checks on coupons redeemed. The test checks were made by taking sample bundles of 37,000 to 60,000 coupons being redeemed for various types of premiums and examining each individual coupon for its expiration date. By this sampling petitioner sought to ascertain how long it took customers to accumulate their coupons, how rapidly the coupons were being redeemed, and eventually how many coupons would be redeemed. The successive samplings developed a pattern from which petitioner determined percentage figures with respect to coupons redeemed monthly and 1951 U.S. Tax Ct. LEXIS 269">*295 annually. Petitioner used these percentages as a guide to project forward its estimate of future coupon redemptions.

29. In filing its income tax returns for the taxable years 1940-1943, inclusive, petitioner computed net income upon the basis that 90 per cent of the cigarette coupons issued each year would eventually be presented for redemption. On its returns for these years petitioner claimed, as a part of its advertising expense, the following amounts for redemption of coupons:

The petitioner never filed with its income tax returns any data dealing with the total issue of coupons each year, the total coupons redeemed in each year, or the rate, in percentage, which coupons redeemed in each year bear to coupons issued in such year. No statement showing the experience of other coupon users was ever filed by petitioner with its tax returns. Such data was furnished regularly to respondent's revenue agents in connection with their examinations of petitioner's books and tax returns. In connection with the audit of its 1934 tax return petitioner furnished the internal revenue agent1951 U.S. Tax Ct. LEXIS 269">*296 in charge, under date of September 11, 1936, detailed monthly and yearly data on its coupon redemption plan from its inception to and including July 1936, together with the experience of five other users of coupon plans. Petitioner cooperated with and assisted respondent's revenue agents in making their various audits of petitioner's books and returns, and prepared statements for the use of the agents summarizing in detail the operation of its coupon redemption plan.

30. In determining the deficiencies herein the respondent held that the amounts subtracted from sales in connection with coupon redemptions were excessive. By use of a formula based upon a so-called "five year cumulation" he determined the percentage of cigarette coupons issued during the taxable years 1940-1943, inclusive, which would eventually be redeemed. These percentages, 16 T.C. 432">*444 after making allowance for minor corrections and adjustments, were as follows:

Applying these percentages to the respective annual issues of cigarette coupons gives the annual number of coupons eventually to be redeemed, which, when multiplied by the1951 U.S. Tax Ct. LEXIS 269">*297 stipulated redemption cost, gives respondent's allowable reserve for each year. For the taxable years 1940 to 1943, inclusive, respondent computed the amounts allowable as subtractions from petitioner's sales for coupon redemption and the excessive subtractions claimed by petitioner to be as follows:

31. For each of the taxable years 1940-1943, inclusive, petitioner's rate, in percentage, which coupons redeemed in each year bear to the total coupons issued in such year, regardless of the year when such redeemed coupons were issued, is 80 per cent.

32. The parties have stipulated the pertinent facts relative to the snuff coupon plan of the petitioner which involves the deficiency determined for 1944. The parties have also stipulated a formula with respect to the snuff coupon plan which becomes operative upon determination by this Court of the "respective annual anticipatable redemption of cigarette coupons," expressed in per cent.

33. At the hearing the respondent conceded that the unemployment1951 U.S. Tax Ct. LEXIS 269">*298 taxes paid by petitioner, as itemized in the parties' stipulation of facts, are deductions for the year for which they were applicable.

34. At the hearing the petitioner announced that it abandoned its allegation of error regarding the pension trust issue for the taxable year 1942.

35. The parties' written and oral stipulations of fact, and Exhibit 5, a statement of coupons issued and redeemed by months and years from September 1932 through February 1946, are incorporated herein by reference.

The amount which could as of the end of each of the taxable years involved be reasonably expected to be required for the redemption of such part of the total of such year's issue of petitioner's cigarette coupons as would eventually be presented for redemption is 80 per cent of the amount which would be required to redeem all such coupons issued in such year.

OPINION.

The single factual issue requires purely a determination of the proportion of premium coupons issued by petitioner with its cigarettes during the years in question which would eventually be presented for redemption. This determination has been made by our ultimate finding of fact. The question arises because of the accounting 1951 U.S. Tax Ct. LEXIS 269">*299 16 T.C. 432">*445 system which respondent's regulations impose upon those who, like petitioner, issue trading stamps or redeemable coupons with their products. The requirement is that "he should in computing the income from such sales subtract only the amount which will be required for the redemption of such part of the total issue of trading stamps or premium coupons issued during the taxable year as will eventually be presented for redemption." 1

1951 U.S. Tax Ct. LEXIS 269">*300 Neither party attacks the regulation ² and, since there is no dispute as to the cost of redemption per coupon, both approach the controversy as involving "reasonable expectation" ³ of the proportion of the coupons issued in a given year which will eventually be redeemed. It is on that presentation of the issue that our conclusion rests.

The proceeding was, by agreement of the parties, heard before a Commissioner of the Tax Court in accordance with Internal1951 U.S. Tax Ct. LEXIS 269">*301 Revenue Code, section 1114, and Rule 48 of our Rules of Practice. ⁴ It is in fact the first tax case to be so treated. See Bibb Manufacturing Co., 12 T.C. 665. In conformity with the procedure envisaged by the rule, ⁵ the Commissioner prepared detailed proposed findings, to which the parties were permitted to file exceptions. Careful consideration has been given to the proposed findings, to the exceptions and arguments of the parties, and to the record as a whole. After such study, 16 T.C. 432">*446 we are satisfied that the proposed findings of the Commissioner accord with the facts as they appear from the record, and the proposed findings have hence been adopted in full.

1951 U.S. Tax Ct. LEXIS 269">*302 All other issues have been or will be disposed of by stipulation of the parties.

Decision will be entered under Rule 50.