Was a lipstick given for returning six valueless makeup containers a nontaxable premium tied to the customers' earlier purchases?

Plain-English summary

A cosmetics company gave customers a lipstick after they returned six empty makeup containers. The containers had no value and were discarded. The company argued that the lipstick was a premium earned through the customers' prior purchases.

Tax counsel relied on the understanding that customers had no contractual right to receive the lipstick and that the company could cancel the promotion at any time. On those facts, the lipstick was a gift rather than a premium sold with the earlier products.

Because the company was assumed to have bought the lipstick ex tax for resale but instead gave it away, it owed use tax measured by its cost. It could not deduct the lipstick's retail value from reported gross sales.

The letter added that even if the lipstick were treated as a premium sold with six makeup items, no deduction would result: the transaction would be a sale of seven items for the price of six, with tax measured by the gross receipts.

The source also clarified that selling a gift certificate was not taxable, but value used at redemption was taxable consideration, and donating lipstick-sale proceeds to a foundation did not by itself exempt those retail sales.

What this means for you

Retail promotion teams

Define whether customers have an enforceable right to the reward and whether the promotion can be canceled after qualifying purchases.

Cosmetics and recycling programs

Returning valueless containers did not create a trade-in or taxable purchase price under the facts assumed here.

Accountants and tax professionals

Distinguish a retailer's gift, a premium sold with qualifying merchandise, a discount, and a gift-certificate redemption. Each can affect the tax base differently.

Common questions

Q: Were the empty containers treated as payment?

A: No. They had no value and were discarded.

Q: Why was the lipstick a gift?

A: Customers had no contract right to it and the company could end the promotion.

Q: What tax did the company owe on the gift?

A: Use tax measured by the company's cost of the lipstick.

Q: Did donating sales proceeds make lipstick sales exempt?

A: No. The letter said no exemption arose simply because proceeds were donated.

Citations and references

• California Revenue and Taxation Code §§ 6007, 6051, 6091, 6094, 6244, and 6403
• California Sales and Use Tax Regulation 1670(c)
• Business Taxes Law Guide Annotations 165.0005 and 280.0350

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 280.0767
• Original supporting opinion: 280.0767 PDF

Original ruling text

280.0767

STATE OF CALIFORNIA

JOHAN KLEHS
First District, Hayward

STATE BOARD OF EQUALIZATION
450 N STREET, SACRAMENTO, CALIFORNIA
(PO BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
TELEPHONE (916) 323-3787
FAX (916) 323-3387

DEAN F. ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles

October 25, 1996

KATHLEEN CONNELL
Controller, Sacramento
___
E. L. SORENSEN, JR.
Executive Director

Mr. R--- M. L--M--- A--- C--- Inc.
XXX --- -----, --- XXXXX
Re:

M--- A--- C--- Inc. [M---]
S- -- XX-XXXXXX

Dear Mr. L---:
Your undated letter to Tax Representative C.C. Harris has been referred to the Board’s legal staff for response. On [M---].’s sales and use tax return, [M---] included an amount on line 10(f) which was deducted from [M---]’s taxable receipts. [M---] labeled the deduction “service
& bac to [M---]” and our Return Analysis Unit wrote [M---] a letter asking for an explanation. In a letter dated March 12, 1996, [M---]’s Assistant Controller, M--- M---, indicated that the description “Back to [M---]” referred to a promotional campaign in which [M---] accepts empty makeup containers in return for a free lipstick. Mr. M--- explained that the retail value of the lipstick was included in the reported gross sales and therefore [M---] reduced this figure by the total of all lipsticks distributed at no charge for the period. Mr. Harris wrote [M---] a letter dated April 24, 1996 requesting clarification on the deduction labeled “Back to [M---].” The letter explained that if [M---] had paid tax or tax reimbursement with respect to the free items, no further tax was due, but that if not, [M---] would owe use tax on its cost of the free items. In either event, no deduction was allowable. In your latest letter, you state: “A description of the promotion which supports its non-taxable nature follows. “In order to induce purchases of additional product, the Company will offer a customer one new lipstick in exchange for six empty make-up containers. Thus, a (prior) purchase of make-up by a customer carries a 16.6% discount toward a (future) lipstick purchase. The entire discount (100%) is redeemable by the customer upon the return of the sixth empty make-up container.

Mr. R--- M. L---

-2-

October 25, 1996
280.0767

“Reg. 1670(c) suggests that the term ‘premium’ connotes a reward or some other inducement offered to encourage a particular transaction (in the immediate sense, the sale of make-up). The promotion can thus be appropriately classified as a premium. The regulation goes on to state that ‘when a person delivers tangible personal property as a premium together with other merchandise sold and the obtaining of the premium by the purchaser is not dependent upon chance or skill, the transaction is a sale of both articles.’ The six containers are simply a convenient way of proving that the customer made the purchases to justify receipt of the premium. The empty containers are not ‘trade-ins’ with any value; they are disposed of by the company. Thus, no additional sales or use tax is due since sales tax was charged and collected at the point of sale of the make-up (and lipstick).” Sales tax applies to retail sales of tangible personal property, measured by the gross receipts, unless the sale is specifically exempt from taxation by statute. (Rev. & Tax. Code § 6051.) A “retail sale” or “sale at retail” means a sale for any purpose other than resale in the regular course of business in the form of tangible personal property. (Rev. & Tax. Code § 6007.) If a purchaser intends to resell tangible personal property in the regular course of business, he or she may purchase the property ex tax by giving the seller a timely and complete resale certificate. (See Rev. & Tax. Code § 6091.) We assume that [M---] purchased all lipstick in question ex tax for resale. As such, if [M---] makes any use of the property other than retention, demonstration, or display while holding it for sale in the regular course of business,
[M---] must report and pay use tax on the cost of the property. (Rev. & Tax. Code §§ 6094, 6244.) Our understanding is that a customer does not have a contract right to the free promotional lipstick, and that [M---] may, at any time, cancel the promotion and thereby cease distribution of the free lipstick even if a customer returns six empty make-up containers. Therefore, the promotional lipstick is a gift of tangible personal property to the customer. Since a gift of tangible personal property is not a sale, [M---] did not purchase the promotional lipstick for resale. [M---] must report and pay use tax, measured by the cost of the promotional lipstick, on line 2 of the sales and use tax return. No deduction is allowable. The facts that you present do not fall within Regulation 1670(c). If [M---] provided the promotional lipstick upon the purchase of six make-up items, the lipstick would be considered a premium sold along with the others. Tax would apply to the gross receipts from that sale of seven make-up items for the price of six. However, our understanding is that the purchaser has no contract right to the free lipstick. The free lipstick is not a premium. No deduction is allowable, and [M---] owes use tax on the cost of the lipstick. Indeed, even if the free lipstick was considered a premium, there is no deduction. The transaction would be regarded as the sale of the lipstick (i.e. the premium) along with the six make-up items. [M---] would owe sales tax on its gross receipts from that sale, with no deduction.

Mr. R--- M. L---

-3-

October 25, 1996
280.0767

We note that in 1994 [M---] claimed a deduction on line 10(e) for “service & consciousness (Donation to charitable org.),” which was explained in a June 7, 1994 letter from
[M---]’s Controller, M--- L---, as “Services and Sale of Gift Certificates” and “Sale of --- --Lipstick.” [M---] apparently believes that these transactions are entirely exempt from tax. The sale of the gift certificates itself is not subject to tax; however, when the gift certificate is redeemed, the value of the gift certificates and any other consideration provided is subject to tax. (See BTLG Annot. 280.0350 (12/19/78).) Thus, if [M---] had sold a $20 gift certificate in the first quarter 1996 and it were redeemed in the second quarter 1996, [M---] would be required to report the $20 on line 1 of its second quarter return and report tax on that $20. You also claimed an exemption from gross receipts for the sale of “--- --- Lipstick,” the proceeds from the sales of which were donated to [M---] --- Foundation. There is no exemption for these sales simply because the proceeds are donated. (Cf. Rev. & Tax. Code § 6403; BTLG Annot. 165.0005 (9/9/93).) Rather, you must report the proceeds on line 1 of your return and report tax on such amounts. This opinion is specifically based on the facts stated in your undated letter, [M---]’s March 12, 1996 letter, and the assumptions made above. If our assumptions are incorrect and you wish an opinion applicable to the actual facts of the transaction, please write and describe with specificity the nature of the promotion, and the manner of [M---]’s sales and use tax reporting. Very truly yours,

Charlotte Chyr
Tax Counsel
CC:cl
cc:

Out-of-State District Administrator
Mr. Chuck Harris -- Return Analysis (MIC: 35)