Canada: Credit Card Rewards Program Expenses: Tax Court Of Canada Doesn't Buy $13.97 Million GST/HST Input Tax Credit Claim

On June 27, 2023, the Tax Court of Canada ("TCC") dismissed the appeal of a Schedule II bank (the "Bank") regarding its entitlement to input tax credits ("ITCs") for GST/HST payable on expenses incurred in connection with the operation of a membership rewards program ("MRP") that the Bank offered to certain credit cardholders ("MRP Cardholders").

• The TCC concluded that all of the elements or components of the MRP are integrated and intertwined components of a composite supply of exempt financial services made by the Bank to the MRP Cardholders and therefore had to be considered components of a single composite supply.
• The TCC also determined that the predominant element of this single composite supply was a financial service (namely the extension of credit by the Bank to the MRP Cardholders), which, under the applicable doctrine, entailed that the single composite supply took on the exempt nature of that predominant element.

BACKGROUND

Between 2002 and 2012, the Bank issued charge cards and credit cards (collectively, "Cards") to members of the public ("Cardholders"). It also operated the MRP, a loyalty program made available only to its Cardholders. Subscription to the MRP would be automatic and free for some Cards, while being optional and subject to an additional fee (the "Enrollment Fee") for other Cards. A Cardholder enrolled in the MRP (i.e, an MRP Cardholder) was credited with a specific number of points (the "") for each dollar charged to a Card for the purchase of goods or services. Upon accumulating a certain number of Points, an MRP Cardholder was entitled to claim a reward (the "Reward").

In the course of operating the MRP, the Bank collected GST/HST on:

• the MRP membership fee charged to Cardholders of certain Cards; and on
• the MRP accelerator fee charged to an MRP Cardholder in order to earn a higher ratio of Points per dollar charged to a Card.

In light of this, the Bank claimed ITCs with respect to the GST/HST it paid on expenses incurred with respect to the operation of the MRP. It took the view that such expenses were incurred in the course of making taxable supplies, which were separate and distinct from the other exempt supplies made by the Bank to its Cardholders.

The tax authorities disagreed with the Bank's position, taking the position that the Bank made a single composite supply to the MRP Cardholders and that the predominant element of such composite supply was an exempt financial service. The Bank's ITC claims were accordingly disallowed and it was reassessed on this basis.

ANALYSIS

Pursuant to subsection 169(1) of the Excise Tax Act ("ETA"), a GST/HST registrant may generally only claim ITCs with respect to taxable expenses incurred for consumption, use or supply in the course of its commercial activities, which excludes the making of exempt supplies. As a result, a GST/HST registrant generally cannot claim ITCs to recover GST/HST payable with respect to property and services acquired for the purpose of making exempt supplies, such as exempt financial services.

The parties' positions

The Bank argued that, although it did provide some exempt financial supplies to its Cardholders, supplies made through its MRP operations should be considered separate and distinct supplies. According to the Bank, the supply of the MRP to its Cardholders was a commercial activity, thereby entitling it to claim ITCs in respect of expenses incurred to operate the MRP.

To the contrary, the Minister of National Revenue (the "Minister") argued that these expenses constituted a single composite supply of which the predominant element was an exempt financial service. Therefore, the MRP's exempt nature should make the Bank ineligible to claim ITCs in respect of related expenses.

The composite supply test

For purposes of determining whether the Bank was entitled to ITCs for expenses incurred in connection with the operation of the MRP, Justice Hogan first examined the different elements of the Bank's supplies to its MRP Cardholders. Justice Hogan summarized the test as follows:

"[I]f an alleged separate supply is, in substance or reality, an integral part, integrant or component of the overall supply, then that alleged separate supply will be considered a part of the overall supply as a single composite supply. This requires observing the degree that the elements or components are interconnected, and the extent of their interdependence and intertwining." (para. 32)¹

In applying the composite supply test, Justice Hogan concluded that the MRP was inherently intertwined and connected with the Bank's exempt supplies (para. 59). In support of this determination, Justice Hogan highlighted that while not all the Cardholders were MRP members, such members were necessarily Cardholders (para. 40). Likewise, Points awarded under the MRP were for the sole benefit and use of Cardholders (paras. 41-42).

Justice Hogan also considered the important fact that the Points were calculated and credited to an MRP Cardholder's account based on the amount charged to their Card (para. 43). In other words, enrollment in the MRP offered no benefits in and of itself, except to the extent that the Bank was already offering financial services to the Cardholders (para. 59).

Justice Hogan also focused on the significant merchant revenue that the Bank derived from the use of Cards by its Cardholders (para. 44). As the Bank's vice president recognized during the hearing, the MRP was purposely structured to incentivize Cardholders to use their Cards (para. 48). The more a Cardholder would use their Card to pay for goods and services supplied by a merchant, the more revenues the Bank would earn (paras. 44-45 and 59).

The connection between the Bank's financial supply of the Cards and the MRP was exemplified not only through an MRP Cardholder's purchase of goods but also through the mechanism put in place to revise an accumulation of Points upon the return of purchased goods by an MRP Cardholder (para. 47).

As further evidence of the link between the Bank's supply of credit and the MRP, the Bank's Point liability was dependent on how much an MRP Cardholder had spent on their Card. Therefore, expenses incurred to provide Rewards to MRP Cardholders (as part of the MRP) were not only incurred in connection with the MRP, but also as a tool to increase the use of Cards by MRP Cardholders (paras. 50-51).

Furthermore, an MRP Cardholder had to be in good standing (i.e., payments on Cards were made on or before the payment-due date) in order to redeem Points (paras. 52 and 59). The Bank's vice president even acknowledged that the purpose of this feature was to help reduce the Bank's exposure to credit default risk, which further evidenced the link between the MRP and the Bank's Card services (para. 52).

Finally, the Bank's revenue from MRP fees which were subject to GST/HST represented less than 0.4% of the Bank's total revenue (para. 59).

In light of the foregoing, Justice Hogan concluded that:

"...all of the elements or components of the MRP [were] integrated and intertwined components of a composite supply of exempt financial services made by the Bank to MRP Cardholders" (para. 60).

Determination of the predominant element

Having determined that the components of the MRP were integrated and intertwined components of a composite supply, Justice Hogan then analyzed the components with the view of identifying the predominant element (para. 65). In making this determination, Justice Hogan considered the perspective of the MRP Cardholders, as recipients of the supply (para. 66).

Justice Hogan concluded that the predominant element of the Bank's single composite supply was the extension of credit by the Bank to an MRP Cardholder, as was made "obvious" by the fact that the value of the Points accumulated by any MRP Cardholder represented a small fraction of the amount of credit extended to them (paras. 68-69). It followed necessarily from this that the predominant element of the Bank's single composite supply was an exempt financial service (para. 76).

Free supplies of rewards

Alternatively, the Bank also submitted that:

• the "free supply rule" provided for in subsection 141.01(4) of the ETA applied so as to characterize the supply of Rewards as a taxable supply; and that
• it was therefore entitled to ITCs in respect of the MRP expenses (para. 80).

Section 141.01 of the ETA is an apportionment rule designed to determine the use of inputs, based on the extent to which the inputs are used or consumed, or acquired or imported for consumption or use, for the purpose of making taxable and non-taxable supplies.

More specifically, the effect of subsection 141.01(4) is that entitlement to ITCs in respect of property or services acquired with the intention of being provided as a free supply or being used directly or indirectly as inputs to a free supply depends on the extent to which the free supply is made to promote or facilitate the making of other taxable supplies by the supplier.

The Bank argued that the supply of Rewards to MRP Cardholders was made for no consideration and therefore, it satisfied the free supply pre-condition set out in subsection 141.01(4) (para. 81). Justice Hogan rejected this argument on the basis that the Bank did in fact provide consideration for the Rewards (i.e., the satisfaction of a redemption liability that was extinguished on completion of the transaction) (para. 82). Even if he were to be found in error on that point, Justice Hogan stated, the pre-condition set out in paragraph 141.01(4)(b) did not apply as he did not share the Bank's view that the purpose of the free supply was to promote the activities of the suppliers of Rewards (paras. 86-89).

Finally, even if his determinations on both pre-condition tests were incorrect, Justice Hogan stated, he would still conclude that the Bank was not entitled to claim ITCs in respect of the MRP expenses because of the language used in paragraph 141.01(4)(c) of the ETA. According to him, the words "to the extent of" used in such paragraph require that an allocation be made. In this respect, there was no evidence of how the Bank allocated the MRP expenses between: (i) the purpose of promoting the Rewards suppliers' activities (such purpose having been denied by Justice Hogan in any event), and (ii) the significant and overwhelming purpose of the composite supply of a financial service (para. 90).

In view of the fact that the Bank had not discharged its burden of establishing that all of the pre-conditions of subsection 141.01(4) were met, Justice Hogan did not allow the ITCs on this basis (para. 91).

Final observations

One could argue that Justice Hogan likely stated this obvious in his final observations, where he mentioned that the Bank's position in this matter was "akin to the task of swimming against a significant riptide" (para. 92). Essentially, Justice Hogan pointed out that if he would allow the Bank's ITCs with respect to the MRP expenses, his decision would contradict several court rulings involving financial institutions who tried to promote their respective credit card businesses through loyalty programs, including his own recent decision issued in 2022 President's Choice Bank v The Queen, 2022 TCC 84 (currently under appeal).

Considering all of the foregoing reasons, the Bank's appeal was dismissed (para. 96).

KEY TAKEAWAYS

• Subject to further appeal, this decision confirms the current unambiguous jurisprudential trend: if a financial institution incurs expenses in connection with a loyalty program used in the carrying out of a financial services business, such as a credit card business, no ITCs can be claimed by the financial institution for any GST/HST payable on such expenses (para. 93).
• While recent case law² has strayed from the previously uncontested test formulated in the seminal case A. Brown Ltd. v. Canada, [1995] G.S.T.C. 40 (T.C.C.), later endorsed by the Supreme Court of Canada in Calgary (City) v. Canada, 2012 SCC 20, this decision confirms the continued relevance of this test to the determination of whether there are single or multiple supplies (paras. 32 and 34).
• Financial institutions should be wary of ITCs claimed in respect of inputs incurred in the operation of loyalty programs, where they are offered as a complement to an underlying financial services business (such as the extension of credit). Where both services are intricately linked, such services are likely to be considered a single composite supply whose predominant element is the supply of an exempt financial service.

The authors would like to thank Oriane Roy, articling student, for her collaboration.

Footnotes

1. All references in this section come from the decision of the TCC (Amex Bank of Canada v. The King, 2023 TCC 93).

2. See Canada v. Dr. Kevin L. Davis Dentistry Professional Corporation, 2023 FCA 76 (Federal Court of Appeal). An application for leave to appeal was filed with the Supreme Court of Canada on June 14, 2023.

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